Markup

A markup is the amount by which the selling price of a product or service exceeds its cost. It is usually expressed as a percentage of cost: an item that costs $50 and sells for $75 has a $25 markup, or 50 percent. Retailers, wholesalers, manufacturers and service firms use markups to set prices that cover their costs and leave a profit. The term is also used in foreign exchange, where a provider adds a margin to the wholesale rate; that sense is covered in the entry on FX markup.

Markup is closely related to gross margin, but the two are calculated on different bases. Markup measures profit relative to cost, while gross margin measures the same profit relative to the selling price. Confusing the two is one of the most common pricing errors in small businesses.

The formula is:

Here $\text{Selling price}$ is the price charged to the customer and $\text{Cost}$ is the cost of the item, normally its purchase or production cost. To set a price from a target markup, the business uses:

A hardware store buys drills for $80 each and applies a 40 percent markup. The selling price is $80 times 1.40, which is $112. The markup in dollars is $32.

Using the same drill, the gross margin is $32 divided by $112, or about 28.6 percent. The table shows how the two measures relate for common markups:

The conversion is gross margin equals markup divided by (1 plus markup). A business that wants a 40 percent gross margin must mark up its costs by about 66.7 percent, not 40 percent. Applying a 40 percent markup when a 40 percent margin was intended leaves the business with a margin of only 28.6 percent, which may not cover operating expenses.

• Cost-plus pricing: contractors and manufacturers add a fixed markup to full cost, a method common in government contracting and construction.
• Keystone pricing: many retailers traditionally double the wholesale cost, a 100 percent markup.
• Category markups: grocery stores apply low markups to staples and higher ones to specialty items, depending on competition and price elasticity.
• Professional services: firms set billing rates by marking up employees' cost per hour to cover overhead and profit.

The cost base must be defined carefully. A markup on purchase cost alone will not cover freight, storage, shrinkage and the eventual markdowns of slow-selling stock. Manufacturers often mark up full absorption cost, which includes factory overhead, while others mark up only variable costs and rely on the markup to cover fixed costs.

Markup itself does not appear as a line item. Its effect shows in gross profit on the income statement: revenue minus cost of goods sold. Analysts infer the average markup from a company's gross margin and compare it with peers. Retailers using the retail inventory method track the initial markup on goods purchased, along with later markdowns, to estimate the cost of ending inventory. In tax and transfer pricing, markups on cost are used to set prices for goods and services exchanged between related companies, a method that tax authorities review closely. Markup should also be distinguished from profit: a high markup can still leave a business loss-making if its operating costs are high or sales volumes are low.