Page 375 - Foundations of Marketing

342 Part 4 | Product and Price Decisions

Cost-Plus Pricing
With cost-plus pricing , the seller’s costs are determined (usually during a project or after a
project is completed), and then a specified dollar amount or percentage of the cost is added
to the seller’s cost to establish the price. When production costs are difficult to predict, cost-
plus pricing is appropriate. Projects involving custom-made equipment and commercial
construction are often priced using this technique. The government also frequently uses
cost-based pricing in granting defense contracts. One pitfall for the buyer is that the seller
may increase stated costs in order to gain a larger profit base. Furthermore, some costs, such
as overhead, may be difficult to determine. In periods of rapid inflation, cost-plus pricing
is popular, especially when the producer must use raw materials that frequently fluctuate
in price.

Markup Pricing

With markup pricing , commonly used by retailers, a product’s price is derived by adding a
predetermined percentage of the cost, called markup, to the cost of the product. For instance,
most supermarkets mark up prices by at least 25 percent, whereas warehouse clubs like Costco
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and Sam’s Club have a lower average markup of around 14 percent. Markups can range a
great deal, depending on the product and the situation. For example, the average markup
for popcorn in movie theaters is a staggering 900 percent. Consumers are willing to pay the
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markup to enhance their movie experience by enjoying warm popcorn at the theater.
Although the percentage markup in a retail store varies from one category of goods to
another— 35 percent of cost for hardware items and 100 percent of cost for greeting cards, for
example—the same percentage is often used to determine the prices on items within a single
product category, and the percentage markup may be largely standardized across an industry
at the retail level. Using a rigid percentage markup for a specifi c product category reduces
pricing to a routine task that can be performed quickly.
The following example illustrates how percentage markups are determined and distin-
guishes between two methods of stating a markup. Assume a retailer purchases a can of tuna
at 45 cents and adds a 15 cent markup to the cost, making the price 60 cents. There are two
ways to look at the markup, as a percentage of cost or a percentage of selling price, as follows:

Markup as percentage of cost = markup / cost
= 15 / 45
= 33.3 %
Markup as percentage of selling price = markup / selling price
= 15 / 60
= 25.0 %

The markup as a percentage of cost is 33.3 percent, while the markup as a percentage of price
is only 25 percent. Obviously, when discussing a percentage markup, it is important to know
whether the markup is based on cost or selling price.

Demand-Based Pricing
Marketers sometimes base prices on the level of demand for the product. When demand-
cost-plus pricing Adding a
specified dollar amount or based pricing is used, customers pay a higher price at times when demand for the product
percentage to the seller’s cost is strong and a lower price when demand is weak. For example, hotels often offer reduced
rates during periods of low demand when they have excess capacity in the form of empty
markup pricing Adding to
the cost of the product a rooms. The belief behind this pricing basis is that it is better to take a lower profit margin than
predetermined percentage of no revenue at all. Some telephone companies, such as Sprint and AT&T, also use demand-
that cost based pricing by charging peak and off-peak rates or offering free cell phone minutes dur-
demand-based pricing Pricing ing off-peak times. While demand-based pricing has long been a common practice with cell
based on the level of demand phone minutes, airplane seats, and hotel rooms, some concerts and sporting events have more
for the product recently implemented demand-based pricing for ticket sales.

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