Margins and Discounts
A margin is the measurement of a difference. In business, you'll be using price margins, gross margins, profit margins, and other margins. Pricing is the task of establishing a price difference between what you pay and what you charge for products and services. Gross margins and markups have an impact on pricing and profitability. A discount is a price reduction.
Margins
First, understand that margins are different depending on what type of business is being discussed. A retail business, for example, will use one level of margins or buy/sell differences, while wholesalers, manufacturers, and representatives use others.
In addition, you must consider the approximate profit margins of your buyers as you establish prices. For example, a wholesaler selling to retailers must know what margins its clients use so that the wholesale price margins can remain competitive.
The gross margin can help you establish profitable prices. If it costs you $600 to produce a specific service and you want to establish a price that offers you a 40 percent gross margin you can divide the cost (600) by 1-minus-the-GM (1-.4 = .6) or $1,000.
Another common pricing term is markup, which is just another way of looking at gross margin. The difference is that it is a markup based on cost rather than sales. Services that cost $600 that you will sell at $1,000, as in the above example, will have a markup of 66.67 percent — the selling price is the cost times 1.6667. The “1” is the cost and the “.6667” is the markup.
Discounts
Pricing also involves discounts, a reduction from the standard price. If you offer a specific service at 10 percent off the regular price, that's the discount rate. The standard price is sometimes called the rate-sheet price, the one you've established for the value of your time. The effective or market price is the one the client actually pays.
Why would your business want to offer discounts to clients? Many reasons. The primary ones include:
Increase short-term sales
Reward valued clients
Motivate clients to buy
Businesses of all types and sizes — from aircraft consultants to hot dog stands — use various discounts and allowances to increase profitability. They include:
Discounts for noncredit payments
Quantity discounts
Functional discounts (for the buyer taking over some function of the transaction, such as implementation)
Seasonal discounts
Promotional discounts
Membership discounts
Your rate sheet should outline any primary discounts and allowances that you will offer to clients and explain why and how the discounts will be applied. In addition, make sure that such discounts and allowances don't have a negative effect on profitability. To be cost effective, discounts must increase profits sufficiently to make up for potential losses.
Discount policies should be in writing: “A 10 percent discount will be granted to any client who uses $1,500 of our services in a month. Each time a client reaches this amount, this discount will be automatically subtracted from the total cost of his next purchase/request for our services.”
How can you determine what discounts and allowances will work for your business? Take a look at your competitors. What discounts do they offer clients and why?
Also look at similar businesses for discount structures that you can profitably apply to your business. Just make sure they meet their intended purpose: to increase overall profitability.
