# Pricing and margin in distribution

> Margin versus markup, the pricing methods distributors use, where pricing leaks margin and how invoice margin differs from pocket margin, with examples.

Source: https://docs.lumina-erp.com/distribution/pricing-and-margin/

**In short.** Margin is profit as a share of the selling price and markup is profit as a share of cost, so the same dollar profit always shows a smaller margin than markup. Most distributors lose more margin to overrides, stale contracts, cost changes that never reach price and rebates the invoice margin never sees than to the price list itself.

A distributor buys and resells, so the spread between cost and price pays for everything else: the warehouse, the trucks, the sales team and the profit. The margin on the invoice is rarely the margin you keep, and the gap comes from how prices are set and where they leak.

## At a glance

| Term | Answers | Formula |
|---|---|---|
| Gross margin % | What share of the selling price is profit? | (Price minus cost) ÷ price |
| Markup % | How much was added on top of cost? | (Price minus cost) ÷ cost |
| Target-margin price | What price gives the margin I want? | Cost ÷ (1 minus target margin) |
| Pocket margin | What is left after everything off the invoice? | Pocket price minus net cost |

## Margin and markup

### What each one measures

Both measure the same dollars of profit. They differ only in what they divide by. **Margin** divides by the selling price, so it tells you how much of each sales dollar you keep. Markup divides by cost, so it tells you how much you added to what you paid. The SEC's beginners' guide to financial statements describes gross profit, sometimes called gross margin, as revenue less cost of sales before operating expenses are taken out.

### Formulas

**Gross margin %:** `(Price − cost) ÷ price`

**Markup %:** `(Price − cost) ÷ cost`

To convert between them, with margin and markup as decimals:

**Margin to markup:** `Markup = margin ÷ (1 − margin)`

**Markup to margin:** `Margin = markup ÷ (1 + markup)`

### Worked example

These numbers are invented. An item costs $42.00 and sells for $56.00.

- Profit: $56.00 minus $42.00 = $14.00
- Margin: $14.00 ÷ $56.00 = **25.0%**
- Markup: $14.00 ÷ $42.00 = **33.3%**

The same $14.00 is a 25% margin and a 33.3% markup. When a salesperson says "I put 25 on it," always ask which one they mean. Putting a 25% markup on $42.00 gives $52.50, a 20% margin and $3.50 less profit per unit than the 25% margin price.

### Conversion table

Each row reads two ways. The middle column takes the left number as a margin and gives the matching markup. The next column takes the left number as a markup and gives the matching margin.

| Percent | As margin, equals markup of | As markup, equals margin of | Price on $100 cost at that margin |
|---|---|---|---|
| 10% | 11.1% | 9.1% | $111.11 |
| 15% | 17.6% | 13.0% | $117.65 |
| 20% | 25.0% | 16.7% | $125.00 |
| 25% | 33.3% | 20.0% | $133.33 |
| 30% | 42.9% | 23.1% | $142.86 |
| 35% | 53.8% | 25.9% | $153.85 |
| 40% | 66.7% | 28.6% | $166.67 |

The gap widens as the percentage grows. At 10% the two are close. At 40% a margin target needs a markup two thirds of cost.

### Pricing to a target margin

To hit a target margin, divide cost by one minus the margin. Do not multiply cost by one plus the margin, which is a markup and falls short every time.

**Target-margin price:** `Cost ÷ (1 − target margin)`

With invented numbers, a cost of $42.00 and a 25% target give $42.00 ÷ 0.75 = **$56.00**. Multiplying $42.00 by 1.25 instead gives $52.50, which is only a 20% margin.

_Interactive calculator available on the web page._

The calculator takes a cost and a price and returns margin and markup, and it also returns the price that would hit the target margin you enter. Use it to check a quote or to translate a markup rule into the margin it delivers.

## How distributors set prices

Most distributors use several methods at once, with a precedence order that decides which one wins on a given order line. Knowing that order matters as much as knowing the methods.

| Method | Price is set from | Typical use |
|---|---|---|
| List less discount | Supplier or house list price | Commodity and catalog items with published lists |
| Cost plus | Your cost | Items without a meaningful list, special orders |
| Matrix pricing | Customer class and product group | The default price for most accounts |
| Contract or special pricing | An agreement with one customer | Large accounts, projects, bids |
| Quantity breaks | Order quantity | Items bought in widely varying quantities |

### List less discount

The price starts at a list price and a discount comes off it. Discounts are often quoted as a multiplier, so a 0.70 multiplier is a 30% discount. Chains of discounts multiply rather than add.

Take an invented item with a list price of $80.00, a 30% discount and a cost of $42.00.

- Price: $80.00 × 0.70 = $56.00, a 25.0% margin
- With a chain discount of 30 and then 10: $80.00 × 0.70 × 0.90 = $50.40, an effective discount of 37%, not 40%
- Margin at $50.40: ($50.40 minus $42.00) ÷ $50.40 = 16.7%

The risk with list-based pricing is that margin depends on how list and cost move. If the supplier raises your cost but you have not loaded the new list, the discount holds and the margin shrinks.

### Cost plus

The price is cost multiplied by a factor. It is easy to explain and keeps margin steady as cost moves, provided you know which cost it uses. A rule that reads "cost plus 20%" on $42.00 gives $50.40, which is a 16.7% margin. Decide whether your cost-plus rules are written as markups or as target margins and label them that way.

Also decide which cost drives the price: last purchase cost, average cost, standard cost, replacement cost or a supplier's current cost. Pricing on average cost after a supplier increase keeps prices low until the old stock sells through, which can be fine or can give away the increase entirely. See [landed cost](/distribution/landed-cost-and-freight-terms/) for what belongs in cost.

### Matrix pricing

A matrix assigns a price rule to each combination of customer class and product group. Customer classes group accounts that should pay alike (for example, contractors, resellers, institutional buyers). Product groups group items that should price alike, often by supplier line or by how sensitive customers are to the price.

An invented matrix, expressed as a multiplier off list:

| Customer class | Fasteners | Power tools | Safety supplies |
|---|---|---|---|
| Walk-in and cash | 0.85 | 0.95 | 0.90 |
| Contractor | 0.70 | 0.85 | 0.80 |
| Reseller | 0.60 | 0.78 | 0.72 |

A matrix keeps pricing consistent and cuts the number of rules to maintain. It works well when classes and groups are kept clean. It degrades when accounts are dropped into the wrong class, or when every exception becomes a new class.

:::note[Price discrimination law]
In the United States the Robinson-Patman Act limits charging competing buyers different prices for the same goods where competition may be harmed. The FTC's guidance names defenses such as cost justification and meeting a competitor's price. This is not legal advice. If your matrix treats competing resellers differently, ask counsel how it applies to you.
:::

### Contract and special pricing

A contract price is an agreement with one customer. It may cover a set of items or a project, and it usually has an end date. Suppliers often back these with special pricing agreements (a lower cost to you for sales to that customer, claimed back later). Contracts win over the matrix in most precedence orders, so a stale contract is one of the most expensive errors in a pricing file.

### Quantity breaks

The unit price steps down as order quantity rises. Check the margin at each break, because the last break is where the margin is thinnest.

The next table uses an invented cost of $2.60 per unit.

| Quantity | Unit price | Margin |
|---|---|---|
| 1 to 49 | $4.00 | 35.0% |
| 50 to 199 | $3.70 | 29.7% |
| 200 and up | $3.40 | 23.5% |

### Price per hundred and per thousand

Small, cheap items such as fasteners, fittings and labels are often priced per hundred (C) or per thousand (M) so that unit prices do not need many decimal places.

- $12.50 per C for 350 pieces: 350 ÷ 100 × $12.50 = $43.75
- $38.00 per M for 2,500 pieces: 2,500 ÷ 1,000 × $38.00 = $95.00

Most pricing errors here are unit errors, such as a price entered per M read as per each, or a cost per C compared to a price per each. See [units of measure](/distribution/units-of-measure/) for how pricing units relate to stocking and selling units.

## Where pricing leaks margin

Pricing leakage is margin you meant to earn and did not, without anyone deciding to give it away. It rarely shows up as one big line. It arrives as many small ones.

### Manual overrides

Order entry staff and salespeople override the system price to win or keep an order. Some overrides are right. Many are habits, with the same customer getting the same discount every time. Report overrides by user, customer and item, with the system price next to the price charged, and review the repeat offenders.

### Stale contracts

Contracts outlive the conditions that justified them. A contract set two years ago at a 15% margin may now be at 8% after cost increases, or may cover items the customer no longer buys in volume. Give every contract an end date, review contracts before renewal and flag contract lines whose margin has fallen below a floor.

### Cost changes that do not reach price

When a supplier raises cost, prices built on list less discount or on fixed contract prices do not move by themselves. Say, with invented numbers, cost rises 7.5% from $42.00 to $45.15 on an item still selling at $56.00. Margin falls from 25.0% to ($56.00 minus $45.15) ÷ $56.00 = **19.4%**, with no one changing a price. Track supplier cost changes and the price updates that should follow them as a pair.

### Rebates and allowances not netted

Customer rebates, prompt-pay discounts, freight you pay but do not bill and marketing allowances all reduce what you keep, but they happen after the invoice. Supplier rebates work the other way and raise what you keep. If margin reporting stops at the invoice, a customer can look profitable while costing you money, and a supplier line can look weak while its rebate carries it.

## Invoice margin versus pocket margin

### What each one measures

Invoice margin is the price on the invoice minus the cost recorded on the order line. It is what most sales reports show because it is available the moment the invoice posts.

**Pocket margin** is our name for what is left after every price adjustment that happens away from the invoice line, on both sides. On the sell side, subtract customer rebates, terms discounts taken, freight you absorb and any other allowance, to get the pocket price. On the buy side, subtract supplier rebates and special pricing claims from cost, to get net cost. Pocket margin is pocket price minus net cost. Pricing consultants often draw this as a waterfall from list price down to what lands in your pocket.

### Worked example

These numbers are invented. One order line invoices at $100.00 with a line cost of $75.00.

| Step | Amount | Running figure |
|---|---|---|
| Invoice price | | $100.00 |
| Customer year-end rebate, 3% | minus $3.00 | $97.00 |
| Prompt-pay discount taken, 2% | minus $2.00 | $95.00 |
| Freight absorbed | minus $4.00 | **$91.00 pocket price** |
| Line cost | | $75.00 |
| Supplier rebate, 4% of cost | minus $3.00 | **$72.00 net cost** |

- Invoice margin: $100.00 minus $75.00 = $25.00, or 25.0%
- Pocket margin: $91.00 minus $72.00 = $19.00, or 20.9% of the pocket price

The supplier rebate recovered some of what the customer side gave away, but the line still keeps $6.00 less than the invoice margin shows.

### How to read it

Rank customers by pocket margin, not invoice margin, before deciding which accounts to grow or reprice. Many rebates are accrued and paid annually, so allocate them to lines or months on a stated basis (for example, as a percentage of qualifying sales) rather than booking them as a lump in the month they are paid.

## Tightening your pricing

1. Agree on one definition. Say "margin" only for margin on price, and label markup rules as markups.
2. Write down your price precedence order (contract, quantity break, matrix, list less discount, cost plus) and check that the system follows it.
3. Price to target margins with cost ÷ (1 minus margin), and check each quantity break against a margin floor.
4. Report overrides, contract margins and cost changes without matching price changes every month.
5. Build a pocket margin view that nets customer and supplier rebates, terms and absorbed freight, and use it for account reviews.

Margin is only half of the return on inventory. Pair it with speed using [inventory turns and GMROI](/distribution/inventory-turns-and-gmroi/).

## Sources

- [A Beginners' Guide to Financial Statements (U.S. Securities and Exchange Commission)](https://www.sec.gov/about/reports-publications/beginners-guide-financial-statements)
- [Price discrimination: Robinson-Patman violations (Federal Trade Commission)](https://www.ftc.gov/advice-guidance/competition-guidance/guide-antitrust-laws/price-discrimination-robinson-patman-violations)

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