A 40% Markup Is a 28.57% Margin, and the Gap Costs $80,000
Markup is measured against cost and margin against price, so they are never the same number. Confusing them is the most common pricing error in small business, and it under-prices every unit you sell.
Two percentages describe the same transaction and produce different numbers, because they use different denominators. Markup is profit divided by cost. Margin is profit divided by price. Treating them as interchangeable is the single most common arithmetic error in small business pricing, and it always errs in the same direction: too cheap.
The same sale, two numbers
An item costs $60 and sells for $84. Profit is $24. Markup is $24 divided by the $60 cost, which is 40%. Margin is $24 divided by the $84 price, which is 28.57%. Both are correct descriptions of one sale.
| Markup on cost | Selling price | Actual gross margin |
|---|---|---|
| 20% | $72.00 | 16.67% |
| 30% | $78.00 | 23.08% |
| 40% | $84.00 | 28.57% |
| 50% | $90.00 | 33.33% |
| 100% | $120.00 | 50.00% |
Margin is always the smaller number, and the gap widens as prices rise. Doubling the cost, a 100% markup, produces exactly a 50% margin, which is a useful anchor to remember.
Pricing to a margin target
Most businesses plan in margin terms, because margin is what appears on the income statement and what rent and salaries are paid out of. To hit a margin target, divide the cost by one minus the target rather than multiplying by one plus it.
| Target margin | Required price | That is a markup of |
|---|---|---|
| 20% | $75.00 | 25.00% |
| 30% | $85.71 | 42.86% |
| 40% | $100.00 | 66.67% |
| 50% | $120.00 | 100.00% |
Why the error is so persistent
Suppliers quote in markup, because they are selling from cost. Accountants report in margin, because they are analysing revenue. A business owner hears both words in the same week, applied to the same products, and the two frameworks are rarely distinguished explicitly.
The error also compounds through a business. A markup applied at wholesale and again at retail produces a final price whose margin nobody has computed, and discounting decisions taken against markup figures can push a product below cost without anyone noticing.
What discounting does to a thin margin
This is where the distinction stops being academic. On the $84 item with a 28.57% margin, a 20% discount takes the price to $67.20 against a $60 cost, leaving $7.20 of profit, which is a margin of 10.71%. A discount of one fifth removed nearly two thirds of the profit.
Push the discount to 30% and the price is $58.80, below cost, and every additional unit sold loses money. The lower your margin, the smaller the discount required to reach that point, which is why margin needs to be known precisely rather than approximately before any promotion is designed.
Gross margin is not the end of it
- Gross margin covers only the direct cost of the goods or services sold. Rent, salaries, software, insurance, and marketing all come out of what remains.
- Payment processing takes roughly 2.5% to 3% of the price, not of the profit, so on a 28.57% margin it consumes about a tenth of it.
- Returns, shipping, and breakage reduce the effective margin on every unit, including the ones that never come back.
- Sales commissions calculated on revenue rather than on profit can consume a disproportionate share of a thin margin, which is a strong argument for basing them on gross profit instead.
A useful discipline is to know three numbers for every product: gross margin, contribution margin after the variable costs above, and the volume at which fixed costs are covered. Businesses that fail on price usually knew the first and had never computed the third.
Converting between the two
Margin equals markup divided by one plus markup. Markup equals margin divided by one minus margin. Both follow directly from the definitions, and keeping the two conversions written down beside your pricing sheet prevents the entire class of error.
The habit worth building is stating which one you mean every time you say a percentage out loud. Not 40%, but a 40% markup or a 40% margin. It sounds pedantic in conversation and it is the difference between $84 and $100.
Convert between cost, price, markup, and marginMargin CalculatorPrice a commission against revenue or profitCommission CalculatorFrequently asked questions
Which should I use for pricing decisions?
Set targets in margin and execute in markup. Margin is what your financial statements report and what fixed costs are paid from, so it is the right basis for deciding what a product needs to earn. Markup is the operational instruction applied to a cost when setting the price. Deciding in one and instructing in the other, with an explicit conversion between them, keeps both consistent.
Is there a standard margin for my industry?
Benchmarks vary enormously, from low single digits in grocery retail to well above 70% in software, and they reflect completely different cost structures. A useful benchmark is one drawn from businesses with a similar shape to yours rather than a similar product. The more meaningful internal question is what margin covers your fixed costs at your realistic volume, which is a number only you can compute.
How do I handle margin on services rather than goods?
The same arithmetic applies with labour as the cost. The difficulty is establishing the true cost of an hour, which must include unbillable time, holiday, sick leave, tools, and both halves of payroll tax if you are self-employed. Many service businesses compute margin against a raw hourly wage and conclude they are profitable when the fully loaded cost is 40% to 60% higher.
What is keystone pricing?
Doubling the wholesale cost, which is a 100% markup and therefore a 50% margin. It is a long-standing retail convention and a rough approximation rather than an analysis. It works where it happens to cover operating costs at achievable volume, and it is simply a starting point that has become traditional.
Should sales commissions be based on revenue or margin?
Margin, wherever it is practical to compute. Commission on revenue rewards volume regardless of profitability and creates a direct incentive to discount, since a salesperson paid on revenue loses little from a price reduction while the business loses most of its profit. Commission on gross profit aligns the incentive with the outcome the business actually needs.
Disclaimer: This article is educational and does not constitute financial, investment, tax, or legal advice. Figures are illustrative and computed from the assumptions stated in the article; your own situation will differ. Verify any decision with a qualified professional before acting on it.