The difference between gross margin and mark-up
A mistake in the use of these terms can lead to price setting that is substantially too high or low, resulting in lost sales or lost profits, respectively.
The difference between margin and mark-up is that 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 derive the selling price.
More detailed explanations of the margin and mark-up concepts are as follows:
- Margin (also known as gross margin) is sales minus the cost of goods sold. For example, if a product sells for $100 and costs $70 to manufacture, its margin is $30. Or, stated as a percentage, the margin percentage is 30% (calculated as the margin divided by sales).
- Mark-up is the amount by which the cost of a product is increased in order to derive the selling price. To use the preceding example, a mark-up of $30 from the $70 cost yields the $100 price. Or, stated as a percentage, the mark-up percentage is 42.9% (calculated as the mark-up amount divided by the product cost).
It is easy to see where a person could get into trouble deriving prices if there is confusion about the meaning of margins and mark-ups. Essentially, if you want to derive a certain margin, you have to mark-up a product cost by a percentage greater than the amount of the margin, since the basis for the mark-up calculation is cost, rather than revenue and the cost figure should be lower than the revenue figure, the mark-up percentage must be higher than the margin percentage.
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.
The following bullet points note the differences between the margin and mark-up percentages at discrete intervals:
- To arrive at a 10% margin, the mark-up percentage is 11.1%
- To arrive at a 20% margin, the mark-up percentage is 25.0%
- To arrive at a 30% margin, the mark-up percentage is 42.9%
- To arrive at a 40% margin, the mark-up percentage is 80.0%
- To arrive at a 50% margin, the mark-up percentage is 100.0%
To minimise mark-up vs. margin mistakes, use a pricing model or pricing tool to help when quoting/estimating. Have the tool calculate both the mark-up percentage and the gross margin percentage.
Terminology and calculations aside, it is very important to remember that there are more factors that affect the selling price than merely cost. What the market will bear, or what the customer is willing to pay, will ultimately impact the selling price. The key is to find the price that optimises profits while maintaining a competitive advantage.
Written by Jon Mailer, CEO of PROTRADE United.