Profit margins, or markups, are sometimes calculated as a percentage of price instead of cost. Markup on price is the profit margin for an individual product or product line expressed as a percentage of price, rather than unit cost as in the markup-on-cost formula. This alternative means of expressing profit margins can be illustrated by the markup-on-price formula:
Markup on Price =
Price - Cost Price
Profit margin is the numerator of the markup-on-price formula, as in the markup-on-cost formula. However, unit cost has been replaced by price in the denominator.
The markup-on-cost and markup-on-price formulas are simply alternative means for expressing the relative size of profit margins. To convert from one markup formula to the other, just use the following expressions:
Markup on Price
r 1 - Markup on Price
Markup on Cost
+ Markup on Cost
Therefore, the 30 percent markup on cost described in the previous example is equivalent to a 23 percent markup on price:
Markup on Price = 1
An item with a cost of $2.30, a 69tf markup, and a price of $2.99 has a 30 percent markup on cost and a 23 percent markup on price. This illustrates the importance of being consistent in the choice of a cost or price basis when comparing markups among products or sellers.
Markup pricing is sometimes criticized as a naive pricing method based solely on cost con-siderations—and the wrong costs at that. Some who employ the technique may ignore demand conditions, emphasize fully allocated accounting costs rather than marginal costs, and arrive at suboptimal price decisions. However, a categorical rejection of such a popular and successful pricing practice is clearly wrong. Although inappropriate use of markup pricing formulas will lead to suboptimal managerial decisions, successful firms typically employ the method in a way that is consistent with profit maximization. Markup pricing can be viewed as an efficient rule-of-thumb approach to setting optimal prices.
Period of full capacity usage off-peak
Period of excess capacity
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