Posted in Marketing and Strategy Terms, Total Reads: 2154
Definition: Markup Pricing
Markup pricing or cost-plus pricing is a pricing strategy where the price of a product or service is calculated by adding together the cost of the products and a percentage of it as a markup. The percentage or markup is decided by the company usually fixed at the required rate of return. Such a strategy is in contrast with fixed-pricing strategy which is used when cost estimates can be made with reasonable accuracy.
It is most often used in public utility pricing, product tailoring like designing jewellery, and in government contracts, which has received criticism for encouraging wasteful expenses.
In order to determine the cost on which you plan on marking up, the fixed cost and the variable cost are determined for an assumed quantity and a portion is added depending on the planned rate of return. When calculated at a good level the price equation is as follows:
P = AVC + AFC + X/Q
AVC is the average variable cost
AFC is the average fixed cost
X/Q is the markup per unit
● Enables vendors to easily calculate profits.
● Requires little information as information on demand and costs might not always be available.
● Provides the means by which fair prices can be easily found.
● Prices based on full cost are more morally defensible and allow for revision of final prices based on changes in price of raw materials etc.
● Reduces the cost of decision-making.
● Provides incentive for inefficiency
● Includes sunk costs rather than just using incremental costs