Why do companies markup their product before selling? Why do they sometimes markdown their products from the selling price that was initially set in place? The simple answer to both of these questions is, ''To make a profit.''
A company cannot sell a product for the same amount that it cost the company to obtain the product. The process of purchasing products to sell actually costs money. There is an expense involved in paying an employee to research and purchase products; there is another expense involved in storing products to be sold; there is another expense involved in paying employees to stock a store and sell products to customers. The owner of a company must cover all the expenses involved in the process of purchasing and selling products before he or she can claim any of the profit from that product. A business owner must be able to pay their own private bills as well; thus, without markup pricing, no businesses would be able to stay in business because they would not make any profit. It is the profitability of a company that determines its lifespan.
So, if markups are designed to allow for the sale of a product to result in profit earned for the company, why would any company use markdown pricing? Again, there is a short answer, ''To entice customers to buy more products.'' Often, discount prices (markdowns) are placed on items that are not selling well or that have been discontinued, and the business is motivated to clear them from the shelves. The amount of the discount will not take the selling price of the item below the original cost to the company for the item, ensuring that a profit is still made on the product. It is human nature to want a deal, so companies will set markups high enough to allow for sales prices without losing out on earning some profit off each item.
The next piece of the markup/markdown puzzle is how to markup a price and how to markdown a price.
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The processes to markup or markdown prices are very similar. The main difference is that the rate, or the percentage amount to be increased or decreased, is either added or subtracted from the original price.
Before reviewing the formulas to markup and markdown prices, it is important to define the variables to be used in the formulas.
- {eq}c= {/eq} cost (original cost of the product).
- {eq}r= {/eq} decimal form of the percentage rate of markup or markdown.
- {eq}m= {/eq} amount of the markup or markdown depending on the context of the problem.
- {eq}S= {/eq} sales price.
- Markup Prices
To markup a price it is necessary to know two pieces of information: the original cost and the rate of markup (remember to use the decimal version of any percentage amount in calculations). There are also two ways to accomplish the task of marking up a product price: two-step or one-step.
- Two-step: First, multiply the cost by the rate to get the markup. Second, add the markup amount to the original cost.
- 1. {eq}c \times r = m {/eq}
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- 2. {eq}c + m = S {/eq}
- One-step: Multiply the original cost by the sum of 1 and the decimal rate of the markup. Using 1+decimal rate automatically incorporates the second step in the previous method.
- {eq}S = c(1 + r) {/eq}
For example, if Company A wants to include a 75% markup on an item that cost the company $15 the process would be:
- Two-step method: {eq}15 \times 0.75 = 11.25 {/eq}
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- {eq}15 + 11.25 = 26.25 {/eq}
OR
- One-step method: {eq}15(1 + 0.75) = 15(1.75) = 26.25 {/eq}
Both methods lead to a markup selling price of {eq}$26.25 {/eq}.
- Markdown Prices
The markdown formula can be referred to as the markdown percentage formula. The formula follows a similar pattern to the markup formulas with the exception being that in the markdown versions the rate (or the markdown) is taken from the original instead of added to it. There are two methods (a two-step and a one-step method) to accomplish markdowns with the formulas using the same variables as defined previously.
- Two-step method: First, multiply the cost (this time it is the cost to buy the item from the company) by the rate to get the markdown amount. Second, subtract the markdown amount from the cost.
- 1. {eq}c \times r = m {/eq}
-
- 2. {eq}c - m = S {/eq}.
- One-step method: Multiply the cost by the difference between 1 and the rate.
- {eq}c(1-r) = S {/eq}.
For example, Company A realized that its hammers were not selling well. They decided to offer a sale on the items. The markdown rate was set at 35% on the hammers which originally sold for $25. What is the new selling price of the hammers?
- Two-step method: {eq}c \times r = 25 \times 0.35 = 8.75 {/eq}
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- {eq}c - m = 25 - 8.75 = 16.25 {/eq}
The new selling price of the hammers is {eq}$16.25 {/eq} after the markdown. Remember that markdowns are often referred to as discounts in retail stores.
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The best way to understand a new formula is to practice using the formula. Use these examples (with full explanations) to practice the concepts presented here.
- What is the new sales price of an item that is sold for {eq}$40 {/eq} and has a markdown percentage of {eq}20% {/eq}?
Use the one-step formula for how to markdown a price: {eq}S = c (1-r) = 40 (1 - 0.20) = 40 (0.8) = 32 {/eq}. The sales price is {eq}$32 {/eq}.
- What was the markup if an item sells for {eq}$55 {/eq} and had an original cost of {eq}$44 {/eq}?
This problem is not straightforward, but still uses the one-step formula for markup: {eq}S = c ( 1 + r) {/eq}, the difference is that the whole rate (the {eq}(1 + r) {/eq} section will be defined as {eq}R {/eq} to work the problem with Algebraic methods of determining the value of {eq}r {/eq}.
- {eq}55 = 44 \times R {/eq}
- {eq}\frac{55}{44} = R = 1.25 {/eq}
- Since {eq}R = 1 + r {/eq} we can determine the actual markup percentage by subtracting {eq}1 {/eq} from the value and multiplying by {eq}100 {/eq} to get a markup percentage of {eq}25% {/eq} for this product.
- Company A offered a {eq}25\% {/eq} discount on sheets for a month before reducing the price by a further {eq}30\% {/eq}. Find the new price of the sheets if they were originally priced at {eq}$100 {/eq}.
It is tempting to add the two markdown percentages together and perform one markdown formula calculation, but this is not the correct way to proceed here. It is necessary to perform two markdown calculations; first to get the new price after the first markdown and second to perform the second markdown calculation on the result of the first step.
- Step 1: {eq}S = 100 (1 - 0.25) = 100 (0.75) = 75 {/eq}
- Step 2: {eq}S = 75 (1 - 0.30) = 75 ( 0.7) = 52.50 {/eq}.
So, the company will sell the sheets for a sales price of {eq}$52.50 {/eq}.
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Markups (the numerical increase in the price of an item) and markdowns (the numerical decrease in the price of an item) are used by businesses to manipulate the company's profit margins, or the financial benefit to the company. Markdowns are often referred to as discounts in retail. Markup and markdown prices can be found through the use of similar formulas. The main difference between the formulas is that for markups the rate (or the percentage amount by which the cost is altered) is added (markup) or subtracted (markdown) from the starting price. It is important to remember that rates should be converted to their decimal forms when used in mathematical formulas. While there are multiple ways to accomplish markups and markdowns, the one-step method formulas for each of these calculations are:
- Markup: {eq}S = c (1 + r) {/eq}
- Markdown: {eq}S = c ( 1 - r) {/eq}
Where:
- {eq}c= {/eq} cost (or starting price of the item).
- {eq}r= {/eq} decimal form of the percentage rate of markup or markdown.
- {eq}S= {/eq} selling price.
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Video Transcript
A T-Shirt Business
Shalon has a t-shirt business where she sells her own line of designer shirts. She is in it for the money. But in order to make money from selling her t-shirts, she needs to make sure her prices are at the right price point both in terms of making money and giving her customers a good deal. What she needs to balance is her markup, how much to increase her prices, and her markdown, how much to decrease prices.
Markup
To calculate her markup, Shalon needs to take into consideration things like the cost of her time spent designing the shirts, the cost to manufacture the shirt, and the cost of keeping the store open. After all these costs are calculated, then she needs to figure out how much more she needs to add so she can make a good living from her t-shirt business.
Say, for instance, after considering all the factors we mentioned, that the total cost to make each shirt for Shalon is $10. Of course, Shalon wants to make a profit from selling each shirt, so she marks up her shirt price to $30. How much of a markup is this? Let's calculate it. $30 is $20 more than $10. So dividing $20 by $10, we get 20/10 = 2. Changing this into a percentage, we see that Shalon has a markup of 200%.
Shalon wants to make sure she is competitive with other t-shirt businesses in town, so she does some investigating of her own. She visits another shop and she finds that this shop has a markup of 100%. If the manufacturing cost of the product is $10, how much is this shop selling the shirts for?
We can calculate this by multiplying the $10 with the 100% to find how much our increase is. Changing the 100% to a decimal, we get 1 for our decimal. Multiplying the 10 with the 1, we find that this shop has increased their prices by $10 per shirt. So the shirts here cost $10 + $10 = $20.
Hmm, Shalon is thinking that her prices might be a bit steep for the customers in the neighborhood based on her investigations.
Markdown
Now she is considering how much to mark down her prices. Her starting price is $30. If she wants to decrease her prices to $20, how much of a markdown does she need? To calculate this, we first see how much of a difference we have. We have a difference of $30 - $20 = $10. So, the markdown is $10/$30 = 0.3333 or roughly 33%.
Shalon can do this two ways. She can either offer a 33% off coupon to all her customers or she can decrease her prices without offering coupons. Even if she sells a shirt for $20, she is still making profit.
What if Shalon wanted to calculate the shirt price based on a percentage markdown? What if she wanted to only mark down her prices by 20%? How much would her shirts cost then? Let's see. We multiply her starting price of $30 with 20% or 0.2 to find how much our decrease is. We get $30 * 0.2 = $6. So, the shirt price with a markdown of 20% will be $30 - $6 = $24.
Special Event Pricing
Shalon was just informed that there is going to be a special event, the grand opening of a skateboard park, in just a few weeks. To help with the celebration, Shalon has created a special limited edition of t-shirts just for the event. Her cost to produce each shirt is $12. She has a markup of 150% and she is offering coupons that give a markdown of 40%. How much is each shirt selling for?
With a 150% markup, the additional cost per shirt is $12 * 1.5 = $18. So the cost of the shirt after the markup is $12 + $18 = $30. A markdown of 40% decreases the price of the shirt by $30 * 0.4 = $12. So the final cost of the shirt is $30 - $12 = $18. Shalon is happy with this price, so she starts to pass out 40% off coupons for the event.
Lesson Summary
Let's review what we've learned:
Markup is how much to increase prices and markdown is how much to decrease prices. To calculate markup, we need to find out how much more our prices are than the cost to produce the item. Then we find the markup percentage by dividing the difference by the cost to produce them. If we are given a markup percentage, we multiply the percentage with the cost to produce the item. Then we add this increase to the cost to produce the item to find the final cost.
To calculate markdown, we find the difference between the beginning price and the decreased price, then we find the percentage by dividing the difference by the beginning price. If we are given a markdown percentage, we multiply the percentage with the original price to find how much of a decrease we are getting, then we subtract this difference from the original price to find the marked down price.
Learning Outcomes
This video lesson aims to prepare you to do the following:
- Understand the concepts of markups and markdowns in sales
- Calculate a markup, markdown amount or percentage
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