Cost Plus Pricing This is the most common cost-based approach to pricing a product, in which a marketer figures all costs for the product and then adds an amount to cover profit. In some cases, any costs of doing business that are not assigned to specific products. The most frequently used type of cost-plus pricing is straight markup pricing. The price is calculated by adding a predetermined percentage to the cost. Most retailers and wholesalers use markup pricing exclusively because of its simplicity - users need only estimate the unit cost and add the markup. The first step requires that the unit cost be easy to estimate accurately and that production rates are fairly consistent. We assume that a jeans’ manufacturer has fixed costs (the cost of the factory, advertising, managers’ salaries, etc.) of $2,000,000. The variable cost for a pair of jeans (the cost of fabric, zipper, thread, and labor) is $20.00. With the current plant, the firm can produce a total of 400,000 pairs of jeans, so the fixed cost per pair is $5.00. Combining the fixed and variable costs per pair are produced at a total cost of $25.00. The total cost of producing 400,000 pairs of jeans is $10,000,000. The second step is to calculate the markup. There are two methods of calculating the markup percentage: markup on cost and markup on selling price. For markup on cost pricing, just as the name implies, a markup percentage is added to the cost to determine the firm’s selling price. (The 2 methods will be explained in the following sections) Markup on Cost For markup on cost, the calculation is as follows: Price = total cost + (total cost × markup percentage) But how does the manufacturer or reseller know which markup percentage to use? One way is to base the markup on the total income needed for profits, for shareholder dividends, and for investment in the business. For example, the total cost of producing the 400,000 pairs of jeans is $10,000,000. If the manufacturer wants a profit of $2,000,000, what markup percentage would it use? The $2,000,000 is 20 percent of the $10 million total cost, so 20 percent. To find the price, the calculations would be as follows: Price = $25.00 + ($25.00 × 0.20) = $25.0 + $5.00 = $30.00 Note that in the calculations, the markup percentage is expressed as a decimal; that is, 20% = 0.20, 25% = 0.25, 30% = 0.30, and so on. Question 5 Imagine you are the business owner who sells custom-made socks that have creative designs and colors. It costs you $3 to have a single pair of socks made by the manufacturer. You also pay $2 per pair for packaging with your logo on the box. You know you want to charge a 50% markup on each pair of socks in order to turn a profit. How much should you sell each pair of socks for? Your Answer:
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Cost Plus Pricing
This is the most common cost-based approach to pricing a product, in which a marketer figures all costs for the product and then adds an amount to cover profit. In some cases, any costs of doing business that are not assigned to specific products. The most frequently used type of cost-plus pricing is straight markup pricing. The price is calculated by adding a predetermined percentage to the cost. Most retailers and wholesalers use markup pricing exclusively because of its simplicity - users need only estimate the unit cost and add the markup.
The first step requires that the unit cost be easy to estimate accurately and that production rates are fairly consistent. We assume that a jeans’ manufacturer has fixed costs (the cost of the factory, advertising, managers’ salaries, etc.) of $2,000,000. The variable cost for a pair of jeans (the cost of fabric, zipper, thread, and labor) is $20.00. With the current plant, the firm can produce a total of 400,000 pairs of jeans, so the fixed cost per pair is $5.00. Combining the fixed and variable costs per pair are produced at a total cost of $25.00. The total cost of producing 400,000 pairs of jeans is $10,000,000.
The second step is to calculate the markup. There are two methods of calculating the markup percentage: markup on cost and markup on selling price. For markup on cost pricing, just as the name implies, a markup percentage is added to the cost to determine the firm’s selling price. (The 2 methods will be explained in the following sections)
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Markup on Cost
For markup on cost, the calculation is as follows:
Price = total cost + (total cost × markup percentage)
But how does the manufacturer or reseller know which markup percentage to use? One way is to base the markup on the total income needed for profits, for shareholder dividends, and for investment in the business. For example, the total cost of producing the 400,000 pairs of jeans is $10,000,000. If the manufacturer wants a profit of $2,000,000, what markup percentage would it use? The $2,000,000 is 20 percent of the $10 million total cost, so 20 percent. To find the price, the calculations would be as follows:
Price = $25.00 + ($25.00 × 0.20) = $25.0 + $5.00 = $30.00
Note that in the calculations, the markup percentage is expressed as a decimal; that is, 20% = 0.20, 25% = 0.25, 30% = 0.30, and so on.
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Question 5 Imagine you are the business owner who sells custom-made socks that have creative designs and colors. It costs you $3 to have a single pair of socks made by the manufacturer. You also pay $2 per pair for packaging with your logo on the box.
You know you want to charge a 50% markup on each pair of socks in order to turn a profit.
How much should you sell each pair of socks for?
Your Answer:
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Markup on Selling Price Most resellers (retailers and wholesalers), set their prices using a markup on selling price. The markup percentage is the seller’s gross margin, the difference between the cost to the wholesaler or retailer and the price needed to cover overhead items such as salaries, rent, utility bills, advertising, and profit. For example, if the wholesaler or retailer knows that it needs a margin of 40 percent to cover its overhead and reach its target profits, that margin becomes the markup on the manufacturer’s selling price. Markup on selling price is particularly useful when firms negotiate prices with different buyers because it allows them to set prices with their required margins in mind.
Let’s say a retailer buys jeans from the manufacturer for $30.00 per pair. If the retailer requires a margin of 40 percent, it would calculate the price as a 40 percent markup on selling price. The calculation would be as follows:
Therefore, the price of the jeans with the markup on selling price is $50.00.
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Question 6 Imagine you are the salesperson who is determining a price for a gourmet cupcake. The cost of each cupcake is $1.50. His firm requires a 35 percent margin, so he is using a mark-up on selling price to calculate the price. What will be the selling price of each cupcake using 35 percent mark-up on selling price?
Your Answer:
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Question 7 Assuming you are the person in-charge on pricing in a factory producing frozen hamburgers. The fixed costs are $2,000,000, variable costs are $ .75 per hamburger. You are selling your product to retailers for $1.25. You sell the hamburger in box of 24.
Question 7A How many boxes of hamburgers do you sell to break even?
Your Answer:
Question 7B How much in dollars do you sell to break even?
Your Answer:
Question 7C How many boxes of hamburgers do you sell to break even plus a profit of $300,000? Your Answer:
Question 7D Assume a retailer (local supermarket) buys your product for $ .89. His business requires all products are with a 35 percent markup on cost. Calculate his selling price?
Your Answer:
Question 7E Following on question 7D, how much must you sell in dollars to break even?
Your Answer:
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