Markup pricing refers to the difference between the cost to produce and market an item for sale, and the retail price that is charged for that item. Typically, the markup is expressed as a fixed percentage, and is determined by applying that percentage to the actual cost of the item. There are many reasons for markups, with the desire to make an equitable amount of profit on each item sold one of the main considerations.
When determining the market pricing, it is important to know exactly how much it costs to produce each unit of an item that is manufactured for sale to consumers. In order to determine this figure, it is necessary to take into consideration the cost of raw materials, the production process itself, administrative and clerical support, packaging, and shipping costs. This total cost serves as the benchmark of how much money the business must earn on each item in order to break even.
After identifying the total cost of the item, the next step in calculating markup pricing is to get an idea of the industry standard for markup. Often, this standard is determined by factors such as the demand for the items, the number of companies that already produce similar items, and the opportunity to gather market share. For example, if the standard markup in the industry is 20% above cost, the company is likely to consider this figure as the starting place for determining the retail price.
To arrive at both the retail price and the true markup pricing, that industry percentage is converted into a decimal and subtracting that figure from 1. For example, if the standard markup in the industry is 20%, this is converted to 0.20, and subtracted from one to yield an answer of 0.80. By dividing the actual cost of the item by 0.80, it is possible to determine what retail price should be set. At the same time, the difference between the retail price and the actual cost, as expressed in currency rather than percentages, is revealed.
There is the possibility that the retail price that results will be lower than the price used by competitors, if the business is able to produce the item for less money. When this is the case, the company may choose to retain the markup pricing that is based on industry standards, or seek to earn a slightly higher profit by adjusting the markup pricing by a few percentage points. By employing the basic markup pricing formula, the company can set the retail price at a level that will attract consumers while still allowing the business to earn a decent profit on each unit sold.