Marketers are not necessarily renowned for our ability with maths. However, in order to carve out a good deal every now and again it is good if you can crunch the odd number or two. My article today is intended to help business owners double-check that they have their head around a pretty important set of numbers. Your ‘Margin’ or ‘Mark Up’.
This may seem obvious to many of you and I apologise if you consider the following to be along the lines of teaching you how to suck eggs. However, over the years I have found many business owners get their mathematical neurones twisted in a knot when under pressure and in front of prospective importers, distributors and brokers.
A few years ago the team at Baker Marketing were engaged to complete a survey of importers, distributors, wholesalers and brokers and their approach to pricing and margin structures. The companies surveyed were based in Australia (SA, NSW, VIC), Singapore, Hong Kong, UK and US.
One of the outcomes of the survey that surprised me was the way that the individuals surveyed used the terms ‘Margin’ and ‘Mark Up’ interchangeably. The two terms were used interchangeably irrespective of which method of calculating profit they were actually using.
Prior to completing this survey I knew that many business operators often confused the two terms when calculating pricing and/or negotiating with distributors. However, after the survey I could see how important it was to have a strong understanding and clarity regarding the two terms prior to negotiating with interstate and export distributors.
The Sausage Roll Exercise
This is where I reveal my Sausage Roll Exercise. The Sausage Roll Exercise is a scientifically proven remedy for overcoming confusion in the face of adversity. The above mentioned adversity being negotiations with a foreign speaking prospective distributor in an unfamiliar export market. The Sausage Roll Exercise simply walks you through two similar but different scenarios.
Scenario No. 1 – you are a supermarket operator selling sausage rolls and you calculate your profit on a ‘margin’ basis.
Scenario No. 2 – you are a snack bar operator also selling sausage rolls and you calculate your profit on a /mark up’ basis.
(Hint: They are exactly the same sausage rolls.)
Scenario No.1 – The Supermarket and the ‘Margin’
In Scenario No. 1 we assume that we are a supermarket operator (please refer to the graphic above). Supermarket operators generally calculate their profit per stock keeping unit on a ‘margin’ basis and so that is what we will do in this exercise. To calculate our profit we subtract the cost of the goods sold from the final price (excluding GST). To then calculate our ‘Margin’ as a percentage we simply divide the profit by the sell price.
In the exercise above we bought the product in at $1.00 and sold it for $2.00. The profit margin is $1.00 which when divided by the sell price ($2.00) equates to a 50% ‘Margin’.
Scenario No.2 – The Snack Bar and the ‘Mark Up’
In Scenario No. 2 we assume that we are a snack bar operator (please refer to the graphic above). Snack Bar operators in various export markets often use ‘Mark Up’ as a way of calculating their profit per stock keeping unit. So this time we will calculate the ‘Mark Up’ on the exact same sausage roll. To calculate our profit we subtract the cost of the goods sold from the final price (excluding GST) (Note: This was the same in the first exercise). What is different is that when calculating our profitability in terms of ‘Mark Up’ as a percentage we divide the profit margin by the original buy prices.
This means we divide the $1.00 profit by the $1.00 buy price. This then equates to a ‘Mark Up’ of 100%.
Maths or Magic?
As you can see, the same $1.00 profit margin equates to 50% ‘Margin’ or 100% ‘Mark Up’.
Question 1: Do Snack Bar operators really make twice as much profit?
Question 2: Will you be able to retire earlier if you only calculate your profit on a ‘Mark Up’ basis?
Question 3: Should all supermarket operators convert their outlets to snack bars?
Answer to 1, 2 and 3 above: Don’t be silly! It’s just a different way of calculating your profit margin but it is pretty important to get right.
Why is knowing the difference important?
Thinking back to the survey that I mentioned at the start of this article I noticed that it is very easy to get confused when dealing on foreign or export turf.
Often when you have progressed discussions in a certain way it can really undo everything when you say you made a mistake and you have to start again.
The danger is that negotiations progress a little way down the track before you realise the other side was talking ‘Mark Up’ whilst you thought they were talking ‘Margin’.
Imagine if you said:
“Margin? I thought you were talking Mark Up. Wow! That changes everything, can we start again?”
The key is simply to ensure that you know the difference in the heat of negotiations and especially when dealing in foreign lands, currencies and languages.
I have found that by having a good understanding of this simple Sausage Roll exercise you can quickly take a moment to re-group in the midst of discussions and negotiations and quickly double-check your numbers. This will help you be confident that you know your ‘Margins’ and ‘Mark Ups’ from your ‘Sausage Rolls’.