Tips & Tools for Small to Mid-Sized Business Owners & Leaders February 2025 The Inspire Results newsletter is published monthly
Pricing by Margin: The Pitfall of Pricing by Markup
The Problem with Markup Pricing
Many business owners fall into the trap of pricing by markup instead of pricing by margin, which can inadvertently erode profits. As a small business owner, setting the right price for your products or services is crucial for profitability and long-term success. Understanding the difference between these two pricing strategies—pricing by margin and pricing by markup—and their impact on your bottom line can make the difference between the small business that slowly goes out of business and the small business that grows and prospers.
Understanding the Problem
Markup is the amount added to the cost price of goods to cover overhead and profit. It is usually expressed as a percentage of the cost price. For example, if a product costs $50 and you apply a 50% markup, the selling price would be $75. On the other hand, margin is the percentage of the selling price that is profit. Using the same example, a $25 profit on a $75 selling price results in a 33.3% margin.
The problem arises when business owners use markup to set prices without considering the actual margin. This can lead to prices that seem profitable but fail to cover all costs, especially as overheads and other expenses fluctuate. Over time, this can significantly impact profitability and sustainability.
Step-by-Step Process for Pricing by Margin
1. Calculate Your True Costs: Start by identifying all costs associated with your product or service. This includes direct costs (materials, labor) and indirect costs (overhead, marketing, utilities).
2. Determine Your Desired Margin: Decide on the profit margin you need to achieve to cover all costs and generate a profit. This should be based on your vision, your long-term business goals, and industry standards.
3. Set Prices Based on Margin: Use the following formula to set your prices based on the desired margin:
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