Margin vs Markup: What's the Difference?
With this piece, I’m starting a new foundational series: the breakdown of agency metrics. My intent is to help you better understand where and how value is being created or squandered in your agency.
My first agency experience was an internship during my junior year of college. I had an opportunity to spend time in different departments to better understand the inner workings of an advertising agency. At the time, I was an undergrad marketing major trying to figure out what made the most sense for my future. Was client-side or agency-side work my calling? My experience with the media buyers was fascinating, as they explained the art and science of buying media. I remember them identifying the standard industry practice of making a 15% margin on media. This was why they pushed clients to TV and other forms of traditional media—because there was so much more money to be made for the agency.
When the media buys did come in, a funny thing happened that I didn't quite understand. Instead of seeing the 15% margin on the invoices, I noticed the media buys were marked up by 17.65%. My curiosity drove me to question this change; and that's when I learned the difference between margin versus markup.
Margin vs Markup
I often hear the terms “margin” and “markup” being used interchangeably. Although I'm far from one of those folks who silently corrects a person’s grammar in their head, the lack of distinction here is troublesome. There is a financial cost to making this mistake. So, let’s clarify the definition to ensure that your staff isn't costing you money by thinking about these terms in the wrong way.
“Profit margin” refers to sales minus the cost of goods sold. The profit margin shows profit as it relates to the selling price.
“Markup” is the amount by which an item’s cost is increased to reach the final selling price. Markup shows the profit as it relates to the cost amount.
Here's a shorthand way to remember it:
Margin is the percent of selling price
Markup is the percent of cost
Reading this section over, I realize that without some numbers, you could not repeat the above to your team members and be confident they know the difference. I know what you're thinking...
Show me the math! (Tom Cruise voice from Jerry Maguire)
Let's say you are making an ad buy on behalf of a client for $100. I know this is an irrationally low price, but it makes the math easier.
If you want to achieve a 15% margin, what price should you charge?
Did you come up with $115? That is not the correct answer. Many people mistakenly multiply the $100 by 1.15 and get $115.
To calculate this gross margin as a percent, you would divide the gross margin of $15 ($115 - $100) by the sales price of $115. This gives you a gross margin of 13%.
To achieve a gross margin of 15%, the mark-up must be greater than the desired gross margin. I’m going to repeat that statement again—it’s probably the most important line in this article. The mark-up must be greater than the desired gross margin.
Here's an easy way to arrive at the correct sales price for a desired margin of 15% (or whatever margin you want in the future).
Take the price from your media partner/vendor/subcontractor (in the above example $100) and divide it by the inverse of the desired profit margin. In this example, we want to make 15%; therefore, the inverse would be 85 percent. The answer is a sales price of $117.65, and the gross margin is 15%.
C (cost) / inverse of PM (profit margin) = Selling Price
Key Takeaway
With this math, we can understand why the media buying folks were marking up media by 17.65% to earn a margin of 15%. The markup always must be greater than the desired profit margin. If you take nothing else away from this article, remember that profit margin shows profit as it relates to a selling price, and markup is a percent of cost.
If you're interested in diving into more metrics, check out my e-book here AGENCY SCORECARD. Additionally, my Agency Operations service provides agency owners with a scoreboard for their agency to track and measure the metrics that matter.