What is margin, markup and how to set the right selling price.

Online marketplaces offer great opportunities: from a stable flow of customers to 24/7 support for sellers, but success in sales is also associated with other factors. You can choose the high-demanded goods and believe in your business, but set a price too low or high, which either will not allow you to pay back the costs, or frighten off all buyers. We want to tell what is margin, mark-up and why they should not confuse you.

Definitions and differences: margin and markup

To a person who does not have the specialized education and experience, market relations are look like something intricate and sophisticated. Every online shop or company that sell something, exist by a mark-up. The cost of goods or services is added with a certain amount to get the basic price for the consumer. Many people think that there is no difference between margin and markup. Most often these indicators are integrated into one.

What is margin?

Margin is a measure of the profitability of sales or the difference between the price and the cost of goods. The difference can be expressed as a percentage of the basic value, or as a profit for each unit of output.

Margin = selling price — cost of goods

Margin = profit per unit / selling price

Margin should be calculated at the end of the reporting period. For example, once a quarter. If the business is stable, then the margin can be calculated at the end of the year. This indicator shows the profitability of the company. The calculation is necessary to determine the increase in sales. If the final value is large, it will say that the enterprise has high income.

What is markup?

A markup is the ratio between the cost of a good or service and its selling price. The price will be different from wholesale and retail.

The amount of the markup depends on the current state of the market, the demand for this product etc. Without markup, online sales and other similar business do not exist. Markup allows to cover the costs of transportation, storage, salaries for employees, marketing, etc. The markup is calculated using the following formula:

Markup = (selling price — cost of goods) / cost of goods * 100%

During the determination of the markup, you should take into account the competitiveness of the goods and the current position of the business on the market. It is important to know the strategic position of the company’s development regarding possible competitors. Because competitors can sell the same products, but at a lower price. A markup must keep a balance between expected sales and an optimal price.

If the markup is established correctly, its value can cover the cost of goods per each unit. Therefore, your business will get profit from sales of every unit. The markup shows the income from each cent that was invested in the purchase or production of the goods.

How to set prices to bring profit

It is clear that every business wants to receive income and recoup all expenses for purchase, delivery or service. Thus it is important to correctly calculate the selling price of the product.

To avoid losses, calculate and set the retail price that will cover temporary and permanent costs. Do not be afraid to sell expensive. If products are bought even at a high price, then they are worth it.

Before to set prices, answer to three questions:

1. What is the cost of goods? You need to calculate your costs: purchase of goods, delivery, salaries to employees etc.
2. What is the threshold price level? The threshold price is the minimum price that ensures breakeven of the business.
3. What is the demand for your goods? If the demand is low it is less likely to reach profit.

Now you can start setting the price for your products. Besides the classical methods of determining the selling price there are two the most common for the online business: high and low markup strategies.

High markup strategy

Mostly, a high markup in online sales signals about the exclusivity of products. However this strategy is widely used by mass market representatives, when the product or shop has no unique features. These merchants just want to make money by carelessness of customers or through the already formed loyalty to the resource.

Advantages:

1. Every sale brings good profit.
2. The markup allows to provide formally free goods or services to clients: additional equipment, gifts, delivery etc.
3. The high price looks more reliable and psychologically causes trust.

Disadvantages:

1. The number of sales may stay small.
2. Because of the high price the shop will be in low positions of searching.
3. Marketing expenses will be higher due to the competition with cheaper products.

At first glance, the number of advantages and disadvantages is the same. However, if you rank them according to the level of significance, the situation will radically change.

The fundamental task of any online shop is to attract a visitor and influence the decision towards concluding a purchase. So, to persuade a potential client to buy something overpriced is a very difficult task.

Attract a customer through marketplaces when having a high markup is almost impossible. Put yourself in the customer’s shoes. No matter what are you choosing: a vacuum cleaner or a laundry detergent, it is the most likely that you will sort the list by price. And in 99% of cases, with other things being equal, you will choose the cheapest one. Choosing the strategy of high markup, you put your business to the end of the list, where just a few people get.

The only solution to succeed is a well-planned promotion or really unique product.

Low markup strategy

In fact, this is a kind of dumping. The plan to kick out competitors from the market, received the desired profit not by quality, but by quantity.

Advantages:

1. Large volume of orders from the moment of sales start on marketplaces.
2. High traffic to the shop.
3. In case of successful management — rapid formation of a loyal customer base and its active growth due to recommendations.

Disadvantages:

1. Low profit.
2. High risk to become unprofitable.
3. Risk of appearance of a merchant with lower prices.

As you can see, the low markup strategy also has enough pitfalls and dangers. However this approach will bring you a stable flow of customers and will help to establish the brand. Whereupon you will be able to review pricing strategy.

To conclude we would like to tell that it is always up to you which pricing strategy to choose. But keep in mind if your product is unique and marketing capabilities are strong, do not understate prices. While in case when a fast takeover of a market is considered, the lower price is the better one.