The terms margins and mark-ups are often confused in business and this can be problematic for several reasons. Margin is sales minus the cost of goods sold, while mark-up is the amount by which the cost of a product is increased in order to determine the selling price.
Confusing the meaning of these terms can cause problems especially regarding the setting of appropriate and adequate prices. Misunderstanding these terms may result in setting prices that are either too high or too low, and this can be a crucial factor affecting inventory management and your businesses success as a whole.
Pricing strategy is a key variable in the success or otherwise of a business, so getting it right is paramount. Inadequate prices may inhibit profit, leave a negative impact on customers, and may also have a negative impact on market share. Below, we explain the key differences between these key terms and how they interact.
Margin, or gross margin, is the deduction of the cost of making the goods from the total sales amount. For example, imagine that a product sells for $100, and it costs the manufacturer $70 to make. The margin for this product would therefore be $30.
Mark-up is the term used to refer to the extent to which the cost of a product is increased in order to arrive at an adequate sales price. To illustrate using the previous example, the product costs $70 to make. Therefore, to arrive at the sales price of $100, the mark-up is $30.
The Relationship Between Margin and Mark-Up
It is easy to see how confusion could arise if the meaning of each of these terms is not fully understood. If a business wants to meet a certain margin on a particular product, then the mark-up of that product must be more than the margin.
The mark-up calculation is more likely to result in pricing changes over time than a margin-based price, because the cost upon which the mark-up figure is based may vary over time; or its calculation may vary, resulting in different costs which therefore lead to different prices.
Why Does It Matter?
Business managers and staff need to be aware of the definitions of these terms and how they relate to one another, as well as how they relate to pricing strategies. A proper understanding of how these two factors interact is key to setting sufficient prices, and pricing strategy is a key factor affecting inventory management.
It is paramount that businesses understand these terms because confusing them may lead to price setting that is too high or low, which could result in lost sales or profits. Setting inadequate prices on the basis of a confused understanding of these terms may also have an inadvertent impact on market share, since excessively high or low prices may be well outside of the prices charged by competitors.
Clarification of Terms
To ensure your staff have an adequate understanding of these terms, you may wish to consider having internal audit staff review the prices for a sample of sale transactions. This will give you a better idea of their level of understanding, and will allow you to step in if it is necessary to clarify the terms. Moreover, this will give you some control over the pricing process, a key factor affecting inventory management.
If the terms continue to cause confusion among staff, it may be a good idea to print cards which show the mark-up percentages to use at various price points, and to give these to staff. You could also include a small description outlining the differences between the terms margin and mark-ups to avoid further confusion.