Markup: what is it, how to calculate it and what is it for?

Markup: what is it and how to calculate it?
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O markup, or mark up, is an economic index applied on the production cost e distribution of a product or service for set the selling price. The markup is calculated on the basis of fixed unit costs, variable costs and expected profit margin.

See in this article:

See also: All about pricing

What is pricing?

Define the sales value of a product or service is among the most important and strategic activities of a company.

Many managers believe that pricing is a strictly mathematical act. Just calculate the company's costs, set an extra margin and you're done.

However, the price is one of the 4 Marketing Pillars more important. It will say a lot about the public-bowel and the positioning from the company.

Therefore, it is very important that a manager master the techniques and concepts of pricing. Markup is one such concept.

Markup: what is it, how to calculate it and what is it for?

What is mark up?

The markup can be observed in two optics. As an economic index, in which it is used to compare industry profitability:

The average markup of the financial services industry is high, it is worth investing

However, the most used optics is that of the company itself, in which it observes index that multiplies the cost of production and distribution to reach the final sale price.

Difference between Markup and Profit Margin

Many managers confuse the concept of markup with profit margin of a product or service. As its name implies, a margin usually refers to a percentage of a value.

If a product has sales price R $ 100 and total unit cost R $ 50, its unit profit margin is 50%.

Already markup is espresso through a multiplier which, when referring to the total unit cost, is the final sale price. In this case, the markup would be 2, because when multiplied by 50, the selling price is R $ 100.

In addition, the desired unit profit margin is part of the mark up calculation, as we will see below.

Difference between markup and contribution margin

We can also notice conceptual differences mark up em relação a contribution margin. Markup is a multiplier that encompasses variable expenses, fixed unit costs e desired profit margin.

A contribution margin is the sales price subtracted from the variable costs (direct) of the product or service. That is, the portion of the product that is left over to pay the fixed costs the company and withdraw the entrepreneur's profit.

The contribution margin is widely used to reach the breakeven from the company.

How to calculate the markup?

The calculation of the markup is quite simple. To do this calculation, we will use the following company indexes:

DV - Percentage of Variable Expenses - are the variable expenses that directly affect the sale, such as commission, tax on revenue and freight, case embedded in the price. They should be expressed in terms of percentage.

DF - Percentage of Fixed Unit Expenses - It is the company's fixed expenses that one unit of the product must “pay”. Administrative costs, salaries, commercial expenses, water bills, electricity, internet and telephone, etc. They should also be expressed in percentage terms.

ML - Wanted Profit Margin - percentage that the entrepreneur wishes to have in his business profit margin.

The mark up formula follows below:

Mark up = 100 / [100 - (DV + DF + ML)]

The easiest way to achieve DV and DF indices in a generic way is to analyze the Simplified or Managerial DRE from the company. I'll show an example below:

  • Operating Revenue = R $ 100.000
  • Direct Costs = R $ 40.000
  • Variable Expenses = R $ 20.000
  • Fixed Expenses = R $ 30.000
  • Profit = R $ 10.000

Analyzing the table above, we can see that:

  • DV = 20.000 / 100.000 = 20%
  • DF = 30.000 / 100.000 = 30%
  • ML = 10% - if the entrepreneur wishes to maintain the profit obtained
  • Mark up = 100 / [100 - (20 + 30 + 10)] = 100 / (100 - 60) = 100 / 40 = 2,5

There are many companies that prefer to do more in-depth study by product to know a “fairer” mark up. In this case she would need to follow the steps below:

  1. Consider only the revenue of the product in question in question
  2. Separate the variable expenses that affect it
  3. Make a apportionment of fixed costs, to analyze how much this particular product should pay.

Why know the markup?

The first positive markup point is simplify company pricing. Let's take the previous example, in which the company got a markup of 2,5. Let's say it's a reseller and buy a certain product for R $ 50. Your selling price should be:

  • PV = 2,5 x 50 = $ 125

Let's do the reverse logic to see if the entrepreneur will have the desired profit margin:

  • Profit = 125 - DV - DF - 50 = 125 - 0,2 x 125 - 0,3 x 125 - 50 = 125 - 25 - 37,5 - 50 = $ 12,50
  • Profit Margin (ML) = 12,50 / 125 = 10%

It was exactly the margin he wanted to have before calculating the markup.

The second reason to know markup is benchmarking with other companies in the same industry. The larger the mark up of a company, the more it can charge on top of its value of production or purchase of products. That is, more will be left to expand its administrative structure or distribute profits, making it more competitive.

Practical example of markup calculation

Let's go back to the previous example:

  • Operating Revenue = R $ 100.000
  • Direct Costs = R $ 40.000
  • Variable Expenses = R $ 20.000
  • Fixed Expenses = R $ 30.000
  • Profit = R $ 10.000

Let us now say that the company in question wants to do a more in-depth study of its structure. One of its products generates a good operating income, but uses more of the company structure, and it wants it to also generate a profit margin of 10%.

For this, the entrepreneur apportionment of costs, and tried to separate the statement from that product. Let's say he found the results below:

  • Operating Revenue = R $ 20.000
  • Direct Costs = $ 8.000 (40%)
  • Variable Expenses = R $ 4.000 (20%)
  • Fixed Expenses = $ 8.000 (40%) - Cost Allocation Result
  • Profit = R $ 0

Through the calculation of markup, he finds:

Markup = 100 / [100 - (20 + 40 + 0)] = 100 / (100 - 60) = 100 / 40 = 2,5

Suppose he sold 100 units of this product to obtain the Operating income of 20.000. That is, the units were sold for R $ 200 and had a unit profit margin of zero.

With this, he finds that this product is not being profitable for the company because it consumes most of the fixed expenses. It is currently being “banked” for products that have a higher mark up due to the lower fixed cost percentage.

He decides to make the markup calculation specific to this product in a way that allows it to have its expected profit margin of 10%:

Markup = 100 / [100 - (20 + 40 + 10)] = 100 / (100 - 70) = 100 / 30 = 3,33.

Remaining Pricing:

  • Unit Cost of Purchase - 8.000 / 100 = $ 80.
  • Selling Price - PV = 80 x 3,33 = $ 266,40.

In an ideal scenario, making the same 100 units sold, we would have:

  • Operating Revenue - R $ 26.640
  • Direct Costs = R $ 8.000
  • Variable Expenses = 20% of 26.640 = R $ 5.328
  • Fixed Expenses = 40% of 26.640 = R $ 10.656
  • Profit = R $ 2.656, approximately 10%

If you liked this article, and need to better control your mark up, check out our spreadsheets for pricing!

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