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 markup pricing strategy is in contrast with fixed-pricing strategy which is used when cost estimates can be made with reasonable accuracy.
Markup is most often used in public utility pricing, product tailoring like designing jewelry, and in government contracts, which has received criticism for encouraging wasteful expenses. In another scenario, maintained markup is used goods don't sell and prices have to be reduced.
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In order to determine the cost on which you plan for markup pricing, 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
e.g. AVC is 50$ and AFC is 8000$ and seller wants to earn 1000$. Total sold units are 100.
The several benefits of markup pricing strategy are:
1. Enables vendors to easily calculate profits.
2. Requires little information as information on demand and costs might not always be available.
3. Markup pricing provides the means by which fair prices can be easily found.
4. 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.
5. Markup pricing reduces the cost of decision-making.
Some of the drawbacks of markup pricing are
1. Provides incentive for inefficiency
2. Markup pricing Includes sunk costs rather than just using incremental costs
Hence, this concludes the definition of Markup Pricing along with its overview.
This article has been researched & authored by the Business Concepts Team. It has been reviewed & published by the MBA Skool Team. The content on MBA Skool has been created for educational & academic purpose only.
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