Determining the price point to sell a product and service may seem very straightforward. The reality is somewhat different. Companies use a variety of calculations, reports, equations, and analysis to choose a price for a product.
Years ago in an interview Warren Buffet explained how price changes as small as a penny has a drastic impact on revenues. He stated that Coca-Cola (which his company owns very many shares of) sell about 1.8 billion units per day. If they could get just one more penny per unit it would equal $18 million dollars a day. Over a year that comes out to $6,570,000,000!
He showed that even something as small as a penny can mean millions in profits when scaled to the number of coke cans sold every day.
At North Star Tax & Accounting, we can help your business determine a good markup by utilizing our professional pricing analytics software and reporting. To determine a product or service markup the first thing we need to understand is what exactly is a markup.
The simple answer is that it is the price a company charges for a good or service above the price it costs the company to produce that product or service expressed in terms of a percentage.
The equation is:
(Selling price-unit cost)/unit cost *100 = Markup Percentage.
An example might better express this.
Let’s say we own a company selling computers. The cost for our company to produce one computer is $1,000.00. We sell our computers for $1,200. Our markup percentage would be ($1,200 – $1000)/$1000 which equals ..2 or 20 percent markup.
Now that we understand what a markup percentage is, how can we use that in a real world scenario? Let’s say your business wants to make 35% on each computer instead of 20%. We can plug in this variable backwards in the equation to see what our selling price needs to be.
35% = (selling price-$1,000)/$1,000
This would show us our selling price would need to be $1,350 to have the correct markup.
Markup is just one part a company needs to understand of how to price a product or service. The other variable is determining what the selling price of a product minus the product cost is as a percentage of revenue instead of cost of production. This is calculation is termed gross margin.
The equation on our example above would be (1,350-$1,000)/$1,350 (instead of /$1,000) to equal a gross margin of 25.9 percent of revenue.
By using these two examples it shows that to generate 25.9 percent revenue on these computers you would have to have a markup or 35 percent.
At North Star Tax & Accounting we help businesses determine using the markup and gross margins calculations, as well as a host of other factors to determine a pricing structure and strategy. We can run numbers a few different ways to help you increase your profits by charging the right price for your product or service.