Page 604 - Business Principles and Management

Chapter 22 • Pricing and Promotion

it is the price they pay their supplier to buy the product plus the cost of tran-
sporting it to their location for resale to their customers. For example, if the in- facts
voice price of an item is $55 and the transportation charge is $5, the cost of &
goods sold is $60.
Operating expenses are the costs of operating a business. They do not include figures
costs involved in the actual production or purchase of merchandise, which would
be part of the cost of goods sold. Most costs involved in the day-to-day running
of a business fall into this category. Figure 22-3 (see p. 592) lists some common Around 80 percent of car buy-
operating expenses. ers use Internet services that
The margin or gross profit is the difference between the selling price and the
cost of goods sold. In Figure 22-2, the margin is 40 cents. Marketers think of the provide information on cars
and car prices, and locate cars
margin as the percentage of sales available to cover operating expenses and pro- from multiple dealers in a given
vide a profit. For example, a business may operate on a 25 percent margin. If op- area. The dealers often offer
erating expenses are more than 25 percent of sales, the company will lose money. discounted prices because they
Net profit is the difference between the selling price and all costs and expenses
of the business. Net profit can be calculated using the following formula: know consumers can easily
comparison-shop.
Net profit selling price cost of goods sold operating expenses.

Markup is the amount added to the cost of goods sold to determine the sell-
ing price. It is similar to margin. When stated in dollars and cents, markup and
margin are identical. For example, in Figure 22-2, the markup is also 40 cents.
Often businesses express the markup as a percentage of the cost of goods sold
or as a percentage of the selling price. Thus, the markup in Figure 22-2 is 66
2/3 percent of cost (40 cents/60 cents). Expressed as a percentage of the selling
price, it is 40 percent (40 cents/100 cents).
Some consumers confuse the markup percentage with profit. They believe
that if a business has a 50 percent markup, it is making a profit of 50 percent of
the selling price. However, markup must cover operating expenses. If the busi-
ness with a 50 percent average markup on its products has operating expenses
of 45 percent of sales, it will have a profit of 5 percent of total sales.
Markdown is any amount by which the original selling price is reduced before
the item is sold. Companies use markdowns when their inventory is not selling at
a satisfactory rate. Because the costs associated with the products remain the same,
markdowns reduce profits, so companies want to avoid them.

FIGURE 22-2 A product’s selling price is made up of several components.

$.05
Net Profit
$.40
Margin or
$.35
Gross Profit
Operating
Expenses
$1.00
Selling
Price

$.60
Cost of
Goods Sold

591