When an entrepreneur is starting up his new business, the most important financial aspect is setting a product price that can cover the costs of production, as well as bring in a decent profit. Markup is the tool that helps in calculating that price.
Markup is the price added by the manufacturer or producer to the original cost of a good or a service to create a profit. A product that costs $25 to produce, and is sold at $35 has a markup of $10. Every person in the distribution chain, including the producers, wholesalers and retailers place their own markup price.
Markup is one of the most important factors in pricing strategy used by business startups and entrepreneurs. It is very important to keep a balance between the production expenses as well as profits. Adjusting markup price involves a thorough understanding of operating costs (fixed costs related to running of the company) as well as variable costs (that pertain to the production of goods). Prices of raw materials as well as manufacturing costs in the industry should be researched before making an educated guess for markup price.
Markup price can be calculated as:
(Sales Price – Production Cost) / Production Cost = Markup percentage
It is not wise to add a straight markup percentage to all the products of a company, rather it should be done while considering the sale frequency of each product. Startups should attach a lower markup price to products with high turnover rates. This indeed has been helpful in gaining more profits than adding higher markups.
Markup price varies from industry to industry as well. Some industries attach a markup price of 25% to their products like small appliances, while some can add a 100% like clothing. Apart from that, markup prices can vary within the same industry as well, like automobiles, 5% is usually added to new cars, whereas sports cars can fetch a much higher markup than that. Some industries set up very high percentage on top of the production cost, for instance fashion industry. A designer line purse will have a very high cost, in some cases this is done to align with industry trends.
It can be said that markup price is an important factor that should not be blindly predicted. A wisely set markup helps retain a continuous flow of profit and give an upper hand against the competitors. With more experience in the industry and knowledge of industry trends can help in easily setting up markup price for the coming years.