Monday, January 9, 2017

On Markup: Is the Price Right?


In Fred Lee's "Post Keynesian Theory of Prices" the concept of markup is the common denominator to the conceptual mishmash post Keynesians call their "theory of prices".

Being such a crucial notion readers could naturally ask what, exactly, is "markup"? And one should expect and indeed demand a clear answer to such a fundamental question. Clear definitions, after all, are of the essence, right?

Unfortunately the answer is not quite clear. The word "markup" (also "mark-up") has entered the vernacular, being used with little regard for consistency and to the best of my knowledge post Keynesians have not added any clarity to it. Furthermore, even for closely related fields, what markup is depends on the context the word is used.

Let's illustrate. Being originally an accounting concept it seems natural to begin with a common accounting definition:
"Markup is an increase in the cost of a product to arrive at its selling price. The amount of this markup is essentially the gross margin of the seller, which is needed to pay for operating costs and generate a net profit. The markup amount may be expressed as a percentage."
It's not entirely clear (i.e. Increase in the cost? What are the costs used as base for the markup?), but it's not too bad and markup seems to be the same as margin.

A somewhat similarly sounding definition, used by financial investors:
"A markup is the difference between an investment's lowest current offering price among dealers and the higher price a dealer charges a customer. Markups occur when dealers act as principals (buying and selling securities from their own accounts, at their own risk), as opposed to brokers (receiving a fee for facilitating a transaction)."
Example: suppose a share of XYZ Corp. is currently being sold at between $50 and $55. You are a stockbroker and you have XYZ in your own portfolio. You could offer your customers your XYZ shares at $50 + "Markup". Against the accounting definition, your markup is the margin over the minimum quoted offer (not necessarily what XYZ cost you when you acquired it).

Okay, not the same, but -- specifics aside -- we could at least say that markup is some kind of margin over some kind of base, yes?

Yes, of course! I mean, kinda … Well, no:
"The difference between margin and markup is that margin is sales minus the cost of goods sold, while markup is the amount by which the cost of a product is increased in order to derive the selling price."
A little confused? It may help to put that in equation form:

(1)     Margin = Sales - Cost_of_Goods_Sold

(2)     Selling_Price = Cost_of_Product + Markup


Great! Clarity, at long last.

But … uh!? Wait a minute! From (2), then Markup = Selling_Price - Cost_of_Product. Is there any difference between this and (1)?

Know what? Let's try the pros. The Business website (part of the Commonwealth government/Australian Taxation Office initiative to stimulate Aussie entrepreneurs' "Animal Spirits", currently dejected) can offer some official assistance, surely?

In "Analyse Your Finances" we find the following two equations:

                  100*(Sales - Cost_of_Goods_Sold)
(3)     Mark_up = --------------------------------
                         Cost_of_Goods_Sold

                 100*(Sales - Cost_of_Goods_Sold)
(4)     Margin = --------------------------------
                               Sales

Leaving aside that now margins and markups are expressed as percentages, not dollars, at least (1) looks like (4) … well, sort of. But how about (2) and (3)?

I don't know about the readers, but I'm getting a bit of a headache.

----------

"Markup" seems a remarkably shaky and imprecise conceptual foundation for the fabled post Keynesian price theory.

The Business website's warning to business people applies equally well to students of economics:
"These two calculations [i.e. equations (3) and (4)] are often confused and used interchangeably, but it's vital you know the difference. Confusing your mark up and margin figures could result in you seriously undervaluing your products/services and risking not making enough profit to cover all of your costs."

5 comments:

  1. Seems like it would be a good idea to use Lee's work as a source for a definition of the term "markup" or "costing margin" or "profit margin" rather than straw man him and make his work appear sloppy by using random internet definitions, when internet definitions of such commonly used words are always going to be unclear and contradictory.

    ReplyDelete
  2. Thanks for your comments Nathan Tankus.

    Would you be kind enough to explain what makes you believe I am "straw manning" Prof. Lee?

    By the way, have you read my post "Lee: Poverty of Post Keynesian Price Theory" (including comments):
    http://aussiemagpie.blogspot.com/2016/03/lee-poverty-of-post-keynesian-price.html
    Don't get me wrong, I have no illusions every single word I write is followed avidly by readers, but given that I linked to it in the first sentence of this post, perhaps in this opportunity I could reasonably expect that.

    I cordially look forward to your reply.

    ReplyDelete
  3. Incidentally, given that I wrote this to the best of my knowledge post Keynesians have not added any clarity to it I'd also appreciate it if you clarify what is the official post Keynesian academic definition of markup, as opposed to the internet definitions.

    Cheers.

    ReplyDelete
    Replies
    1. u seem unable to make friends w/pokeys, m-pie. that way u wont get their secret sauce for prices, evah.
      - the oo

      Delete
    2. D'oh! I think my nice guy side doesn't work any better than my asshole side.

      I'll have to read Dale Carnegie, then. :-)

      The technical, academic, official post Keynesian definition of markup -- as opposed to the internet definitions -- will remain elusive, it seems.

      Delete