When setting a pricing strategy, both online shops and manufacturers usually consider a target or a minimum margin level. For manufacturers, the reference point is then the production costs incurred, for the online shop – the purchase price. E-shops using automatic price management (dynamic pricing) often use a certain level of margin as a boundary condition – prices change automatically, but only within a range whose lower limit is determined precisely by the minimum level of margin or mark-up. But what is the difference between these two concepts, what is a shop’s margin and how do you calculate a profit mark-up?
Margin and mark-up – the difference
Both the margin and the price mark-up indicate how much a company earns from a product. Margins and mark-ups are usually provided as a percentage (we then speak of percentage margin). The difference between a margin and a mark-up is that they use different reference points – there are different values in the denominator in the calculations. In the case of a margin, it is the selling price, and in the case of a mark-up, it is the unit production cost (in the case of a manufacturer) or the purchase price (in the case of a shop).
Margin and mark-up – formulas
The easiest way to understand how to calculate margins and mark-ups, and what both are, is to look at the difference in the formulas:
As you can see, although the margin and mark-up calculations are very similar, the formulas are different and a mistake can have significant consequences. The easiest way to illustrate this is with an example.
How are margins and mark-ups calculated? Example
A health and beauty shop buys shampoo from the manufacturer for EUR10. In setting the pricing policy, it was decided that the margin should be no less than 20%. How do we calculate the margin to determine the minimum profitable selling price for this shampoo?
(x – 10) / x = 0,2
x-10 = 0.2x
x = EUR 12.5
So, the minimum price at which a shop should sell the shampoo is EUR 12.5.
What would happen if the employee in charge of pricing mistook a margin for a mark-up?
They could then set the price at a level corresponding to a markup of 20% rather than a margin of 20%. The price would then be
(x – 10) / 10 = 0,2
x = EUR 12
The minimum price (set, for example, as the lower limit in the dynamic pricing) would therefore be EUR 0.50 less. When selling 10k SKUs this would mean a profit difference of EUR 5,000.
Why calculate margins and mark-ups?
In what situations are margins and mark-ups calculated?
Firstly, these are the basic parameters that speak of profitability. They are therefore used to check which products or product categories bring in the most profit for the shop. This is the basis for subsequent decisions on the assortment and promotions.
Secondly, awareness of the level of margins and mark-ups is useful during commercial negotiations with the manufacturer. Low margins and the inability of fierce competition to raise margins can be the basis for talks about more favourable trading conditions.
Thirdly, awareness of current and target margin levels enables effective planning of promotional campaigns. This is because it shows the permissible “spreads” within which prices can fluctuate.
Margin and mark-up versus online shop price
Should the target margin (or mark-up) level be the basis for pricing?
This is an approach characteristic of the ‘cost-plus’ strategy, which ignores customers’ willingness to pay and competitors’ prices and is considered outdated (although still frequently used by some companies).
Does this mean that shops should ignore margin and mark-up levels? No. These are key elements that determine the level of the company’s profit. But they cannot be the only consideration – especially in e-commerce, where prices are extremely transparent.
To learn about how to use a price monitoring tool to set the right price level, feel free to download our ebook on e-commerce price management! In the ebook, we show you how to analyse prices in the marketplace to maximise your e-commerce profits with the right margin:
The advantages of knowing the difference between margin and mark-up when running an e-commerce business
Knowledge of the terms that operate in the economy is essential to correctly analyse your business and optimise profits. Therefore, for e-commerce owners, knowing the difference between margin and mark-up, and being able to calculate both indicators is crucial as they will bring crucial benefits for the business. Which ones?
- More effective negotiations with trading partners. They will result not only from the ability to better analyse the terms, but also from the image of an expert that will be built through the knowledge of such terms.
- Learning the right lessons from sales. Not being able to differentiate between margin and mark-up can result in an online shop owner not being able to generate the right information about the financial policies of their business, which can lead the business into profitability problems.
- More effective sales management in the context of pricing and promotional activities. Price in e-commerce is one of the key factors in deciding whether to buy or abandon an offer. Therefore, intelligent price management can make a significant difference to sales and profits.
- More effective use of data collected by price monitoring tools. By optimising the amount of your offers and reacting to your competitors’ movements, you will be able to meet your financial and sales targets.