Markup and gross margin are measures of profitability used to gauge businesses' ability to make money above their direct costs. Markup is expressed as a percentage of the purchase or material cost of individual products, while gross margin is expressed as a percentage of the direct cost of all goods sold. Knowing the difference and correlation between the two can give you deeper insight into your company's financial performance.
Businesses' core purpose is to earn profit for their owners, and price markup is exactly how this is achieved. A markup represents the amount a company charges above what it directly paid for a product. In retail businesses, a markup is added to the purchase price of specific items. In manufacturing organisations, markup is based on the cost of all materials used directly in manufacturing a product. Service organisations' markup can be more challenging to determine, since service expenses are based more on salaries and tools than on material costs.
Markups can vary greatly between industries, between individual stores in the same industry or between individual products in a single store.
Whereas markup is a more controllable concept, gross margin represents the profit result of sales activities before taking selling, general and administrative expenses into account. Gross margin is based on products' markup, but it includes the full range of products sold during a specific period, each at different markups. This can cause gross margin to represent a weighted average of multiple markups. Refunds and temporary sales promotions can also cause gross margin to differ from the original markups.
Altering product markups can affect gross margin in a number of ways. If you find that your gross margin is too low, increasing your markups can give you a boost. Raising your markups too high, however, can cause your sales volume to drop, effectively lowering your gross margin.
Business owners use a range of techniques to increase gross margin without affecting product markups. Lowering operational costs by increasing efficiency and reducing waste can increase margins across the board. Increasing sales volume through marketing activities such as advertising and customer service can also boost gross margin.
Since markup is expressed as a percentage of products' direct cost, there are additional options other than raising prices to increase your markups. Negotiate with your suppliers to gain access to lower prices, or search for new suppliers that offer lower-priced products with quality standards high enough to merit keeping your sales prices consistent.