Mark-Up Or Margin - What is the Difference?
October 22nd, 2009 |
Almost every contractor I worked with over the last few years, and there have been many, used a mark-up formula in their pricing. In most cases it was something like $55 per hour for labor, plus materials marked up 25%. (We will talk about the labor charge later because it is more complicated.)
“I need 25% margin to be profitable” they say. “So why don’t you price to achieve that margin?” I ask. “Your 25% mark-up is actually a 20% margin!” It usually takes half an hour plus a calculator and several scraps of paper before they agree that they are pricing their product/service 5% lower than they intended.
You can try it yourself, remembering that the formula for margin is:
Gross Margin % = (Selling Price - Cost)/Selling Price all *100.
If you do this you can see, the margin mark-up disparity increases as the mark-up increases with a 33.33% margin requiring a markup of 50%.
OK, so what is the point? The point is that the difference can turn a profit into a loss. Let us assume your overheads are running at 25% of sales. If you want to make a profit of 5% on sales you must have a margin of 30%. That is a mathematical requirement. If you interpret this to mean a markup of 30% your margin is only 23%, so instead of making 5% profit you are losing 2%.
When you read this it all seems so obvious, but think seriously about the implications. In the example used above, the difference between using a margin of 30% and a mark-up of 30% is 7%, and that 7% is out of your pocket. The numbers I use in the example are taken from an actual client. He worked his heart out for years, keeping his head above water by taking a low salary and working long hours (Sound familiar!). A little training in the management skills required to be a small business CEO gave him his life back, not to mention a more healthy bank account.
In a later article we will talk about the labor element, but suffice to say here, that is one of the most incorrectly calculated elements of pricing by a majority of contractors.
With 45 years of experience in leading positions in business across North America and internationally, Mike Anderson knows the business of business. More important, he has learned how to teach it. He is now consulting to small and medium sized companies, specializing in CEO and senior management training. Please Visit http://trainmetobeaceo.blogspot.com.
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