Setting Price

Cost Pricing

Under cost pricing the marketer primarily looks at production costs as the key factor in determining the initial price.  This method offers the advantage of being easy to implement as long as costs are known.  But one major disadvantage is that it does not take into consideration the target market’s demand for the product.  This could present major problems if the product is operating in a highly competitive market where competitors frequently alter their prices.

There are several types of cost pricing including:

Markup Pricing

This pricing method, often utilized by resellers who acquire products from suppliers, uses a percentage increase on top of product cost to arrive at an initial price. A major general retailer, such as Walmart, may apply a set percentage for each product category (e.g., women’s clothing, automotive, garden supplies, etc.) making the pricing consistent for all like-products. Alternatively, the predetermined percentage may be a number that is identified with the marketing objectives (e.g., required 20% ROI).

For resellers that purchase thousands of products (e.g., retailers) the simplicity inherent in markup pricing makes it a more attractive pricing option than more time-consuming methods. However, the advantage of ease of use is sometimes offset by the disadvantage that products may not always be optimally priced resulting in products that are priced too high or too low given the demand for the product.

Resellers differ in how they use markup pricing with some using the Markup-on-Cost method and others using the Markup-on-Selling-Price method. We will demonstrate each using an item that costs a reseller (US) $50 to purchase from a supplier and sells to customers for (US) $65.

• Markup-on-Cost – Using this method, markup is reflected as a percentage by which initial price is set above product cost as reflected in this formula:
  
                                  Markup Amount = Markup Percentage
                                      Item Cost
  
                                       $15 = 30%
                                       $50
  
  The calculation for setting initial price is determined by simply multiplying the cost of each item by a predetermined percentage then adding the result to the cost:
  
                    Item Cost + (Item Cost x Markup Percentage) = Price
  
                             $50 + (50 x .30 = $15) = $65
  
   
• Markup-on-Selling-Price – Many resellers, and in particular retailers, discuss their markup not in terms of Markup-on-Cost but as a reflection of price. That is, the markup is viewed as a percentage of the selling price and not as a percentage of cost as it is with the Markup-on-Cost method. For example, using the same information as was used in the Markup-on-Cost, the Markup-on-Selling-Price is reflected in this formula:
  
                             Markup Amount = Markup Percentage
                                 Selling Price
  
                                    $15 = 23%
                                    $65
  
  The calculation for setting initial price using Markup-on-Selling-Price is:
  
                                   Item Cost                 = Price
                      (1.00 – Markup Percentage)
  
                                   $50         = $65
                              (1.00 – .23)

So why do some use Markup-on-Cost while others use Markup-on-Selling-Price? One answer is that it is a traditional way for resellers in certain industries to discuss how they arrive at price (e.g., “We only make 5% of the price of the product.”). But many feel the reason is that Markup-on-Selling-Price serves as an aid to company promotion because the amount of money a reseller makes is in percentage terms always lower when calculated using Markup-on-Selling-Price than it is with Markup-on-Cost. For example, in the Markup-on-Cost example where the markup is 30% the gross profit is $15 ($65-$50). If the reseller using Markup-on-Selling-Price received a gross profit of $15 their markup would only be 23% ($50/[1.00-.23] = $65). Consequently, a retailer’s advertisement may say: “We Make Little, But Our Customers Save A Lot” and back this up by saying they only make a small percentage on each sale. When in reality how much they really make in monetary terms may be equal to another retailer who uses Markup-on-Cost and reports a higher markup percentage.