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Introduction to Margins This module covers the concepts of margins (currency and percentages), the relationship between selling price, cost, and margins, and total contribution margin. Authors: Paul Farris and Stu James Marketing Metrics Reference: Chapter 3 © 2015 Paul Farris, Stu James, and Management by the Numbers, Inc.

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The goal of this tutorial is: Define margins Learn how to calculate margins from selling prices and costs, and vice versa In this module, we will only be concerned about calculating margins within a single business entity, such as a manufacturer or a retailer, and won’t cover margins in multi-level channels of distribution. Let’s start with the basic definition of margin: I NTRODUCTION TO M ARGINS 2 Introduction to Margins MBTN | Management by the Numbers Definition Margin ($) = Selling Price ($) – Cost ($) (Note, in this formula, “margin” may also be called “contribution margin” per unit)

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C ALCULATING M ARGIN ($) 3 Calculating Margin ($) MBTN | Management by the Numbers Cost $ 80 Margin $ 20 Price $100 For example, if a jacket sells for $100 and the store purchased the jacket for $80,what would be the margin (in $) for the store on the jacket? Recall that: Margin = Price – Cost, so The margin on the jacket is $100 - $80 = $20 What would the percent (%) margin be?

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C ALCULATING M ARGIN (%) 4 Calculating Margin (%) MBTN | Management by the Numbers Cost $ 80 Margin $ 20 Price $100 That leads us to our second definition: So Margin % = $20 / $100 = 20% If the retail store dropped its price by 10% what would be the new margin ($ and %)? Definition Margin (%) = Margin ($) / Selling Price ($)

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C ALCULATING M ARGIN % 5 Calculating Margin % MBTN | Management by the Numbers Cost $ 80 Margin = $ 10 Price $90 First, we need to calculate the new price. A 10% price decrease on a price of $100 =.10 * $100 = $10. So, the new price would be $100 - $10 = $90. The cost is still $80. So Margin % = $10 / $90 = 11.1% Insight Note that in this example, a 10% decrease in price ($100→$90) leads to a 50% decrease in $ margin ($20→$10), requiring them to sell twice as many jackets at the lower price to generate the same total margin.

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C ALCULATING T OTAL C ONTRIBUTION M ARGIN ($) 6 Calculating Total Contribution Margin ($) MBTN | Management by the Numbers One might want to calculate the total margin generated for multiple sales of the same item in a given time period. This is called Total Contribution Margin. For example, if the margin on an item was $10, and a store sold 500 items / week, what would be the total contribution margin generated by that item in a week? Definition Total Contribution Margin = Margin ($) * Units Sold Margin ($) = $10 Units Sold (week) = 500 Total Contribution Margin = $10 * 500 = $5,000

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C ALCULATING P RICE U SING T ARGET M ARGIN 7 Calculating Price Using Target Margin MBTN | Management by the Numbers Cost $ 40 Target Margin 60% Price = ? Sometimes, a business may want to maintain a particular margin % (target margin), and need to determine their selling price based on this, leading to our third definition. Sales Price = $40 / (1 –.60)= $40 /.4 = $100 One might also want to be able to calculate the cost necessary to achieve a target margin for a given price. Definition Selling Price = Cost / (1 – Target Margin%)

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C ALCULATING C OST B ASED ON P RICE AND M ARGIN 8 Calculating Cost Based on Price and Margin MBTN | Management by the Numbers Price = $100 To calculate the cost based on price and target margin, we can just rearrange the basic formula once more as follows: Cost = $100 * (1 –.60)= $100 *.4 = $40 This is all very simple math, but margins are one of the fundamental building blocks of business. Know these!! Definition Cost = Selling Price * (1 – Target Margin%) Cost = ? Target Margin 60%

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R ELATIONSHIPS 9 Relationships MBTN | Management by the Numbers Finally, when you are calculating any of these margin related values, it is helpful to keep in mind the relationships among the variables. Relationship Definitions* If Price increases, Margin ($) and Margin % increase If Cost increases, Margin ($) and Margin % decrease If Margin ($ or %) increases, then Price must have increased or Cost must have decreased. *Presumes only the single variable changes (e.g. only Price increases and there is no change in cost. If both price and cost change, one must do the calculations) Insight Knowing these relationships is a great rule of thumb to check your work. After you do your calculation, make sure these basic relationships hold.

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C ALCULATING M ARGINS : S AMPLE P ROBLEMS 10 Calculating Margins: Sample Problems MBTN | Management by the Numbers Answer: We know that Margin = Selling Price – Cost And that Margin % = Margin / Selling Price Therefore, substituting in our values: Margin = $150 - $100 Margin = $50 Margin % = $50 / $150 Margin % = 33.3% Question 1: A retailer buys mobile phones for $100 and sells them for $150. What is the retailer’s $ margin and % margin?

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C ALCULATING M ARGINS : S AMPLE P ROBLEMS 11 Calculating Margins: Sample Problems MBTN | Management by the Numbers Answer: We know that Selling Price = Cost / (1 - % Margin) Therefore, substituting in our values: Price = $30 / (1 – 25%) Price = $30 / (1 –.25) Price = $30 /.75 Price = $40 Question 2: A manufacturer’s product costs $30 per unit. Their target margin is 25%. What price should the manufacturer charge?

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C ALCULATING M ARGINS : S AMPLE P ROBLEMS 12 Calculating Margins: Sample Problems MBTN | Management by the Numbers Answer: We know that Margin ($) = Selling Price – Cost and that Margin % = Margin ($) / Selling Price New Margin ($) = $40 - $32 = $8 New Margin % = $8 / $40 New Margin % = 20% Quick check: Costs rise, margin decreases from 25% to 20%. Previous Total Margin = 100 units * $10 margin = $1000 Previous Total Margin ($1000) / New Margin ($8) = 125 units Therefore 25 (125-100) additional units. Question 3: If that same manufacturer discovered that costs had risen to $32 / unit, what would be the new % margin? If they had sold 100 units previously, how many additional units would they need to sell to maintain the total margin for the product line?

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Marketing Metrics by Farris, Bendle, Pfeifer and Reibstein, 2 nd edition, pages 65-85. - And - MBTN Modules: Channel Margins, Breakeven, and Profit Dynamics. These modules build on margins to further explain costs, breakeven, and volume – price interactions and their impact on profits. M ARGINS – F URTHER R EFERENCE 13 Margins - Further Reference MBTN | Management by the Numbers

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