In general terms for business managers, margin refers to the difference between the selling price of a good or service and the cost to the business that good, most commonly expressed as a percentage of the selling price.
Calculating Your Margin
In practice, this means we take the average price per purchase of any item, and divide the cost of that item by that sale price. For example, if you sell widgets for $20, and it costs you $15 per widget, your margin is 25% (20 – 15 = 5 / 20 = .25)
When calculating your margin, you only want to use variable costs. Variable costs are those costs that change as you sell more goods or services. Fixed costs are things like your building and any staff that you would have regardless of how many goods or services you sell.
For most companies, it’s not as easy to simply say, “we sell this one thing for one price, and it costs us this much every time”. So the easiest way to calculate will be to take total revenue from sales and total variable costs over a period of time. For example, if last year you generated $100,000 from widget sales, and it cost you $70,000 to market, produce, and service those widgets, your margin was 30% (100,000 – 70,000 = 30,000 / 100,000 = .3)
Why Margins Matter
Margins matter because you need to know how much money you make for every item you sell, after costs. If you spend more than you make, you will never turn a profit. The bigger your margins, the more room you will have to grow and invest in the future.
Businesses with the biggest margins and the highest sales volume will end up being the most profitable.
For marketers, one metric we want to know is marketing contribution. This is a form of the margin that ignores all costs except for marketing.
Marketing contribution is similar to ROI, just expressed as a percentage of revenue. It tells you and your company what percentage of revenue you are spending on marketing, so you know how much you can afford to spend on other things – like service and development.
In the example above, let’s say that $30,000 of the variable cost was marketing. That means your marketing contribution is 70%, or that marketing costs represent 30% of total revenue.
Again, it is common for businesses to set targets for marketing spend as a percent of total revenue. It will vary by company size and industry – but general targets range from 20-40%.