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Retail Math: Markup vs Margin

Updated: May 23

In the world of retail, markup and margin often cause confusion due to their seemingly similar functions. In fact, people sometimes use these terms interchangeably. While both are important inputs in driving profitability and analyzing overall financial health, the two are vastly different. In this post, I'll demystify the concepts of markup and margin, highlight their differences, importance, and provide examples to help you apply these methodologies in real time.


 Markup vs Margin Table of Contents


In my retail 101 post, I explain that cost, markup, and retail are three of the most impactful components of achieving profitability. Markup is the amount added to the cost to calculate the retail or selling price. Said another way, it's the difference between the retail and cost. How does one determine the markup? Well that comes down to a few key considerations such as,  profitability goals and market value.

 

Retailers' profitability goals help inform how much markup dollars should be added to the cost to determine the retail price. However, retailers also have to be cognizant to ensure that their product isn't priced above market value. This is especially apparent in commoditized businesses like produce.



markup calc

For example, if organic granny smith apples are widely sold for $.90 per apple, it would be difficult for a grocer to justify a retail price of $1.75 per apple to its customers. This is because there is no true differentiator between one organic granny smith apple from another. In other words, "an apple is an apple". Customers are likely to either buy their granny smith apples elsewhere, or opt for a different, more appropriately priced fruit. This means that the sales for the grocer's organic granny smith apples, would suffer. This would likely result in things like excessive inventory, food spoilage, lost sales, and overall unprofitability.


Markup vs Initial Markup


I think the biggest contributor to the confusion of differentiating markup vs margin is stemmed from the lack of understanding the difference between markup vs initial markup. Afterall, markup is literally part of both words. However, they are very different. The biggest differentiator between the two is that as a rate, markup is in relation to cost and initial markup is in relation to the initial retail price. This means that initial markup is more closely related to margin as opposed to the basic markup rate (in relation to cost). I'll go into more detail to help delineate between initial markup and gross margin a bit later. First, Let's take a look at the formula, for markup.


markup formula



Understanding Initial Markup


When working with vendors, retail buyers often reference a product's initial markup (IMU). IMU looks at the initial retail price, less the cost. This means that IMU only considers the base retail price of an item. It does not take into account the actual sell price of an item.

 

IMU is typically expressed as a percentage in relation to the initial retail price. This allows retailers to better assess whether product will be profitable for them.  For example, if a buyer has an assortment that comprises of thousands of women's shoes across varying price points, simply looking at an item's markup dollars doesn't really indicate anything. A markup of $50 vs $100 doesn't  gauge potential profitability, given the wide range of assortment and price points. That's because an item's markup dollars isn't a measure of profitability, it's merely an input. 

 

However, if the Buyer knows that, on average, the items within their assortment has an IMU rate of 50% and this rate allows them to achieve their profitability goals, that information is  far more useful. That's because this rate can serve as a solid benchmark regardless of an item's price.


How to Calculate Markup


markup calc

Building on the examples above, Item A has markup dollars of $100 and Item B has a markup dollars of $50.



how to calculate markup


markup calc

Even though the markup dollars are higher for Item A, Item B is a more profitable item. In fact, Item B does not meet the Buyer's IMU goal of 50%.


What is Margin?

 

In retail, there are varying levels  of "margin" when it comes to assessing profitability. For the sake of simplicity, in this post, we'll be focusing on gross margin (GM). Unlike initial markup, which only considers the initial retail of an item, gross margin takes into account the actual revenue generated for an item (actual sell price). Gross margin looks at total revenue, less the cost of goods sold (COGS). This is in relation to total revenue.


For example, Item B has an initial retail of $100. However, the retailer runs a sale for 25% off and the item sells for $75. When calculating gross margin, the initial retail becomes less relevant because when an item sells for less than it's initial retail, there is a dollar gap that we need to take into account to better understand profitability. Because an item's sell price can fluctuate, we look at the revenue to calculate gross margin. This is because revenue is generated based on the actual sell price for goods or services. Like IMU, gross margin is typically referenced as a percentage. Let's see this in action in the example, below.


How to Calculate Margin


gross margin calculation

Using Item B from above, we know that it's initial retail is $100. However, the retail Buyer decides to run a sale for 25% off. The Buyer wants to analyze sales for the month. She sees that 500 units of the item sold at the sale price of $75. However, 100 units sold at the initial retail price of $100. The Buyer wants to calculate the gross margin.


gross margin calculation

In order to solve, the Buyer must calculate the revenue generated based on the final sell price for the units sold.


how to calculate gross margin

how to calculate gross margin

We see that while, the initial markup rate for the item was 50%, the gross margin rate for the item is 37%, a meaningful difference, which is why gross margin is much more indicative of potential profitability for an item.

 

Conclusion

When assessing markup vs margin, the biggest difference between initial markup rate and gross margin rate, is that initial markup rate only takes into account an item's initial retail. Whereas, gross margin takes into account an item's actual sell price by utilizing revenue. Both initial markup and gross margin are important factors to consider when working to drive profitability. However, initial markup is better suited when a retailer is assessing profitability potential before an item generates revenue. For example, when initially selecting items for an assortment. Gross margin is a much better and more accurate metric to assess profitability potential once revenue has been generated.

 

 


retail consultant

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