Basic Marketing: A Global Managerial Approach

Perreault−McCarthy: Basic
Marketing: A
Global−Managerial
Approach, 14/e

18. Price Setting in the
    Business World

Text © The McGraw−Hill

Companies, 2002

Price Setting in the Business World 517

Exhibit 18-2 illustrates the markup chain for an electric drill at each level of the

channel system. The production (factory) cost of the drill is $21.60. In this case, the

producer takes a 10 percent markup and sells the product for $24. The markup is 10

percent of $24 or $2.40. The producer’s selling price now becomes the wholesaler’s

cost—$24. If the wholesaler is used to taking a 20 percent markup on selling price,

the markup is $6—and the wholesaler’s selling price becomes $30. The $30 now

becomes the cost for the hardware retailer. And a retailer who is used to a 40 percent

markup adds $20, and the retail selling price becomes $50.

Some people, including many conventional retailers, think high markups mean

big profits. Often this isn’t true. A high markup may result in a price that’s too

high—a price at which few customers will buy. You can’t earn much if you don’t

sell much, no matter how high your markup. But many retailers and wholesalers

seem more concerned with the size of their markup on a single item than with their

total profit. And their high markups may lead to low profits or even losses.

Some retailers and wholesalers, however, try to speed turnover to increase profit—

even if this means reducing their markups. They realize that a business runs up costs

over time. If they can sell a much greater amount in the same time period, they may

be able to take a lower markup and still earn higher profits at the end of the period.

An important idea here is the stockturn rate—the number of times the average

inventory is sold in a year. Various methods of figuring stockturn rates can be used

(see the section “Computing the Stockturn Rate” in Appendix B). A low stockturn

rate may be bad for profits.

At the very least, a low stockturn increases inventory carrying cost and ties up

working capital. If a firm with a stockturn of 1 (once per year) sells products that

cost it $100,000, it has that much tied up in inventory all the time. But a stock-

turn of 5 requires only $20,000 worth of inventory ($100,000 cost 5 turnovers

a year). If annual inventory carrying cost is about 20 percent of the inventory

value, that reduces costs by $16,000 a year. That’s a big difference on $100,000

in sales!

Whether a stockturn rate is high or low depends on the industry and the prod-

uct involved. A NAPA auto parts wholesaler may expect an annual rate of 1—while

a Safeway supermarket might expect 20 to 30 stockturns for soaps and detergents

and 70 to 80 stockturns for fresh fruits and vegetables.

$24

Selling price 
 $30.00  $20.00 
 $50.00 
 100%

dollars

Retailer Cost 
 $30.00 
 60% Markup 
 $20.00 
 40%

Wholesaler Cost 
 $24.00 
 80% Markup 
 $6.00 
 20%

Producer Cost 
 $21.60 
 90% Markup 
 $2.40 
 10%

$30 $50

Selling price 
 $24.00  $6.00 
 $30.00 
 100%

Selling price 
 $21.60  $2.40 
 $24.00 
 100%

$50 Consumer price

$21.60

Exhibit 18-2 Example of a Markup Chain and Channel Pricing

High markups don’t

always mean big

profits

Lower markups can

speed turnover and the

stockturn rate