Markup vs. Margin: Which one wins?

There’s often confusion around these two terms – Markup and Margin – so this brief article explains the difference, why it matters, and what the mathematical formulas are that you need to know in your consulting business.

Before we delve into the differences between the two terms, we need to explore what goes into the make up of a consulting fee.

As can be seen in the diagram below, a consulting fee has 3 core components:

 

This article doesn’t go into depth on how to determine project costs and overheads, and for the purposes of the remainder of this article, the term ‘Cost to deliver’ refers to: Project Costs + Overheads.

Markup

Markup refers to the amount added to the cost to deliver. It represents your profit, and is expressed as a financial value or a percentage.

The formulas

There are two formulas you need to know:

  1. The Markup based on the fee and cost: Markup = (Fee – Cost to deliver) / Cost to deliver x 100
  2. How much to charge based on your predefined Markup:  Fee = Cost to deliver + (Cost to deliver x Markup percentage)

Let’s look at some examples:

Example 1: Determine the Markup of a project with a £10,000 fee of which cost to deliver is £5,000

(10,000 – 5,000) / 5,000 x 100 = 100%

Example 2: Determine the fee of a project with a cost to deliver of £5,000, and a required markup of 50%

5,000 + (5,000 x 50%) = £7,500

Margin

Margin is the portion of the fee that is profit i.e. what is left after subtracting the cost to deliver. Margin is typically stated as a percentage.

The formulas

Here are the two formulas you need to know:

  1. The margin based on the fee and cost: Margin = 1 – (Cost to deliver / Fee)
  2. How much to charge based on your target margin: Fee = Cost to deliver / (1 – Margin Percentage)

Let’s look at some examples again:

Example 1: Determine the Margin of a project with a £10,000 fee of which cost to deliver is £5,000

1 – (5,000 / 10,000) x 100 = 50%

Example 2: Determine the fee of a project with a cost to deliver of £5,000, and a required margin of 50%

5,000 / (1 – 50%) = £10,000

Why does it matter?

The primary reason that it matters which term you are using is that the same value – i.e. a 50% markup and a 50% margin – do not equal the same thing. That’s a problem as your expenses can be higher than expected, or conversely the client might be expecting to pay less.

Let me share an example from my own experience. I engaged a contractor to help me on a project. I agreed with the recruitment agency that their ‘cut’ would be 15% and that the day rate to the contractor would be £550. I had assumed that they were going to apply a 15% markup, when in fact they were applying a 15% margin. The difference in financial numbers looked like this:

Markup: £550 + (£550 x 15%) = £632.50

Margin: £550 / (1-15%) = £647.06

The difference in cost, therefore, was an extra £14.56 (£647.06 – £632.50). Whilst that doesn’t sound like much, it’s a difference of 2.25%. Over the life of the project, which was circa 100 days, that was an extra cost of £1,456!

 

Images courtesy of unsplash.com and the following photographers:

Hermes Rivera

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