What is Markup?
Markup refers to the difference between the selling price of a good or service and its cost. It is expressed as a percentage above the cost. In other words, it is the added price over the total cost of the good or service that provides the seller with a profit.
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Markup Percentage Formula
Below is the formula:
Therefore, the formula can be expressed as:
For example, if a product costs $10 and the selling price is $15, the markup percentage would be ($15 – $10) / $10 = 0.50 x 100 = 50%.
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John is the owner of a company that specializes in the manufacturing of office computers and printers. He recently received a large order from a company for 30 computers and 5 printers. In addition, the company tasked John with installing software into each of the computers.
The cost per computer is $500 and the cost per printer is $100. The cost of installing the software to run on all the computers is $2,000. If John wants to earn a 20% profit for the order, what would be the price charged by John?
Step 1: Calculate the total cost of the order (computers + printers + installation of software). $500 x 30 + $100 x 5 + $2,000 = $17,500 (total cost).
Step 2: Determine the selling price by using the desired percentage of 20%. 20% = (Selling Price – $17,500) / $17,500 therefore Selling price must be: $21,000 (selling price).
Therefore, for John to achieve the desired markup percentage of 20%, John would need to charge the company $21,000.
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The Importance of Understanding Markup
Understanding markup is very important for a business. For example, establishing a pricing strategy is one of the most important parts of strategic pricing. The markup of a good or service must be enough to offset all business expenses and generate a profit.
The Difference Between Markup and Gross Margin
A lot of people use the terms markup and gross margin interchangeably. Although both terms are used to help determine profitability, they are different!
Markup is the percentage difference between a product’s cost and its selling price. For example, if a product sells for $125 and costs $100, the additional price increase is ($125 – $100) / $100) x 100 = 25%.
Gross margin is the percentage difference between a product’s selling price and the profit. For example, if a product sells for $125 and costs $100, the gross margin is ($125 – $100) / $125 = 0.2(20%) = 20%.
Recall the example above. The gross margin would be ($21,000 – $17,500) / $21,000 = 0.1667 = 16.67%. While the markup was 20%
Intuitively, the markup is always larger as compared to the gross margin, as shown in the table below. (As long as you charge more than what the product costs.)
Markups in Different Industries
Markup percentage varies greatly depending on the industry. In some industries, the increase is a tiny percentage (5%-10%) of the total cost of the product or service, while other industries are able to mark up their products or services extraordinarily high. Therefore, there is no “normal” markup percentage, although there may be an average for a particular industry. Learn more about industry analysis in CFI’s Financial Analyst Training Program.
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