Okay everybody, we're now going to get some terminology down, some language.
And in particular we're going to talk about margins and markups.
And how those are different, and how they're used in practice.
Margins occur across the distribution channel.
So everybody in business basically tries to make a margin, right?
All that means is you're selling it for more than you're buying it or
making it for, right?
So that's the goal of a lot of businesses, so
to have a positive margin is a good thing.
What we need to be very careful about, is how we use the terminology
to make sure that when we're talking to other business people,
we use the language that they understand and that they can interpret correctly.
So, what is a margin?
Margin is just the selling price minus the cost to produce, right?
So, that's the basic formula.
And remember cost to produce
could be the manufacturer who's actually making the item.
The cost to produce an item for
a retailer is just the amount that they're buying it for, right?
Whatever is the cost that is to get that good in the door.
It's often expressed as a percent as well.
So the selling price, think about that, is 100%.
That's a 100% of the cost to consumers.
And then you subtract out the cost,
which is equal to either the manufacturing cost or the cost to buy it.
And then that's the margin, the percent margin for that particular business.
So imagine your selling price is $100 and your cost to produce is $75.
What's the margin?
I bet you all get this.
It's just 100 minus 75 equals $25, and that's your margin.
Everybody I know, I have a daughter in the second grade, and
this is kind of math I would do with her at home.
So I know you're not in second grade, and you can do that subtraction.
The key here is not the math, it's to make sure the terminology is correct.
And that is a margin or a dollar, what we sometimes call a dollar margin, okay?
So a percent margin is the selling price minus the cost,
divided by the selling price.
Now, this is a key point to make.
Sometimes, if you hadn't taken this course for example, you might think that
a percent margin would be selling price minus cost, divided by cost.
It's not, margin is defined on a percent basis as divided by the selling price.
In a minute, I'll show you a markup,
a percent markup that's going to have a different formula.
Now, I just did a little bit of algebra on this formula right up here.
And you can see from that, that if you know the percent margin, and you know
what it costs you to produce it or buy it, that directly suggest a selling price.
The reason that formula can be useful sometimes,
as you may have a target margin.
You may know that in this business, you want to make a 30% margin.
And this allows you to see how your ultimate selling price would fluctuate,
based on the cost that you can procure the item for, and
also based on any kind of target margin that you may have.
So that's just that formula, rewritten.
So what's a markup?
Well, in a dollar sense, or whatever currency you're working in,
a markup in a margin is exactly the same.
So, if a percent or decimal is used, that's when the trick part comes.
That's when a margin and markup are going to look different.
And different businesses talk in terms of margins or markups.
And you need to make sure which one they're talking about.
So you don't get confused and
you really know what that 20% means on any particular item.
So, how do you calculate a markup?
A markup is that selling price minus cost.
So that looks a lot like margin, but here you're dividing by the cost, okay?
So sometimes smaller retailers will use markups,
and larger retailers will use margins.
The truth of the matter is, everybody, you just gotta figure out whatever industry
you're in, and figure out what the conventions are.
Some use margins and some use markups.
And I just rewrote this formula, just like I did with the margin before.
So that if you have a target markup percent and
you know the cost of procure, that directly suggests the selling price.
An example, lets just do a quick one to show you how the percentage of margins and
markups are different.
Suppose your selling price is equal to $10, and
the cost to produce it or buy it is equal to $5.
Then the way you would do percent margin is to take the $10,
subtract off the $5, and then you divide that by the selling price, right?
That's 10.
So your margin here is 50%.
Your percent markup on the other hand.
So markup is equal to that same $10 minus $5,
but you're dividing that now by the cost which is $5.
So here that markup is going to be 100%.
So you can see it's sometimes not a real trivial difference.
It's not like the difference between 19 and 20%.
These numbers can look quite different in a lot of real-world situations.
So I would end this segment by saying, look, you all can do the math.
Just make sure you know when you're speaking to someone about how much money
you intend to make on a product, or how much money they're making on a product.
And you're talking about margins and
markups, make sure you know which one is which.
Jean Manuel IzaretSenior Partner and Managing Director, Leader of BCG’s Global Pricing Practice
Thomas KohlerAssociate Director, Pricing
Ronald T. WilcoxNewMarket Corporation Professor of Business Administration & Senior Associate Dean for Degree Programs
