What is Price Margin? Definition, Benefits & More | Vendavo (2024)

What is a Price Margin?

Pricing margin – or profit margin – isthe difference between the cost of an itemandthe price at which it is sold. The aim, therefore, of most businesses is to make as much profit margin as possible while ensuring prices stay competitive.

There’s no denying that pricing is crucially important. It defines the value of your product, services, and business as a whole, and acts as a reflection of what you work towards as an organization.

Your prices are the final point that lets a customer know whether or not your business is worth investing their time and money in. Getting it right is therefore a delicate balancing act, one that needs to be struck between pricing for profit and maintaining healthy sales.

But how can a price be set effectively? One option is to use theprice margin model.

Price Margin versus Price Markup

Most people are already aware of what aprice markupis. When a company sells a product, they will typically sell it at a higher price than it cost them – enabling them to make a profit. This difference in price is the markup. Margin-based pricing is very similar, only it takes more factors into account.

When placing a markup on a product, it will usually involve applying a percentage to add on to the price. So, if a product costs you $100 and you wanted to make $10 per product sold, you’d sell it for $110 – a 10% markup.

When calculating a price margin, however, other costs like utilities, transportation, property rental, and staffing costs, et cetera, are also taken into account. So you will need to calculatehow much these extra costs apply to each unit. How do you do this? By taking the total of the extra costs and dividing it by the number of units you expect to sell.

Once you have worked out what all the other costs are per unit, you then add this number to the cost of the product. So, if the product costs $100 and additional costs are $10 per unit, you come to a total of $110.

At this point, we only havethe break-even figure, without takingprofitinto account. Let’s say you want to make a $10 profit per item; we take the $110 we previously came up with and add the $10 to come to a price of $120.

Why is Margin-Based Pricing Important?

Aprice marginmodel is important because it lets youmore accurately work outhow much profit you are likely to make at a certain price. It might be tempting to look at your competitors and try to undercut them to grab a market share. However, this approach can leave you selling a product for less than what it cost you, meaning you’re actually making alossoverall.

Margin-based pricing helps you know how much you need to sell a product in order to make a profit, rather than setting a price just with sales volumes in mind. If the price after all costs plus your desired profit is too high? Then you’ll know the product is not viable and that you should focus on investing in another product, or at least consider changing product specifications to reduce the cost.

Know Your Margins: The Benefits of Margin-Based Pricing

Knowing pricing margins is one of the key steps in figuring out if a profit can even be made, and how much volume will need to be sold to do so. Margins are ultimately one of the most crucial aspects of a pricing strategy, affording organizations valuable insight into their business performance. Here are some major benefits of knowing your margins:

Added Flexibility

Margin-based pricing also gives youflexibility. It helps you to determine your break-even point accurately so you can calculate the impact of discounts and promotions, and so on, from there. If you’re planning a sale, for example, then a price margin model will let you know if the additional revenue from making more sales is equal to or higher than the total revenue from making fewer sales but without any changes in pricing.

The whole point of a sale is usually to increaseprofits, not onlysales, so if additional profits aren’t made, then you’ll know the sale is not worth it, at least from a profitability standpoint.

Maintaining Brand Value

Previously, we mentioned the risk ofdevaluing your brand, and it’s something to take into account when it comes to your price margin. In many cases, reducing prices to increase sales will improve your profits. But that’s not the full picture. Because if you reduce your pricestoomuch, then it might give the impression that your products, and your brand, are of poor to middling quality. It can be very difficult to lose this reputation once acquired so it’s something to take into account when setting your price margin.

Maintaining a high price margin is something that exclusive brands arealwaysmindful of when pricing for profit. TakeRolls-Royceautomobiles, for example. You’re very unlikely to find a brand new Rolls-Royce discounted because the company wants to maintain the brand’s image as being exclusive. When discounts are implemented, they’re typically“hidden” ones.

Even if keeping a high price margin might reduce profits in the short term, it’s beneficial for the company tomaintain its reputation for exclusivityover the long term. If you want a brand new Rolls-Royce? Then you’ll need to pay a high price margin for it, which helps to make them more desirable to those who can afford it.

The Advantages of a Pricing Margin Model

With a price margin model, it becomeseasier to find the right balancebetween making sales and the profit per unit sold to improve your profit overall. A price margin model also makes it easier to see the benefit or otherwise of discounts and promotions, and helps you to make the right decisions when it comes to which products to invest in.

To sum up? Margin-based pricing canhelp you maximize your profitsin the long term, helping to give you a very desirable edge over the competition.