Markup as the Conversion Factor in a Two Factor Marketing Machine

Ted Mitchell

What is the definition of

• Markup on Price?• 1) The cost per unit divided by the price per

unit• 2) the price per unit divided by the cost per unit• 3) the profit per unit divided by the cost per

unit• 4) the profit per unit divided by the price per

unit?

The definition is

• Markup on Price, Mp, is the ratio of• Profit per unit divided by the Price per unit• Markup on Price = (Profit per unit)/(Price per unit)• Mp = (P–V)/P• It is an identity; if you know any two of the

three elements you can calculate the third.

A boy buys an apple

• for $2 and sells it for $5. What is the percent markup on price?

• Markup on Price by definition is (P–V)/P• Mp = (P–V)/P• Mp = ($5-$2)/$5• Mp = $3/$5 = 0.60 = 60%

Need to know and understand

• the markup on price, Mp• YOU WILL NEED IT to set a cost-based price

that provides the normal target profit.

What is a Two-Factor Machine?

• A car is a Two-Factor Machine• It converts gallons of gas into miles travelled• Output = Conversion efficiency x Input• Miles =(miles per gallon) x (number of gallons)• Output can only be improved by changing one or

both of the Two-factors that explain distance• Miles = Factor 2 x Factor 1• Factor 1: the amount of gas in the input, gallons• Factor 2: the efficiency of the conversion, mpg

Marketing is easy to Conceptualize

• As a Two-Factor Marketing Machine• It has many possible Outputs:• profits, sales, costs, customer awareness, customer

satisfaction, etc.• Many possible Inputs:• servers, hours open, price, product quality, promotion,

location, etc.• Many possible conversion rates and machine efficiencies:• revenue per cup, sales per hour, sales to satisfaction,

cups per server, return on sales, markup, etc.

R = (R/Q) x Q

• Output = Conversion rate x Input• Revenue = (Revenue per cup) x (Cups Sold) • To increase revenue, increase one or both of the two factors• Revenue = Factor 2 x Factor 1• Factor 1: quantity of cups sold, Q• Factor 2: increase the conversion efficiency, revenue per

cup• Revenue = (Revenue/Q) x Q• R = (R/Q) x Q• Revenue = Price per cup x Q

• Change the Output of the machine from• Revenue to Profit

G = (G/Q) x Q

• Output = Conversion rate x Input• Gross Profit = (gross profit per cup) x (Cups Sold) • To increase gross profit, increase one or both of the two

factors• Gross Profit = Factor 2 x Factor 1• Factor 1: quantity of cups sold, Q• Factor 2: increase the conversion efficiency, gross profit per

cup (Gross Profit/Cups Sold)• Gross Profit = (Gross Profit/Q) x Q• G = (G/Q) x Q• Gross Profit = Gross Profit per cup x Q

Rates can be treated as

• Inputs and Outputs• Want to improve the rate

Gross Profit per cup• Consider a marketing machine that uses • (Revenue per Cup) as an Input • And the • (Gross Profit per Cup) as the Output

Gross Profit per Cup = Conversion rate x Revenue per Cup

• Output = Conversion rate x Input• Gross Profit per Cup =

Conversion Rate x Revenue per Cup• (Price-Variable Cost per cup)=

Conversion Rate x Price per Cup• (P-V) = Conversion Rate x P• Conversion Rate = Output/Input = (P-V)/P• P–V = (P-V)/P x P• (P-V)/P = dollar markup on price, Mp• P – V = Mp x P

The Two-Factor Marketing Machine

• That produces profit per cup (P–V) as an output is

• (P – V) = Mp x P• Factor 1: Input is the selling price, P• Factor 2: Conversion rate is the markup, Mp• It is an identity, if I know any two of three

components I can calculate the third.

Using the Two Factor Marketing Machine

• To Improve or explain the output, Profit per unit, (P-V)

• (P – V) = Mp x P1) Improve the Input = Increase the price2) Improve the efficiency of the price conversion in to profits per unit = increase the markup, Mp

Compare and Explain Differences12 oz Cup 16 oz cup ∆

Input, Price $4.00 $5.00Conversion Efficiency, Mp

95% 80%

Output, Profit per Unit

$3.80 $4.00 $0.20

Why the difference in profit per unit?

Compare and Explain Differences12 oz Cup 16 oz cup ∆

Input, Price $4.00 $5.00 $1.00Conversion Efficiency, Mp

95% 80% -15%

Output, Profit per Unit

$3.80 $4.00 $0.20

• We also use the Two-Factor Model to calculate a selling price that will achieve the target profit per unit

Using the Two-Factor Model

• to Set a Price, P• Solving for P means I know the variable cost, V

and I know the normal, fair markup I must achieve, Mp

• P – V = Mp x P• P – Mp(P) = V• P(1 – Mp) = V• P = V/(1 – Mp)

You are about to

• Start a new Café!• You have had a lot of experience running a

profitable coffee shop?• What is your normal price for a 16 oz cup?• What is your normal cost to make one cup of

organic coffee?• What is you normal profit per cup?• What is your normal markup percent per cup?

A New Coffee flavor

• Becomes available.• It will increase the cost of a 16oz cup to 30¢ a cup. You

normally get a 95% markup per cup• What selling price do you have to set to get the normal profit

per cup that you need to stay in business?• P–V = Mp x P• P – $0.30 = 0.95P• P – 0.95P = $0.30• P(1-0.95) = $0.30• P = $0.30/(1-0.95)• P = $0.30/0.05 = $6 per cup