When it comes to pricing products, no two terms are more often confused than margin and markup. While they are similar, they are two different things.
Margin is the amount of money that a business makes on each sale after the cost of goods sold (COGS) has been subtracted. COGS is the cost of the materials, labor, and other expenses that go into producing a product. For example, if a product costs $10 to make and is sold for $15, the margin is $5.
Markup is the amount of money that is added to the cost of a product in order to arrive at a selling price. For example, if a product costs $10 and has a markup of 50%, the selling price will be $15.
The main difference between margin and markup is that margin is a percentage of sales, while markup is a dollar amount. For example, if a product has a margin of 20% and is sold for $100, the profit will be $20. However, if the product has a markup of $20 and is sold for $100, the profit could be any number of things, depending on the cost of goods sold.
Why is it important to understand the difference between margin and markup?
Understanding the difference between margin and markup is important for businesses because it can help them to set prices that are profitable. If a business sets prices too low, it will not make enough profit to cover its costs. If a business sets prices too high, it may lose sales to competitors.
How do you calculate margin and markup?
To calculate margin, you can use the following formula:
Margin = (Selling Price - COGS)
For example, if a product costs $10 to make and is sold for $15, the margin is $5.
To calculate markup, you can use the following formula:
Markup = (Selling Price - COGS) / Selling Price
For example, if a product costs $10 to make and has a markup of $5, the markup percentage is 50%.
What are some factors to consider when setting prices as a small business?
When setting prices, there are a number of factors businesses should consider especially if your goal is growth.
1. Know your target market
It’s important to understand what your target market is willing to pay for your product or service. If you already know, great; if you can easily research it, great; if neither of those options are available, then “ask for a demo” and get to the pricing. If you have karmic reservations about wasting a competitors’ time, remember it’s useful practice for their sales team as well as indirect sales training for you.
2. Consider your costs
In addition to the cost of goods sold, there are a number of other costs that you need to consider when setting prices, such as:
- Overhead costs, such as rent, utilities, and insurance.
- Marketing and advertising costs
- Employee salaries and benefits
With the last point, it’s important to keep in mind especially if you want to grow your business and eventually hire employees. If you’re making enough for your business and yourself, but you’re doing all the work yourself, you won’t be able to grow. You also won’t be competitive if you suddenly price everything up to cover the cost of an employee. Make sure you’re thinking ahead.
3. Monitor your prices
It’s important to monitor your prices on a regular basis and make adjustments as needed. Your costs may change over time, so you need to make sure that your prices are still competitive.
By following these tips, you can set prices that are both profitable and competitive.
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