Thursday, August 5, 2010

The Gross Margin Equation - For the Record

It happened again. Actually, it’s happening more often all the time. Last week I sat in on a manufacturer – distributor discussion. During part of the conversation gross margin levels came into the conversation. Guess what? The manufacturer’s sales guy didn’t know the difference between “gross margin” and “mark-up”. After the conversation, I politely (and privately) pointed out the error in his calculation. He thanked me, but then said, “My product offers good profit potential, why get hung up on semantics?”

Earlier today, I read an article by an industry expert. Somehow his confusion in the gross margin calculation slipped past his editor. It was a small point - just a few cents difference. So, why the fuss? In my mind, it’s all about vocabulary.

We develop vocabulary to describe in a couple of words things that otherwise would take many words to describe. We build benchmarking metrics, business formulas and other important descriptors around these terms. One small mistake in a calculation could lead to big issues down the line.

If you are a manufacturer’s sales person, an industry consultant or a neophyte wholesaler, remember this formula.

Gross Margin = (Sell Price-Cost of goods sold)/Sell Price
Mark-up = (Sell Price – Cost of goods sold)/ cost of goods sold

An example:
Sell Price = $167
Cost of Goods Sold = $100

Gross Margin = (167 – 100)/ 167 = 40% Gross Margin
Mark-up = (167 -100)/ 100 = 67% Mark-up

Can you see how this kind of confusion could lead to trouble?

By the Way....
Some people mistakenly substitue gross margin for gross profit. I don't like that habit either. It implies that distributors actually get to keep a significant piece of those gross margin dollars, but that is a different story.

1 comment:

jonathan ruppert said...

Hi Frank,

I have a number of companies that want to be distributors around the world for our product.
Our cost of goods is $11.64, our retail price is $32.99 I am trying to figure out
what I should be charging to the distributor ? I want to provide them a price FOB China.

Any recommendations would help.

Thanks Jon