The term “margin” refers to the difference between the purchase price of a product and its selling price in e-commerce, distance selling, and online marketing. In general, margin is also used for lending and securities trading in order to calculate the differences between debit and future interest rates as well as different share prices. It is one of the most important instruments for calculating profit and determining product prices. The calculation of the margin may vary depending on the type of business, industry and target. Alternate terms are profit margin, gross margin, cover amount, operating margin or EBIT margin, although their calculation formulas often differ.
General information on the topic
Margin is one of the most important tools in business, since it is the economic basis for entrepreneurial activity. Margins have to be high enough to cover costs and profit to achieve viability so that the company can finance all its expenses through its sales and a profit remains. As a rule, such a cost estimate is already carried out as part of the business plan to determine whether the company can be profitable at all. If the margin is calculated before the sale of a product, one may also refer to a mark-up calculation.
If the calculation takes place in retrospect, the term “deduction calculation” is used. Margins can be expressed either in terms of dollar values or in relative percentages, which are usually positive. An exception is the achievement of larger market shares. If an entrepreneur tries to increase their market shares for a product or its portfolio at very low prices, negative margins may occur for a limited period of time. Online start-ups often pursue this strategy at the beginning of their business.
Types of margins
There are different margins, which differ considerably in their calculation. Aspects such as the size of the company and line of business affect the calculation basis. Some companies must be able to provide certain calculations, while others may choose a calculation basis themselves. The most important calculation methods are listed below as an overview:
- Sales charge on purchasing price: A premium in the form of a factor, percentage or dollar amount is added to the fixed purchase price. The objective is to determine the ideal selling price for a product. This is also described as a trading margin.
- Sales charge with sales price: A target margin is determined and added to the purchase price. The target product price determines the margin.
- Sales charge with discounts and costs: A surcharge is added to the purchase price. However, the mark-up is based on the operating costs and possible discounts for purchasing large quantities of a product. This approach is also called trade calculation.
- Deduction calculation: If a product has already been sold, a deduction calculation can be used to determine the profit in retrospect. All operating and purchasing costs are deducted from the selling price of the product.
- EBIT margin: The EBIT margin does not refer to individual products, but to the entire company for a certain period of time. Revenue is adjusted by various items such as personnel and material costs to calculate the profit for the year. The EBIT margin is an instrument that is used to calculate the operating result and also as a benchmark for calculations of other KPIs as well as for competitive comparisons. The EBIT is first calculated, then divided by the turnover, and multiplied by 100. The higher the EBIT margin, the more profitable is the company.
If an entrepreneur purchases a product for 40.00 dollars and the margin is also 40.00 dollars, the net selling price is 80.00 dollars and the gross sales price is 95.20 dollars (19%). The latter is the ideal selling price of the product. It can vary depending on the control system. The following values result:
- Absolute margin: 40.00 dollars
- Margin relative to the purchase price: 100.00%
- Net factor: 2.0
- Gross factor: 2.38
If you want to calculate the margin for other products, you can simply multiply the purchasing price by the respective factors and receives the net and gross selling prices. This mark-up calculation results in a selling price which is intended to enable profitable economics, but does not take into account the exact operating costs and discounts with this kind of simplification.
Relevance to online marketing
The calculation of the margins is essential in the distance selling trade and is therefore also regarded as a basic tool of the trade. How they are specifically calculated depends on several internal and external factors. In individual cases, the exact purchasing, operating and personnel costs, as well as comparative values for specific markets are included in the calculation. In any case, the bookkeeping system is based on the company structure. A dealer has to keep different records than the manufacturer of the product that the dealer distributes. The same applies to certain professional groups such as doctors, lawyers or self-employed persons.
In online marketing, it is customary to include any marketing costs into the calculation of the margin. Whether and to what extent digital business models turn out to be profitable is to a considerable extent dependent on the effectiveness of marketing. In order to calculate the margins, different KPIs should be added depending on which digital channel is the main sales route and what reach is intended. Thus, channels such as SEO, SEA, affiliate marketing, and email marketing are often associated with lower costs than display marketing, print, radio, and TV advertising.
For new business models and start-ups, it is therefore necessary that they compare the margins to be achieved with marketing costs and establish a balance between these factors. This is especially true for the first 24 months. With an increasing budget, other channels can also be used, even if the margins per sale are lower.