Leading Entrepreneurship

Markup tends to be one of those concepts that makes a business owners uncomfortable. Let’s fix that, shall we?

To make one thing clear up-front, in order to calculate a gross profit margin, we have to know what the sales price is. That is not always the case with markup. So, let’s take a look at the markup formula (assuming we are marking up from cost, and not anything else):

% Markup = ($ Price - $ Cost) / $ Cost

or

% Markup = $ Gross Profit Margin / $ Cost

Pretty simple, but I did say that we did not always need the final price information with markup. The reasoning behind that statement is the fact that when most business owners talk about “markup” they are really referring to the end resulting price, or the dollar value between the end price and cost:

$ Price = $ Cost + ($ Cost * % Markup)

$ Markup = Price - Cost

So, let’s assume a medical device costs $12 to produce, and the standard wholesale markup is 40%. What is the price and dollar markup?

$ Price = $12 + ($12 * 0.4) = $12 + $4.80 = $16.80

$ Markup = $16.80 - $12 = $4.80

One parting thought: When you are new to an industry, or have developed a new product, you will typically turn to the average industry gross profit margin (GPM) to help you with your pricing and markup analysis. The following formula will allow us to convert this margin to an average markup.

$ Price = Cost / (1 - GPM %)

So, assuming a GPM % of 25% and product cost of $12:

$ Price = $12 / (1 - 0.25) = $12 / 0.75 = $16

However, there are a couple of reasons why the industry standard gross profit margin can provide you a misleading final price… anyone know why?