Markup is the amount that a seller of goods or services charges over and above the total cost of delivering its product or service in order to make a desired profit. For example, if the total cost of a manufacturer's product is $20, but its selling price is $29, then the extra $9 is understood to be the "markup." Markup is utilized by wholesalers, retailers, and manufacturers alike.
For entrepreneurs in the process of starting a business, establishing markup is one of the most important parts of pricing strategy. Markups must be sizable enough to cover all anticipated business expenses and reductions (markdowns, stock shortages, employee and customer discounts) and still provide the business with a good profit. The informed small business owner, then, is far more likely to arrive at a good markup price than the business owner who has a flawed understanding of the company's likely sales, its total operating expenses—including material, labor, and overhead costs—and its place in larger economic trends.
Entrepreneurs should also recognize that a flat markup percentage should not be blindly stamped on all of the company's products or services regardless of the frequency with which customers purchase those goods or services. As the Small Business Administration noted in its brochure Pricing Your Products, small business owners "should seriously consider different markup figures when some lines have very different characteristics. For instance, a clothing retailer might logically have different initial markup figures for suits, shirts, pants, and accessories. [The small business owner] may want those items with the highest turnover rates to carry the lowest initial markup."
Indeed, a small business may be able to realize a hefty profit even when it attaches a considerably smaller markup to one line of products, provided that the sales volume for that product line is high. For example, if company A and company B are selling the same $5 product, but company A insists on attaching a $4 markup on the product while company B limits itself to a $2 markup, the disparity in retail price may allow company B to register sales three or four times greater than the sales posted by company A. Company B thus realizes greater profits from the product than company A, even though the latter business had a higher markup.
MARKUPS IN SPECIFIC INDUSTRIES Markups vary enormously from industry to industry. In some industries, the markup is only a small percentage of the total cost of the product or service. Companies in other industries, however, are able to attach a far higher markup. Small appliance manufacturers can sometimes assign markups of 30 percent or more, while clothing is often marked up by as much as 100 percent. Even within industries, markups can vary widely. The automotive industry, for example, is usually limited to a 5-10 percent markup on new cars, but it realizes a far higher profit in the hugely popular sports utility vehicle market, where markups of 25 percent or more are not uncommon.
Aguirregabiria, Victor. "The Dynamics of Markups and Inventories in Retailing Firms." Review of Economic Studies. April 1999.
Berry, Leonard L., and Manjit S. Yadav. "Capture and Communicate Value in the Pricing of Services." Sloan Management Review. Summer 1996.
Pricing Your Products. Small Business Administration, n.a.
Rugledge, John. "Pricing for Growth." Forbes. October 7,1996.
Service Corps of Retired Executives (SCORE), Chapter 225. Handbook for Small Business. Small Business Administration, 1989.
Sinanoglu, Elif. "Want a Markdown? Learn the Markup." Money. February 1996.
SEE ALSO: Pricing