Markup vs. Margin, and Pricing Products and Services During COVID

Markup vs. margin is one of the most common points of confusion in pricing, and getting it wrong can quietly cost you profit on every sale. Say your vision is to launch a new product or service and price it by looking at the market, your markup, and your margin. You may be doing this as a new business or adding to an existing product line. Either way, you want to be clear on the difference between markup and margin before you set a price.

This article defines margin, price, and markup, explains how to calculate each and why you use them, walks through a pricing example, provides markup-to-margin conversion tables, and covers the considerations for pricing well, including during an emergency like COVID-19. It also includes a free calculator that works out price, markup, and margin from whatever you already know.

What Is Profit Margin?

Gross profit margin is the share of each sale you keep after removing the cost of the goods sold. It is expressed as a percentage of the selling price.

Gross margin % = (sales - cost of goods sold) / sales

What Is a Good Margin?

It varies widely by industry and business size. A grocery store can thrive on thin margins because it sells huge volumes, while a software company may need far higher margins to cover development. For a benchmark, the margin data published by Aswath Damodaran at NYU Stern shows the average net margin across U.S. companies at roughly 10%, with individual industries ranging far above and below that. Compare your own numbers with your industry rather than a single rule of thumb, and remember that net margin, after all expenses, is always lower than gross margin.

What Is Price?

Price is the dollar amount you set for your product or service. It needs to be high enough to cover the cost of the product or service plus freight, rent, and every other expense, and still leave a profit.

Selling price = cost of product + markup

Keystone Pricing, or What Is a Good Markup?

In retail, a common rule of thumb is keystone pricing: doubling the wholesale cost to set the selling price. That is a 100% markup, which produces a 50% gross margin. A $20 item sells for $40. You still need to take your own costs and market research into account, but keystone is a useful starting point because, in many retail categories, it covers operating expenses and still leaves a profit. Many products, especially in competitive categories, use lower markups, and some specialty items use higher ones.

What Is Markup?

Markup is the amount you add to a product's cost to reach the selling price, expressed as a percentage of the cost.

Markup % = ((price - cost) / cost) x 100

Markup vs. Margin

The definitions are above, but it is easy to confuse them, especially if you do not use them often. They use the same inputs, price and cost, but they are not the same thing, and the same sale produces two different percentages.

The key takeaways: profit margin is the share of revenue left after paying the cost of goods sold, and it is measured against price. Markup is the difference between price and cost, measured against cost. Because markup divides by the smaller number, it is always the larger of the two percentages. Mixing them up is how businesses end up with thinner margins than they planned: someone aims for a "40% margin" but applies a 40% markup, which is only a 28.6% margin.

Considerations When Determining the Price of a Product or Service

Your brand image. The lowest price in the market may make your product look cheap, while the highest price could price you out of the market.

All of your costs. You have to cover every cost and then some. The formulas in this article help make sure your margin is what you expect, not just your markup.

Your customers' expectations. What do they expect to pay? If you are brand new, they may have no expectations, depending on your marketing. If you are established, is the price in line with others?

Perceived value. How do customers see your product compared with others in the market? Can you justify the price, and does it deliver an appropriate level of value?

Testing. You may want to price products for an A/B test to see how customers respond at different price levels.

Example: Launching a New Bath Product

Let's put it all together. Say a new bath product costs $20. Competitor and customer research shows that a selling price of $30 is appropriate, not the cheapest in the market and not the most expensive, so that is the target. We need to find the markup and confirm the price covers costs by finding the margin. After reviewing costs, the business knows it must make at least 15% gross margin on this product for it to be worth selling.

Markup

Markup = (($30 - $20) / $20) x 100 = 50%

Margin

Gross margin = ($30 - $20) / $30 = 33.33%

Result: with a 50% markup on cost, you sell at $30, which leaves a 33.33% gross margin, comfortably above the 15% minimum. It looks good. Note that this is not keystone pricing; keystone would put the price at $40.

Markup and Gross Margin Reference Tables

These two quick reference tables convert markup to gross margin and gross margin to markup. The third column shows the selling price on a $100 cost, so you can check the math at a glance.

Table 1: Markup to Margin

Table 2: Margin to Markup

The formulas behind the tables are simple. To convert markup to margin, divide the markup by one plus the markup: margin = markup / (1 + markup). To convert margin to markup, divide the margin by one minus the margin: markup = margin / (1 - margin).

Free Markup and Margin Price Calculator

Use the calculator below to price a product or service. Enter your cost per unit, then whichever you already know: the selling price, the markup, or the margin. The calculator works out the other two, the profit per unit, and the gross profit on the number of units you expect to sell.

Enter the minimum gross margin you need, and it tells you whether your price clears it and what price would be required if it does not. The example uses the $20 bath product at $30. Copy it to Excel with live formulas or print it.

How Do Margin, Pricing, and Markup Tie Into COVID-19?

During COVID-19, many prices rose as supplies ran short across several industries. It may have seemed like a good time to raise prices, since it looked like everyone else was doing it, but there are things to watch for. When you set your markup during an emergency, be careful to avoid price gouging. Outside an emergency, an inflated price usually just means the product does not sell. During a declared emergency or disaster, it can also mean legal trouble and lasting damage to your brand.

What Is Considered Price Gouging?

Price gouging is when a seller raises the price of a good or service far above what is reasonable or fair, typically during an emergency. According to the National Conference of State Legislatures, most states have statutes or regulations that define price gouging during a disaster or emergency, and the rules, including what size of increase is allowed and when they apply, vary from place to place. Check the rules where you sell before raising prices during an emergency, and make sure any increase is tied to real increases in your own costs.

If you want to report price gouging, PIRG explains how to identify and report it.

Final Thoughts

Following the considerations above and using the formulas and tables will put you in a strong position to price products and services appropriately, in normal times or during an emergency. Price from your costs, check your margin rather than just your markup, and compare against your market.

When you are ready to track costs, quotes, and invoices in one place, Updoot is business management software for $5 per user per month.

Sources

Operating and Net Margins by Industry (Aswath Damodaran, NYU Stern)

Price Gouging State Statutes (National Conference of State Legislatures)

How to Identify and Report Price Gouging (PIRG)