The Difference Between Markup and Margin

Markup vs margin—know the difference or risk losing money. In this video, Steve shares the costly pricing mistake he made early in his business journey—and how you can avoid doing the same.

You’ll learn the real difference between markup and margin, the exact formulas to use, and how to price your products or services with confidence. If you want to protect your profits and avoid common pricing traps, this one’s a must-watch.

TRANSCRIPT:

When it comes to pricing products and services for a company, there's a major difference between markup and margin. And I'm going to explain the big mistake that I made early on in business that cost me so much money.

And here's the deal. It's a simple calculation and it could cost you thousands, if not millions of dollars if you're making the same mistake. So let me explain.

When I was first starting out in business, I had a landscape company. And here's one of my workers with a little wheelbarrow. And we were doing these projects where we'd plant trees like this. We'd put in boulders, some flowers. We'd also build things like a fire pit.

Now, when I was doing these jobs, I would just price them out in the beginning as a lump sum. So for example, here, I'd say this project is $100,000. And then the customer would say, great, I want you to do it.

So we would start doing these projects. And then inevitably, a lot of customers would say, hey, while you're out here, can we plant some more trees? And why don't we do some more boulders, right? Let's do some more boulders over here. And then let's build a gazebo over the fire pit.

And yeah, can you just give me a price to keep things going? I said, sure. So to make it easy, I would give them a price. And I would turn this around pretty quickly.

And I would use a different technique than what I used to come up with this lump sum price, which involved a very complicated calculator and whatnot. So on the spot, I would just say, OK, let's just do some easy math.

And this is where I'd make my mistake. Let's say I added up all the material and the labor cost of this additional work. And I'm going to keep it really simple here. And let's say those costs were $1,000.

Now, let's also assume I wanted a profit margin of 40%. All right, that was my target. So then I would just take $1,000 times 1.4. In other words, 40% is 0.4 times 1 to get 140% markup. And then I would come up with $1,400, right?

And then I would give this bid to the customer. And they would say, great, go ahead and do it. And I'd do it.

And then I realized the more additional work that we were doing on these projects, the less profitable we actually were. And I was like, what the heck's going on? We're doing more work. We should be earning more profits.

Here's the deal. With this, this is the mistake. So I charge the customer $1,400. This is my price that I came up with, with my 40% markup.

But if I take my materials and my labor and I subtract them out, then I'm left with $400 in profit. So $1,400 is my price, $1,000 in cost, and I get $400 in profit.

Now, let me pull up my handy-dandy calculator here. If we take $400 in profit and we divide it by the price, $400 divided by $1,400, guess what that gives me? A 28.6% margin. $400 divided by $1,400, 28.6% margin.

Well, what the heck? I wanted a 40% margin. So where am I going wrong? And this is the calculation that so many people get wrong.

And if you don't catch it early enough, you just think everything's great because you're doing the math. You're multiplying it by 140%, right, to get your 40%. But this is the weird math.

Now, I'm not going to explain all the math to you and make it even more complicated, but it's really simple. Instead of multiplying your cost times 1 plus your desired profit, or 1.4 in this scenario, you have to divide it by this.

You have to take your cost and you divide it by 1 minus your desired profit. That's what you need to know, okay?

If I did this instead, let me just walk you through this math here. I'll do it up here where I have a little bit more room.

If I took the same $1,000 in cost and instead of multiplying it by 1.4 like I did here, I'm going to take 1 minus my desired profit, which is 0.4 for 40%, which is 1,000 divided by 0.6. And if I do that, then I come up with 1,667, okay? It's kind of scary.

Let me just round it. 1,667, that should be the price because then if we do the backwards math and I take 1,667, this price, which I got from taking 1,000 divided by 1 minus my desired profit, not 1,000 times 1.4, check this out.

I have 1,667 is my price minus my cost. My costs are still the same, 1,000 bucks. I end up with 6,67, can't even write here, 6,67 in profit.

And then if I do the same math, 6,67 divided by 1,667, then I get 40%. And that's the major difference between multiplying your cost times 1 plus your desired profit and dividing your cost by 1 minus your desired profit, okay? That's the big difference.

I know it's such a simple calculation, but it's not very intuitive. You're like, what the heck? Why am I dividing it by this? Why don't I just multiply it by this? But I could tell you if you don't do this, you're losing out.

I mean, look in this example, I'm losing out on, what is it? 13.4% of margin just by doing bad math. And when I realized this, I was like, oh my gosh. I was doing this on so many projects, and I lost thousands and thousands of dollars in the process.

So I was working harder, and I was losing more money the harder I worked. So just remember that this right here is margin, okay? This is margin.

And remember, we figured out margin by taking our profit divided by our price. And markup, markup is this. This is your markup right here.

Okay, so the markup is 1 minus your desired profit. This is not markup. Please do not do this.

All right, happy calculating. Until the next time, cheers.