Pricing and commercial decisions
Clear definitions and practical examples to help you understand the numbers and decisions.
Markup
Markup is the amount added to cost to set a price, usually expressed as a percentage of cost. It differs from gross margin, which expresses profit as a percentage of selling price.
Read the explanationCost-plus pricing
Cost-plus pricing sets a selling price by adding a chosen markup to a defined cost base. Its result depends on what costs are included and whether the markup covers profit, risk, discounts, and overheads.
Read the explanationValue-based pricing
Value-based pricing sets a price by reference to the economic value a customer receives, rather than starting only with cost plus a margin or a competitor’s list price. It requires a credible customer-specific mechanism: lower labour, fewer failures, faster cash collection, higher sales, lower risk, or a measurable combination.
Read the explanationTarget costing
Target costing starts with the price customers will pay and subtracts the profit the business requires. The remainder is the allowable cost of delivering the offer. It reverses the usual sequence of designing a product, adding its cost, and hoping the market accepts the resulting price.
Read the explanationUnit cost
Unit cost is the cost of producing, buying, delivering, or serving one defined unit. It may include direct materials and labour, variable operating cost, and an allocated share of fixed cost. The number is useful only when the unit, period, volume, and allocation method are visible.
Read the explanationUnit contribution
Unit contribution is selling price less the variable costs that change when one more unit is sold or served. It is the amount available to cover fixed costs and then profit. It is not the same as gross revenue, and it should not include a fixed cost merely because it has been allocated per unit.
Read the explanationBreak-even point
The break-even point is the sales volume at which total contribution equals fixed costs, so profit is zero under the stated assumptions. In a single-product case it is fixed costs divided by contribution per unit. It is a model of a specific cost and price structure, not a promise that the business will reach that volume.
Read the explanationBreak-even sales
Break-even sales expresses the break-even point in revenue rather than units. In a stable single-margin model it equals fixed costs divided by contribution margin ratio, where the ratio is contribution divided by sales. It is useful where products are priced differently or management plans in revenue, but it is only as sound as the margin assumption beneath it.
Read the explanationMargin of safety
Margin of safety is the excess of actual or expected sales over break-even sales, expressed in currency, units, or a percentage. It measures the cushion in the current plan, not certainty that the cushion will remain. A small margin means a modest fall in volume, price, or contribution can move the business below break-even.
Read the explanationSales mix
Sales mix is the proportion of total units or revenue contributed by each product, service, or channel. It matters because products usually have different contribution margins, capacity needs, return rates, and cash timing. A change in mix can change profit even when total revenue is unchanged.
Read the explanationProduct profitability
Product profitability compares a product’s revenue and contribution with the costs, assets, service demand, and capacity it causes. It goes beyond gross margin by asking whether a product absorbs engineering, returns, warehousing, sales support, or scarce production time that the basic unit cost does not show.
Read the explanationCustomer profitability
Customer profitability measures the revenue and contribution associated with a customer after the costs the relationship causes: acquisition, onboarding, service, returns, payment, bespoke work, and account management. It explains why a large account can look attractive in sales reporting while consuming disproportionate cash and capacity.
Read the explanationCost to serve
Cost to serve measures the resources used to supply and support a customer, channel, or order. It can include picking, packing, delivery, returns, account support, and collection work. These costs explain why customers with the same sales and product margin can contribute very different amounts to the business.
Read the explanationRelevant cost
A relevant cost is a future cost that differs between the options being considered. The comparison also includes benefits given up, such as the proceeds from selling a resource that would instead be used. A past payment is not relevant merely because it appears in the accounts, and a future cost is not relevant if it is identical under every option.
Read the explanationIncremental cost
Incremental cost is the increase in total cost caused by a particular change: accepting an order, opening a shift, or adding a service. It is not necessarily the usual variable cost per unit. The change may also trigger a fixed amount, such as a special setup or another supervisor. The useful comparison is total cost with the action versus total cost without it.
Read the explanationAvoidable cost
An avoidable cost disappears if the business takes a particular action, such as closing a product line or cancelling an activity. Avoidability depends on the decision and the time period. A monthly warehouse cost may be unavoidable during a lease notice period but avoidable once the contract ends. Calling a cost fixed does not mean it can never be removed.
Read the explanationSunk cost
A sunk cost has already been incurred and cannot be changed by the decision now being made. It may remain visible in the accounts and matter when reviewing how the original decision was made. But it does not make a weak future investment attractive. The question is what each available option will cost and deliver from this point forward.
Read the explanationOpportunity cost
Opportunity cost is the benefit forgone when choosing one use of a resource prevents its next-best use. It is part of a decision even when no supplier sends an invoice for it. A warehouse, machine, employee, or amount of cash can have an alternative use. The comparison must use an alternative the business could actually pursue.
Read the explanationLimiting factor
A limiting factor is the resource or condition that prevents a business from meeting all otherwise profitable demand. It might be skilled labour, machine time, material availability, or customer demand itself. When one production resource is scarce, the useful ranking is contribution per unit of that scarce resource, not contribution per product. Contribution here means sales less the relevant variable costs.
Read the explanationMake-or-buy decision
A make-or-buy decision compares internal production with obtaining the same item or service from an external provider. The financial comparison uses costs that change with the choice, plus any value released by using capacity elsewhere. A supplier quote should not be compared blindly with a fully allocated internal cost: some internal costs may remain after outsourcing.
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