How to Fairly Mark Up Products

Consider what the market will bear when determining your desired markup.

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The difference between the actual cost and the selling price of products and services is the basic definition of markup. Markup must be carefully monitored by businesses to ensure it meets its financial responsibilities, appropriately manages its operations and hopefully, turn a profit. Whether the difference between the two figures is a few percentage points or a wide gulf, from this gap is where businesses derive most of their incomes and pay salaries and taxes. However, the gap can’t be so big as to price a product out of the market. There are competitors to think about, and depending on your business, potentially shareholders and investors to consider.

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Realize there are several variables at play when determining a markup percentage. Respect that your desired markup must balance the costs of producing or acquiring your product as well as what the market will bear. Some industries, like construction, contracting and auto dealing, have special “fair and reasonable markup,” or FaRM pricing policies. Generally, they require a business to set markup at the lowest level to get a required rate of return. For example, the federal government sets a profit percentage cap on many of its contractors. This can set a high bar beyond which your pricing can’t exceed to be competitive and a minimum price you can’t get below before acceptable quality will likely be breached.

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Calculate your operating costs. Ensure your markup covers the cost of doing business and provide some margin for profit. For example, a portion of your markup must cover your rent, labor, marketing and advertising and other fixed costs of operating. Keep in mind that the portion you set aside for profit will affect your break-even calculation. In other words, the more profit you build into your markup, the more volume of sales you’ll have to achieve to be on sure ground financially.

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Understand that markup is not profit. Not knowing the difference can cause endless confusion when trying to honestly represent your company’s financial health to others. Markup is a percentage over the total cost of a product or service. Your total profit margin is based on the selling price of your product or service.

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Decide whether you want an across-the-board markup on all products or whether different products should have different kinds of markup. If you run a warehouse-type retail outlet, you may be able to serve your customers at a lower cost than a boutique and can offer one markup percentage on all your products. For example, you’ll have less d├ęcor, limited selection and little service. Your profit is earned by a high volume of discount-seeking customers. Costco runs this model, and has limited all markups to 14 percent. By contrast, if you run a shop that sells convenience, specialty or luxury goods, know that both can bear a greater markup. Restaurants, by contrast, have a mix of markups for entrees, dessert and wine selections.

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Segment your customers if you have more than one location. Use nearby customers’ price sensitivity to inform your markup strategy. If you are a dentist, gas station owner, optician or any multilocation business owner with offices in a downtown business district as well as in the outskirts and suburbs, your clientele at each location can expect different markup and prices on goods and services. Be sensitive to nearby competitors, however. Keep your markup lower where competition is more intense.

Tips & Warnings

Consider whether time is a factor in your markup formula. Movie theaters, bowling alleys and other recreational business providers, for example, mark up the same service for people who want to partake of them later in the day or on the weekend. Public transportation providers mark up more during rush hour.

The cost of doing business has many nickels and dimes. When figuring your markup percentage, don’t neglect details like: credit and debit card processing fees, the cost of transporting your goods to market, insurance and discounts you may offer to certain segments of your clientele.

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ReferencesUniversity of Tennessee Agricultural Extension Service: Selling Price, Gross Margin & Mark-Up DeterminationSmallBizU: Pricing Strategy and TacticsJournal of Construction Engineering and Management : Fair and Reasonable Markup (FaRM) Pricing ModelResourcesEntrepreneur: 7 Biggest Mistakes in Setting PricesMSNBC: 'Gross Profit Margin' vs. 'Markup'New York Times: How Costco Became the Anti-Wal-MartPhoto Credit Comstock/Comstock/Getty ImagesRead Next:

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