11.10 Markup
Markup
As you wait in line to purchase your Iced Caramel Macchiato at Starbucks, you look at the pricing menu and think that $4.99 seems like an awful lot of money for a frozen coffee beverage. Clearly, the coffee itself doesn’t cost anywhere near that much. But then gazing around the café, you notice the carefully applied colour scheme, the comfortable seating, the high-end machinery behind the counter, and a seemingly well-trained barista who answers customer questions knowledgeably. Where did the money to pay for all of this come from? You smile as you realize your $4.99 pays not just for the macchiato, but for everything else that comes with it.
The process of taking a product’s cost and increasing it by some amount to arrive at a selling price is called markup. This process is critical to business success because every business must ensure that it does not lose money when it makes a sale. From the consumer perspective, the concept of markup helps you make sense of the prices that businesses charge for their products or services. This in turn helps you to judge how reasonable some prices are (and hopefully to find better deals).
The Components in a Selling Price
Before you learn to calculate markup, you first have to understand the various components of a selling price. Then, in the next section, markup and its various methods of calculation will become much clearer.
When your business acquires merchandise for resale, this is a monetary outlay representing a cost. When you then resell the product, the price you charge must recover more than just the product cost. You must also recover all the selling and operating expenses associated with the product. Ultimately, you also need to make some money, or profit, as a result of the whole process.
Most people think that marking up a product must be a fairly complex process. It is not. Formula 1.5 illustrates the relationship between the three components of cost, expenses, and profits in calculating the selling price.
Formula 1.5 – The Selling Price of a Product
S is Selling Price: Once you calculate what the business paid for the product (cost), the bills it needs to cover (expenses), and how much money it needs to earn (profit), you arrive at a selling price by summing the three components.
C is Cost: The cost is the amount of money that the business must pay to purchase or manufacture the product. If manufactured, the cost represents all costs incurred to make the product. If purchased, this number results from applying an appropriate discount formula. There is a list price from which the business will deduct discounts to arrive at the net price. The net price paid for the product equals the cost of the product. If a business purchases or manufactures a product for $10 then it must sell the product for at least $10. Otherwise, it fails to recover what was paid to acquire or make the product in the first place—a path to sheer disaster!
E is Expenses: Expenses are the financial outlays