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Cost oriented pricing

Cost-oriented pricing is a straightforward approach in retail, where prices are set based on the cost of merchandise plus a markup to achieve profitability. Here’s a breakdown of the process and key concepts.

1. Setting Prices Based on Costs

  • Basic Principle: The retail price is determined by adding a markup to the cost of goods.
  • Formula: 
    Retail Price = Cost of Merchandise + Markup
  • Example: If a retailer buys a tennis racket for $75 and marks it up by $50, the retail price is set at $125.

2. Markup

  • Definition: The difference between the retail price and the cost of the item.
  • Purpose: The markup covers operating expenses (like rent, utilities, and wages) and ensures a profit.
  • Calculation:
    • Markup Percentage: Markup as a percentage of the retail price. 
      Markup Percentage = (Markup / Retail Price) x 100
    • Example: For a $125 tennis racket with a $50 markup: 
      Markup Percentage = ($50 / $125) x 100 = 40%

3. Keystoning

  • Definition: A common cost-based pricing approach where the retail price is set at double the cost of the item.
  • Application: Used to quickly set initial prices and ensure profitability.
  • Example: If a retailer buys a jacket for $40, using keystoning, the retail price would be: 
    Retail Price = $40 x 2 = $80

4. Initial Markup vs. Maintained Markup

  • Initial Markup: The markup based on the original selling price set by the retailer.
  • Maintained Markup: The actual markup realized after deductions for markdowns, discounts, or shrinkage (inventory loss).
  • Importance: Differences between initial and maintained markups impact final profitability due to promotional activities or inventory losses.

5. Break-Even Analysis

  • Purpose: Determines the sales volume needed to cover costs.
  • Formula: 
    Break-Even Quantity = Fixed Costs / (Selling Price per Unit - Variable Cost per Unit)
  • Example: If fixed costs are $10,000, the selling price per unit is $50, and the variable cost per unit is $30: 
    Break-Even Quantity = $10,000 / ($50 - $30) = 500 units
  • Application: Useful for ensuring that all costs are covered before setting profit goals.

Conclusion

Cost-oriented pricing enables retailers to set prices that meet operating expenses while targeting profitability. With calculations like markup, keystoning, and break-even analysis, retailers can set cost-based prices effectively and strategically.

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