Markup vs. margin, and pricing products and services during COVID

Your vision is to launch a new product or service and price it by looking at the market, markup, and margin.

You may do this either as a new business or an addition to your product portfolio very soon. You want to be clear on the difference between markup and margin. This article is going to look at defining margin, price, markup, considerations in pricing your product, how to calculate those, why you use each, handy conversion charts, and using these to price as a general rule, but especially during COVID-19.

What is profit margin?

The amount of money made after removing the cost of the goods from the total sales or revenue.

Gross margin percentage = (sales - cost) / sales

What is a ‘good’ margin?

This varies according to industry and size of business but a general rule according to an NYU report about margins in the U.S. states 5% is low, 10% is good and 20% is high.

What is price?

The dollar amount you are going to set your product or service at to sell. It needs to be high enough to cover the cost of the product or service, and all other freight, rent and expenses.

Selling price = cost of product + markup

Keystone or what is a ‘good’ markup?

In general, a 50% markup is used as a standard rule of thumb in pricing several retail products and you will see this called Keystone. You need to take your costs and market intel into account, but this is a general rule to target as it typically covers most business expenses to still turn a profit.

What is markup?

The amount a product or service is increased above the cost in order to find a final selling price.

Markup percentage = ((price - cost) / cost) * 100

Markup vs. margin

The definitions are above, however, it’s easy to get confused especially if you don’t use them often. Here are the key takeaways to remember.

1. Profit margin and markup are separate from each other, they do not mean the same thing, but they are the same inputs.
2. Profit margin is the revenue made after paying COGS.
3. Markup is the retail price - cost.

Considerations when determining the price of a product or service

• Your brand image: Lowest price in market may make your product or service look too cheap. The highest price could price you out of market.
• All of your costs: You have to cover all costs and then some, so using the formulas below can assist to ensure your margin is what you expect.
• Your customer expectation: What do they expect to pay? If you are brand new, they may not have expectations, depending on your marketing. If you are established, is the price in line with others?
• How does your customer perceive your product compared to others in the market? Can you justify the price? Is it providing an appropriate level of value?
• You may want to price products in order to do an A/B test and see how customers respond to various products at differing price levels.

Example: Launching a new bath product

Let’s put it all together in an example. Let’s say this is a new bath product that costs $20. We’ve done competitor and customer research and we know that a selling price of $30 is appropriate so we would like to target that. It’s not the cheapest in the market, not the most expensive. We need to determine what that markup is and confirm the selling price covers the costs by finding the margin. As a business, you have reviewed costs and you know you have to make at least 15% in margin for this product to make sense to sell.

Markup:

Markup = ((price - cost) / cost) * 100

Markup = (($30 - $20) / $20) * 100

Markup = 50%

Margin:

Gross margin percentage = (sales - cost of good sold) / sales

Gross margin percentage = ($30 - $20) / $30

Gross margin percentage = 33.33%

Result: You can see that with a 50% on your cost, you sell at $30, which leaves you with 33.33% gross margin. Looks good!

Markup and gross margin reference charts

These two quick reference charts for using either mark up to yield gross profit or gross profit to yield a markup.

Table 1 converts markup to margin.

Table 2 converts margin to markup.

How does margin, pricing and markup tie into COVID-19?

Since COVID-19, most are aware of the increases in price as supply is short in several industries. It may seem like a great time to increase prices as it may seem everyone else is doing it, but there are some things to watch for. So as part of determining your product or service markup you want to be sure to avoid price gouging. Of course, if this were done outside of an emergency, product wouldn’t sell, so this statement is primarily geared towards an emergency or pandemic situation. If you price gouge during an emergency, you risk legal trouble along with damage to your brand.

What is considered price gouging?

This is when a seller of a good or service increases the price much higher than is reasonable or fair and it’s illegal in many places, California being just one. For example, Penal Code Section 396 doesn’t allow price increases of more than 10% after an emergency has been declared. This link goes to a site that lists the various states and the stance they take on price gouging laws. As a general rule, a price increase of 20% is considered too much if it’s to take advantage of a situation such as a pandemic and it’s not directly related to increased supply cost. If you are reading this and you want to report price gouging, this is the link to do that.

In summary, following the considerations above and using the formulas will put you in a place to appropriately price products.