The Math (feel free to skip this part)
Start with price minus cost and call that margin dollars (per unit). Markup is margin dollars divided by cost. Margin is margin dollars divided by price.
Markup = (price – cost)/cost
Margin = (price – cost)/price
As an example, if you purchase something for $1.00 and sell it for $1.50, you have a 50% markup and a 33% margin.
Markups are commonly used in retail. They buy something for a price and apply a standard markup to get to the price. Since retailers buy thousands of items at different prices this seems to make sense. BE AWARE – This is cost plus pricing. Starting with a cost and adding a markup is the definition of cost plus pricing. Hopefully by now you realize that cost plus pricing is not optimal. It leaves money on the table.
Margins are what are reported on companies’ annual reports. Margins represent what you actually realized from a price and cost perspective. The implication is that margins are what materialized, not how to set the price. If you use Value Based Pricing (as you should) then you are closely monitoring your margins, looking for areas of improvement, watching for indicators of decline. Margins are a KPI (key performance indicator), not a means to drive pricing.
What are you using? If your company commonly uses markup, you are almost certainly in the cost plus pricing mentality. Throw that concept away and focus instead on margins. If your company uses margins, it is not a guarantee that you use value based pricing, but at least it’s an enabler.
Mark Stiving, Ph.D. – Pricing expert, speaker, author
Photo by The Consumerist