If you are a marketer or business owner, you must know how to calculate margin. Not only is it helpful to measure the margin your product generates, but you may also benefit from being able to calculate the margin of the rest of your distribution channel. After all, if you are a manufacturer, you will likely be dealing with distributors and retailers before your product reaches the final customer.
There are two basic formulas that you will find helpful:
Margin = Selling Price – Cost
Margin % = (Selling Price – Cost) / Selling Price
Margin in Action:
Margin is equal to your selling price minus the cost to produce your product, while margin percentage is equal to margin divided by selling price. For example, let’s compare two companies that sell shoes for $100. Company A’s shoes have a cost to produce of $10 while Company B’s shoes have a cost to produce of $50.
As such, Company A’s margin is $90 and margin percentage is 90%, while Company B’s margin is $50 and margin percentage is 50%. Thus, although both companies appear to be the same when comparing their selling prices, Company A’s margin is considerably greater than that of Company B. Although this is not a reflection of actual sales, Company A benefits more from one sale than Company B.
Adding a Link to the Chain:
Let’s circle back to Company A’s shoes. Company A has expanded, and its distribution channel now involves a distributor and retailer before reaching the final customer. As established previously, Company A sells its shoes to their distributor for $100 and generates a 90% margin percentage. Both the distributor and retailer want a margin percentage of 20% and want to know the retail price to the consumer.
How would we go about this?
Easy, we would circle back to the margin percentage formula but transform it so that we are solving for selling price instead:
Selling Price = Cost / (1 – Margin %)
We want to get to the final retail price to the consumer, but we must work our way there. We only know that Company A’s Selling Price to their distributor is $100. This number is the distributor’s cost, and we know that the distributor wants a 20% margin. If we substitute these values into the equation, it looks as follows:
Distributor Selling Price = $100/ (1 – 20%)
= $100 / 0.80
The distributor sells Company A’s shoes to the retailer for $125. To get to the final price to consumer, or the Retailer Selling Price, we would go back to the Selling Price formula once more. Substitute $125 for the cost to retailer and 20% for margin percentage:
Retailer Selling Price = $125/ (1 – 20%)
= $125 / 0.80
For the distributor and retailer to have a 20% margin on Company A’s shoes, the final price to consumers would be $156.25.
Utilize the margin, margin percentage formulas and variations to better understand the degree to which you benefit from your revenue. After all, your product may be selling at the same rate and price as your competitor, but you may be benefiting less if you have a higher production cost. In addition, these formulas will give you an upper hand when negotiating and gauging your relationship with other members of your distribution channel. Good luck!