Introduction to Margins

Transcription

1 Introduction to Margins This module covers the concepts of margins (currency and percentages), the relationship between selling price, cost, and margins, and total contribution margin. Authors: Paul Farris and Stu James Marketing Metrics Reference: Chapter Paul Farris, Stu James, and Management by the Numbers, Inc.

2 The goal of this tutorial is: Define margins Introduction to Margins Learn how to calculate margins from selling prices and costs, and vice versa In this module, we will only be concerned about calculating margins within a single business entity, such as a manufacturer or a retailer, and won t cover margins in multi-level channels of distribution. Let s start with the basic definition of margin: INTRODUCTION TO MARGINS Definition Margin ($) = Selling Price ($) Cost ($) (Note, in this formula, margin may also be called contribution margin per unit) 2

3 Calculating Margin ($) For example, if a jacket sells for $100 and the store purchased the jacket for $80,what would be the margin (in $) for the store on the jacket? Price $100 Margin $ 20 Cost $ 80 Recall that: Margin = Price Cost, so The margin on the jacket is $100 - $80 = $20 What would the percent (%) margin be? CALCULATING MARGIN ($) 3

4 Calculating Margin (%) That leads us to our second definition: Definition Margin (%) = Margin ($) / Selling Price ($) Margin $ 20 So Margin % = $20 / $100 = 20% CALCULATING MARGIN (%) Price $100 Cost $ 80 If the retail store dropped its price by 10% what would be the new margin ($ and %)? 4

5 Calculating Margin % First, we need to calculate the new price. A 10% price decrease on a price of $100 =.10 * $100 = $10. So, the new price would be $100 - $10 = $90. The cost is still $80. Price $90 Margin = $ 10 Cost $ 80 So Margin % = $10 / $90 = 11.1% Insight Note that in this example, a 10% decrease in price ($100 $90) leads to a 50% decrease in $ margin ($20 $10), requiring them to sell twice as many jackets at the lower price to generate the same total margin. CALCULATING MARGIN % 5

6 Calculating Total Contribution Margin ($) One might want to calculate the total margin generated for multiple sales of the same item in a given time period. This is called Total Contribution Margin. For example, if the margin on an item was $10, and a store sold 500 items / week, what would be the total contribution margin generated by that item in a week? Definition Total Contribution Margin = Margin ($) * Units Sold Margin ($) = $10 Units Sold (week) = 500 Total Contribution Margin = $10 * 500 = $5,000 CALCULATING TOTAL CONTRIBUTION MARGIN ($) 6

7 Calculating Price Using Target Margin Sometimes, a business may want to maintain a particular margin % (target margin), and need to determine their selling price based on this, leading to our third definition. Definition Selling Price = Cost / (1 Target Margin%) Price =? Target Margin 60% Cost $ 40 Sales Price = $40 / (1.60) = $40 /.4 = $100 One might also want to be able to calculate the cost necessary to achieve a target margin for a given price. CALCULATING PRICE USING TARGET MARGIN 7

8 Calculating Cost Based on Price and Margin To calculate the cost based on price and target margin, we can just rearrange the basic formula once more as follows: Definition Cost = Selling Price * (1 Target Margin%) Price = $100 Target Margin 60% Cost =? Cost = $100 * (1.60) = $100 *.4 = $40 This is all very simple math, but margins are one of the fundamental building blocks of business. Know these!! CALCULATING COST BASED ON PRICE AND MARGIN 8

9 Relationships Finally, when you are calculating any of these margin related values, it is helpful to keep in mind the relationships among the variables. RELATIONSHIPS Relationship Definitions* If Price increases, Margin ($) and Margin % increase If Cost increases, Margin ($) and Margin % decrease If Margin ($ or %) increases, then Price must have increased or Cost must have decreased. *Presumes only the single variable changes (e.g. only Price increases and there is no change in cost. If both price and cost change, one must do the calculations) Insight Knowing these relationships is a great rule of thumb to check your work. After you do your calculation, make sure these basic relationships hold. 9

10 Calculating Margins: Sample Problems Question 1: A retailer buys mobile phones for $100 and sells them for $150. What is the retailer s $ margin and % margin? Answer: We know that Margin = Selling Price Cost And that Margin % = Margin / Selling Price Therefore, substituting in our values: Margin = $150 - $100 Margin = $50 CALCULATING MARGINS: SAMPLE PROBLEMS Margin % = $50 / $150 Margin % = 33.3% 10

11 Calculating Margins: Sample Problems Question 2: A manufacturer s product costs $30 per unit. Their target margin is 25%. What price should the manufacturer charge? Answer: We know that Selling Price = Cost / (1 - % Margin) Therefore, substituting in our values: Price = $30 / (1 25%) Price = $30 / (1.25) Price = $30 /.75 Price = $40 CALCULATING MARGINS: SAMPLE PROBLEMS 11

12 Calculating Margins: Sample Problems Question 3: If that same manufacturer discovered that costs had risen to $32 / unit, what would be the new % margin? If they had sold 100 units previously, how many additional units would they need to sell to maintain the total margin for the product line? Answer: We know that Margin ($) = Selling Price Cost and that Margin % = Margin ($) / Selling Price New Margin ($) = $40 - $32 = $8 New Margin % = $8 / $40 New Margin % = 20% Quick check: Costs rise, margin decreases from 25% to 20%. CALCULATING MARGINS: SAMPLE PROBLEMS Previous Total Margin = 100 units * $10 margin = $1000 Previous Total Margin ($1000) / New Margin ($8) = 125 units Therefore 25 ( ) additional units. 12

13 Marketing Metrics by Farris, Bendle, Pfeifer and Reibstein, 2 nd edition, pages And - Margins - Further Reference MBTN Modules: Channel Margins, Breakeven, and Profit Dynamics. These modules build on margins to further explain costs, breakeven, and volume price interactions and their impact on profits. MARGINS FURTHER REFERENCE 13