Topic 2 - Pricing Flashcards
What is a mark-up?
The amount added by a seller to the cost of a commodity to cover expenses and profit in fixing the selling price.
Mark Up
Applies to Cost
Mark up:
Selling price 120
Profit (20)
Cost 100
Profit/Cost x 100 = Markup %
How is mark-up percentage calculated?
Mark-up % = (Profit / Cost) * 100
What is a margin?
The difference between a product’s (or service’s) selling price and the cost of production, expressed as a percentage of the sales price.
Margin
Applies to Sales
Margin:
Selling price 100
Profit (20)
Cost 80
Profit/Selling Price x 100 = Margin %
How is margin percentage calculated?
Margin % = (Profit / Selling Price) * 100
What is cost-plus pricing?
A pricing method where a percentage mark-up is added to the total production cost to set the price.
What are the two options for setting full cost-plus prices?
Option 1: Unit sales price = Total production cost per unit + Percentage mark-up
Option 2: Unit sales price = Total production cost per unit + Other costs per unit + Percentage mark-up
Cost-plus pricing
Cost-plus pricing INCLUDES OAR
In practice cost is one of the most important influences on price. Some organisations will base their selling price decision on simple cost-plus rules, whereby costs are estimated and then a percentage mark-up is added in order to set the price.
Setting full cost-plus prices
There are two options for calculating a full cost-plus price.
Option 1
Unit sales price = Total production cost per unit + Percentage mark-up
Option 2
Unit sales price = Total production cost per unit + Other costs* per unit + Percentage mark-up
*Other costs include selling, distribution and administration costs.
Formulas Cost-plus pricing
There are two options for calculating a full cost-plus price.
Option 1
Unit sales price = Total production cost per unit + Percentage mark-up
Option 2
Unit sales price = Total production cost per unit + Other costs* per unit + Percentage mark-up
*Other costs include selling, distribution and administration costs.
A business may have an idea of the percentage profit mark-up it would like to earn; however, the percentage profit mark-up does not have to be rigid and fixed.
Why would a business want to change the mark-up on a product? 3
Supply and demand
Seasonality
Too expensive - market conditions
Allowing for inflation when setting selling prices
The mark-up added to total cost must be sufficient to earn the required profit; therefore, managers must estimate costs as accurately as possible and must decide whether to include allowances for anticipated inflation.
The seller bears the risk of inflation when a selling price is determined prior to delivery of the goods or services.
However, if the buyer agrees to a price based on the actual cost incurred the inflation risk is borne by the buyer.
If the seller determines a price prior to delivery of goods and services, who bears the burden of risk of inflation?
The seller bears the risk of inflation when a selling price is determined prior to delivery of the goods or services.
If the buyer agrees to a price based on the actual cost, who bears the burden of risk of inflation?
If the buyer agrees to a price based on the actual cost incurred the inflation risk is borne by the buyer.
What problems might there be in agreeing to a price based on actual costs from the buyer’s point of view? 4
1 .No idea how much you will pay - large amount of uncertainty and risk
2. Seller has no incentive to keep costs low
3. Inflation risk passed on
4. If buyer sells onto someone else increase cost and decreased profit, long term unsustainable
What are the advantages of full cost-plus pricing? 4
- Quick and easy
- Decisions can be delegated
- Covers costs if at normal capacity
- Can justify price rises
What are the disadvantages of full cost-plus pricing? 3
- Will not maximise profit - Ignores supply and demand
- Less incentive to control costs
- Arbitrary absorption of overheads required
COGS
Cost of goods sold = Purchases + Opening Inv - Closing Inv
What is marginal cost-plus pricing?
A pricing method where a profit mark-up is added to either the marginal cost of production or the marginal cost of sales. APPLYING A MARKUP TO BASIC VARIABLE COSTS
What type of businesses would marginal cost-plus pricing be appropriate for?
When Retailers Might Use Marginal Cost-Plus Pricing
1. Clearance & Seasonal Sales – When retailers need to clear excess inventory, they may price products at or near marginal cost to avoid losses from unsold stock.
2. Loss Leaders – Some retailers sell certain products at marginal cost or even below cost to attract customers, hoping they’ll buy other high-margin products.
3. E-commerce & Digital Goods – For digital downloads or subscription services within retail (e.g., Amazon Kindle books, software), marginal cost pricing can work because of low production costs.
- Businesses with High Fixed Costs and Low Variable Costs
Airlines & Railways – Once a flight or train is scheduled, the marginal cost of adding one more passenger is low (fuel and catering), making marginal cost pricing useful for last-minute ticket sales.
Hotels & Hospitality – Marginal pricing can help fill empty rooms since the main costs (building, staff, utilities) are already incurred. - Industries with Perishable or Expiring Products
Food & Beverage (Restaurants, Bakeries, Grocery Stores) – Fresh goods that would otherwise go to waste can be sold at marginal cost to recover some value.
Event Ticketing – Unfilled seats at concerts or sports events are lost revenue once the event starts, so last-minute discounts using marginal cost pricing can be useful. - Businesses with Seasonal or Fluctuating Demand
Tourism & Travel Agencies – Off-peak periods can be priced at marginal cost to attract more customers.
Utility Companies (Electricity, Internet Providers in certain cases) – In times of surplus capacity, marginal pricing can incentivize extra consumption. - Manufacturing & Industrial Firms with Excess Capacity
Factories with Unused Production Capacity – A manufacturer might accept marginal-cost pricing for additional orders that utilize spare capacity without affecting regular pricing.
B2B Bulk Supply Chains – When demand dips, companies may temporarily price at marginal cost to maintain factory operations. - Entry-Level or Market Penetration Strategies
Tech Startups & SaaS Companies – Offering services at marginal cost can help acquire new users who might later convert to full-paying customers.
Freemium Business Models – Some digital platforms provide basic services at marginal cost and monetize premium features. - Competitive Bidding & Government Contracts
Infrastructure & Public Service Contracts – Bidding for contracts at marginal cost can help a company gain a foothold in a long-term government project.
What are the advantages of marginal cost-plus pricing?
- Simple - no OAR
- No arbitrary apportionment and absorption of overheads required
- More useful for short-run decision making
What are the disadvantages of marginal cost-plus pricing?
- Not profit maximising
- Full costs may not be recovered
What must be removed before calculating a discount on a price that includes sales tax?
Sales tax must be removed before calculating the discount.
How is a discount calculated when sales tax is included?
Once the discounted price has been calculated, the sales tax can be added back in to determine the gross sales price.
Why might a business want to change the mark-up on a product?
To remain competitive, adjust for cost changes, or align with pricing strategies.
What is the formula for determining the required selling price based on cost and mark-up?
Selling Price = Cost + (Cost × Mark-up %)
What is the difference between mark-up and margin?
Mark-up is based on cost, while margin is based on sales price.
ROI
ROI = Profit/Investment
or
Return on investment (ROI) = Controllable divisional profit/divisional capital employed x 100%
