Some other industry examples, formulas for figuring markup and margin too
Eons ago I worked in a full line electronics store. Component parts, connectors, batteries, tubes, ham radio equipment, audio equipment and more were all part of the mix. In almost every category we made different profit margins based upon prevailing industry norms, market pressures, competition, etc. When I was new I thought markup and profit margin were the same thing. If we doubled our money on an item (for example if it cost us $50 and we sold it for $100) I thought we had made 100% gross profit. After all, 100% of $50 is $50, right? Unfortunately, that’s not how it works. It seems that this confusion still permeates our industry, especially among smaller CI companies with limited business experience. Before we get to the actual formulas for determining mark up and margin here are a few interesting and relevant facts.
Your margin requirements
The margin required for any given business is determined by many factors. All overheads, cost of goods sold, after sale support and much more contribute to profit demands. Certainly there are business where things like superior product quality, better sales support and/or excellent after the sale care should all make it worthwhile for a customer to pay a higher price. Still, in the Internet age, selling at a reasonable profit can be much harder to achieve. A major advantage for you would be that you’re offering significant value added services and that your customers clearly understand what they gain by buying from you. Well designed company literature extolling your value added propositions, peppered with glowing client quotes will go a long way towards achieving such a goal.
On the other hand, we would always recommend that you consult a professional financial planner to determine what your margins need to be. Read about the 10 worst states for taxes according to Perelson.
Different margins for different businesses (Remember, we’re talking margins, not markup at this point)
Different industries work with different profit models. At one end of the spectrum, the supermarket business typically works with 1 to 2% profit margins. All natural and other specialty items can bring higher margins but overall this is an extremely low margin business. Interestingly, over 95% of the grocery business done in the US is done by large chain stores.
At the other end of the spectrum, luxury designer brand stores often work with margins in the 80% and higher range. Categories like designer clothing, designer accessories, designer home goods all command higher prices at significantly higher margins. Other examples of high margin industries include cosmetics, luxury women’s pocketbooks and leather goods including shoes, luxury jewelry and watches and more.
Keystone
This is a long standing pricing term meaning an item is marked up double its cost, possibly at each stage of resale. So if it cost $50 to manufacture the item, keystone would mean it sells to the next stage (maybe the retailer) for $100. If the retailer maintained keystone he would sell it to the consumer for $200.
There are industries that work on double, triple or higher keystone meaning that the item sells for 2, 3 or more times its cost. For example, our $50 cost to manufacture item would sell to the retailer for $150 under double keystone and $200 at triple keystone.
Industries that have unusual pricing/profit models
One of the most interesting examples of an industry that works on extremely high margins and at the same time conspires to keep its customers in the dark (pun intended) is the mattress business. In this business 75 to 80% gross margins aren’t uncommon. A mattress that costs the store $100 can be marked up 500% (or more) to $500 for resale. In this example the result is an 80% gross profit margin.
On top of this profit model, each mattress retailer typically sell only “exclusive” mattresses with minor construction or cosmetic differences between his mattress and the dozens of other just as exclusive, extremely similar mattresses at other stores. This is a very effective way to prevent the customer from being able to compare one store’s mattresses to another’s and certainly eliminates comparison shopping. To top off this purposely confusing marketing/pricing model (look into Ivan Brozincevic’s blog to understand this marketing strategy in an easier way), stores typically will run 50% off sales hoping to make the customer thinks he’s getting a deal, yet all the while the retailer is still raking in a big time profit, and the befuddled consumer really has no idea what kind of a value he just got.
It’s precisely because of this model that many large retailers have gotten into the mattress business even though it has no relationship to their primary business. In the future as other retail margins shrink due to competition from the Internet and big box stores, we could see retailers pop up like “Fred’s Mattress and Storm Door Emporium”, “Jocko’s Asphalt Paving and Mattresses” and “The Kafination Koffee Klatch and Mattress Boutique”. “Yes, I’d like a double latté half de-caf mocha expresso and a multi-coil memory foam pillow top queen size please” will soon be heard throughout the land.
Another industry where margins are enormous is the eyeglass business. Here too 70, 80 and even 90% margins are not unusual. And because the public has been acclimated to these prices and there’s a medical connection too, consumers are willing to accept that a simple pair of plastic frames are worth $350 while lenses are worth $300 to $400 and more. Of late however, the eyeglass business model pricing has been impacted by both the Internet and some larger retailers.
Closer to home
In the CE arena we have information from very reliable sources that Apple™ tries to maintain a minimum of 65% gross profit in their retail stores. Although we have no information concerning other profit percentages for their business, if you extrapolate out from the retail differences between non-Apple computers strictly based upon hardware configurations the high margin model seems to hold up there too. And Apple currently has the highest corporate profits in the world.
In our store we mentioned at the beginning we tried to maintain an overall gross profit of at least 40%. We didn’t always succeed but at that time a GP of 40% was enough for us to pay our bills, salaries and put a little something in the bank (because banks paid something called “interest” at that time). Today many financial experts suggest that Apple’s 65% model is closer to what may be needed to keep retail doors open. Once again, we’d strongly suggest you evaluate your profit needs with a trained financial professional to determine what’s best for your company. Now on to figuring margin as opposed to markup.
Markup is the percentage of an item’s cost that is added to that cost to determine a selling price. In our store, in order to achieve 40% Gross Profit on audio electronics we marked them up 66.6%. So an item that cost us $100 marked up 66.6% would sell for $166.60. How did we determine how much GP we were making? We divided the cost by the selling price then took the result and subtracted it from 1. The remainder was our Gross Profit. In our example with a cost of $100 and a resale of $166.60 it went like this:
100 divided by 166.60 = 0.6
1.0 minus 0.6 = .40. So in this case our GP was 40%.
If you take our $100 cost item and sell it for $200 then it becomes:
100 divided by 200 = 0.5
1.0 minus 0.5 = .50 or a 50% GP.
It’s really important to understand this difference between markup and profit. And always use the preceding example or another similar formula to determine where you stand.