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Mark-up or Margin, what is the difference.

 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.

 but to save a little time, here is a table:

                         Mark-up %                  Mark-up Factor           Margin %

                           10.00%                                 1.10                    9.09%

                           15.00%                                 1.15                 13.04%

                           20.00%                                 1.20                 16.66%

                           25.00%                                 1.25                 20.00%

   33.33%                                 1.33                 25.00%

                           40.00%                                 1.40                 28.57%

                           50.00%                                 1.50                 33.33%

 As you can see, the margin mark-up disparity increases as the mark-up increases. So remember, to get your 25% margin, you need to mark-up by 33.33%. By doing that you increase you profit by 5%.  For the mathematically minded, it is interesting to rework the formula for gross margin in terms of mark up factor, and you get:

Gross Margin %    =   Markup %/Markup Factor.

This rework clearly shows that the resulting gross margin percent must always be less than the markup %..

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.

(Just for interest, some of you may want a formula for finding the markup factor for a specific gross margin. That is quite simple - it is:

Mark up factor = 1/Gross Margin % all *100.)

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.

A more detailed  table!

To download the table click here!

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The Author After 25 years consulting to small and medium sized companies, Mike Anderson, principal of Train Me To Be a CEO realized that the most important part of his work was training the CEO, and the reason he was such a good consultant was that he did that very well. Trained as an engineer, he became a CEO of a midsize corporation at the age of 35. After a spell at Harvard Business School he entered the world of consulting. Read More

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