ALTERNATIVEAPPROACHESTODETERMININGPRICE 243
Thereareseveralreasonswhyexpressingmark-upasa percentageofsellingpriceis
preferredtoexpressingitasa percentageof cost.One is thatmanyotherratiosareexpressed
asa percentageofsales.Forinstance, sellingexpensesareexpressedasa percentageofsales.
If~ellingcostsare8%, this meansthat foreach$ 100,000innetsales,thecostofsellingthe
merchandiseis$8,000. Advertisingexpenses,operatingexpenses, andothertypesofexpenses
arequotedinthesameway.Thus,thereisa consistencywhenmakingcomparisonsin express-
ingallexpensesandcosts,includingmark-up,asa percentage ofsales (sellingprice).
Middlemenreceive merchandise dailyandmakesalesdaily.Asnewshipmentsare
received,thegoods aremarkedand putintostock.Cumulativemark-upisthetermapplied
tothedifferencebetweentotaldollar deliveredcostofallmerchandiseandthetotaldollar
priceofthegoodsputintostockfor a specified periodoftime.Theoriginalmark-upat
whichindividualitems areputintostockis referredtoastheinitialmark-up.
Maintainedmark-upis anotherimportantconcept.Themaintainedmark-uppercentage
isan'::ssentialfigureinestimatingoperatingprofits.Italsoprovidesanindicationofeffi-
ciency.Maintainedmark-up,sometimescalledgrosscostofgoods,isthedifferenceoe~ween
the actualpri ceforwhichallofthemerchandiseissoldan d thetotaldollardeliveredcost
ofthegoodsexclusiveofdeductions. Themaintained mark-upistypically lessthantheini-
tialmark-updueto mark-downsandstock shrinkagesfromtheft, breakage, andthelike.
Maintainedmark-upisparticularlyimportantfor seasonalmerchandisethatwilllikelybe
marked-downsubstantiallyat theendoftheseason.
Althoughthispricingapproachmayseemoverlysimplified,it hasdefinitemerit.The
problemfacingmanagersofcertaintypesofbusinessessuchasretailfoodSloresisthat
theymustpricea verylargenumberofitemsandchangemanyofthosepricesfrequently.
Thestandardmark-upusuallyre flectshistoricallyprofitablemarginsandprovide,;a good
gui.delineforpricing.
Toillustratethiscost-\:'asedprocessofpricing,let'slook at thecaseofJohnnieWalker
BlackLabelScotchWhiskey.Thi s produc t sellsfor about$30inmostliquorstores.How
wasthispricederived?
$5.00production, distillation,maturation+$2. 50 advertising+$3.11 distribution
+$4.39taxes+$7.50mark-up(retailer)+$7. 50 netmargin(manufacturer)
Certainlycostsareanimportantcomponent ofpricing.Nofirmcanmakea profit
untilit coversitscosts. However,theprocessofdeterminingcostsandthensettinga price
basedon costs does not takeintoconsiderationwhat thecustomeriswillingtopayatthe
marke tplace. As a result,many companiesthat have set outtodevelopa producthavefallen
victimtothedesireto continuously addfeaturestotheproduct,thusaddingcost.Whenthe
productisfinished, thesecompanies ad d so mepercentagetothecost andexpectcu stomers
topaytheresulting price. Thesecompanies areoftendisappointed,ascustomersarenot
willingtopaythiscos t-basedprice.
Break-EvenAnalysis
A somewhatmoresophistic atedapproachtocost-ba3edpricingis thebreak-evenanalysis.
Theinformationrequiredfortheformulaforbreak-evenanalysisisavailablefromtheaccount-
ingrecordsinmostfirms.Thebreak-evenpriceistheprice thatwillproduceenoughrev-
enueto coverallcosts ata given levelofproduction.Total costcanbedividedintofixed
andvariable (totalco st=fixedcost+variablecost).Recallthatfixedcostdoesnotchange
asthelevelofproductiongoesupordown.The rent paidforthebuildingtohousetheoper-
ationmightbeanexample. Nocostisfixedinthelongrun, butintheshortrun, manyexpenses
ca nnotiealisticallybechanged. Variablecostdoeschangeasproductionisincreasedor