A pricing markup is the price difference between a product’s selling price and its cost. Essentially, a pricing markup results in profit for the company; the markup adds a certain amount to the product above what it costs to make the product. There are some key differences between a pricing markup and a profit margin, however. Here’s how to determine how much to mark up your product or service, and how this pricing strategy could work for your company.
Pricing markup vs. profit margin
Both a profit margin and a markup use revenue and cost as part of their calculations. However, these are not the same metric.
“The main difference between the two is that profit margin refers to sales minus the cost of goods sold while markup to the amount by which the cost of a good is increased in order to get to the final selling price,” explained Investopedia.
These indicators show two different aspects of a transaction. If your company sells a product for $100, and it costs $70 to create the product, your profit margin is $30 (expressed as a percentage, 30%, or margin divided by sales).
The markup in this same example is the same as gross profit, $30. However, the markup percentage is expressed as a percentage of costs, rather than a percentage of revenue. The markup percentage would be 42.9%, or ($100 in revenue – $70 in costs) / $70 costs.
How do you determine your product markup?
There’s no standard rule for how much to determine your markup. It varies by industry and is often determined by indirect costs.
“Although there is no universal ‘normal’ markup, within a given industry sector, indirect costs are relatively consistent, and where indirect costs are generally low, markups will tend to be low as well. Retail grocers, for example, typically have markups of less than 15 percent,” wrote the Small Business Chronicle. “In the restaurant industry, on the other hand, food is generally marked up about 60 percent, and some beverages may be marked up as much as 500 percent.”
As a result, determining your markup is a combination of understanding your expenses, industry best practices, and business goals.
[Read more: 3 Proven Ways to Stay Competitive Without Lowering Prices]
If your competitors all have lower profit margins and you offer a higher price that would give you a higher margin, you could lose sales.
Alka Sood, BDC Senior Business Advisor
How to calculate your markup
Pricing is a tricky business activity. Set a price too high, and customers will head to your competitors. Set a price too low, and you’re leaving potential money on the table.
Start by calculating your break-even point: the amount of sales dollars you need to generate to cover all your expenses (where your profit is equal to $0). Once you have your break-even point, you can set a markup based on the profit margin you hope to achieve. “The markup is expressed as a percentage of cost of goods sold or cost of sale,” wrote the Business Development Bank of Canada.
You’ll need to do some math to figure out how to distribute your markup on a price per unit basis. An easy way to do this is to use a markup calculator, like this one from Freshbooks.
You may find that the profit margin you originally hoped for will set your unit price too high based on market rates. “If your competitors all have lower profit margins and you offer a higher price that would give you a higher margin, you could lose sales,” said BDC Senior Business Advisor Alka Sood. “How much you can charge depends on your strategic position in the market.”
[Read more: What Businesses Must Know to Establish an Effective Pricing Strategy Today]
Revisit your pricing regularly
Adjust your markup as the market changes to stay competitive. When there’s a supply chain issue and you need to raise your markup, you should transparently communicate to customers why your prices are increasing. Most consumers have little insight into what it takes to manufacture a product, so the more information you provide the better.
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