When adding a markup percentage for your services, you might think figuring out the right amount is a pretty straightforward affair. However, the reality can be far more complex.
Markup refers to the amount added to the cost of material and labour. It helps you to cover your overheads and generate profits.
In service-based businesses, including plumbers, electricians and HVAC, you should always account for a markup percentage when establishing the cost of goods sold.
Yet this isn’t as simple as just coming up with a rudimentary markup percentage to add on at the end of the job. There are a tonne of factors contributing to finding the right amount that keeps you competitive while still earning you net margins.
To ensure your business offers fair pricing for customers and remains profitable with high total revenue, read this blog.
You can learn more about margin vs markup, how to calculate margin percentages, and how you should set your product’s selling price.
Margin vs Markup: How Do They Affect Price Setting?
What’s the difference between margin and markup?
- A margin is your costs of goods sold subtracted from your net sales. To find it, take your sales minus your direct and indirect costs (more on that below).
- A markup is a product’s cost price subtracted from it’s selling price.
To put things a little clearer, a margin is the expression of net profit you’ll make after your markup. It’s usually expressed as a percentage that tells you a revenue figure.
You might also hear it called a margin percentage, profit margin, gross margin or gross profit.
Generally, you need to determine what you want your margin to be before you can calculate a markup. That’s why margin and markup go hand in hand with each other.
A good margin formula to keep in mind is margin divided by the costs of goods. This will give you the markup percentage you need to price your items.
Navigating the Tricky Margin vs Markup Process for Service Businesses
Where product-based businesses can generate a profitable sales price based on labour and material costs alone, pricing for service-based businesses can be considerably more challenging.
With customer requests and requirements ranging significantly from job to job, it can be tough to establish one sales price that covers both the cost of work and provides a profit.
For instance, a simple pipe repair job for one customer can turn into an entire excavation process for another.
In this scenario, you may be tempted to give each customer different costs. But the truth is, you need to stay consistent with your prices charged.
To develop a retail price that benefits your business, your technicians and your customers, keep in mind these best practices for establishing your markup.
1. Calculate Your Costs Before Your Markup Percentage
Don’t get caught out undercharging for your labour. Not only will you pay for some of the costs the customer should cover, but you might see any profit evaporate before your eyes.
These lost profits can do real damage to your business.
For service-based businesses, the best way to avoid undercharging — and generate profit — is by utilising a cost-based pricing technique.
Using cost-based pricing, a business owner adds up the cost of their services from both a direct and indirect standpoint.
Direct Item Costs and How They Affect Your Gross Profit
Direct costs are the exact expenses involved with providing a service.
Whether you’re talking about HVAC projects or pool cleaning companies, direct costs typically entail the materials required to complete the job and the cost of the labour.
You’ll need to pay close attention to what you spend when buying from your supply chain. Keep records of all costs in a given period to see what you’re spending in order to calculate gross profit.
While calculating gross profit may seem quite simple, it’s the indirect costs that can get confusing.
Indirect Item Costs and How They Affect Your Gross Profit
Indirect costs are any expenses that are necessary to operate the business but are not connected to specific jobs. These costs can include company vehicles, marketing, utility and insurance costs.
Indirect costs are often what set product-based markups apart from service-based markups.
The main difference between these two are that with a service-based markup, you’ll need to consider all of these extra costs in your number. In turn, this type of markup shows a higher amount.
With both direct and indirect costs in hand, you can begin to calculate your average monthly costs, as well as how much your markup needs to be to cover these costs and generate more revenue.
2. Conduct Market Research to Determine Your Profit Margin
Numerous market and other factors influence how you establish your markup formulas, with some of the most prominent elements being your competitors and your local standing.
Look at How Competitors Cover Costs for Their Goods Sold
While you shouldn’t base your selling prices solely on competitor research, it’s helpful to understand what others are charging and the level of service that comes with price setting when developing your markups.
If you plan to charge more than a local competitor, you have to take this extra cost seriously, as your customers will expect a higher quality service.
If a competitor has a retail price way less than you, you might investigate why.
Do they have a lower defined markup? Have they found a cheaper supply chain? Maybe you’re not comparing the same transaction types?
Chances are, there’s a reason their price is lower. If you can figure out why, you might be able to adjust your cost figure calculations accordingly.
What Would Your Customers Think Is a Fair Margin Percentage?
Next, you’ll want to consider your clientele. From location-specific needs to average income, local demographics can help you gain a better understanding of what customers are willing to pay for certain services.
Conduct a basic market study to learn more about your target customers to receive personalised insights on what different prices they are comfortable with.
Supported by this data, you can determine a markup amount that’s fair for customers and profitable for business.
Most customers will want the lowest price possible, so you need to ensure you provide good value perception for your services.
You may provide more detailed explanations of how your work is better than the competitor so they’re more comfortable paying a higher dollar amount.
3. Establish a Gross Margin and Calculate Your Markup
To ensure you generate profit, you must establish a reasonable profit margin that makes sense for your company.
A profit margin for service-based businesses is how much profit your company will bring in after subtracting your product cost.
Finding Acceptable Gross Margins Without Losing Customer Engagement
Although your gross profit margin will vary depending on your industry and target market, the standard accepted margins for a service-based business is around 10%.
This means you’ll make 10% more than what you spend.
You can calculate markup percentages for your specific business by thinking about what you want your net profit margin to be.
How to Use Your Markup Percentage in Calculations to Determine Selling Price
Wondering how to convert margin to markup? You can use this simple margin formula. To construct a selling price for a specific service, take the cost of the service and multiply it by your chosen percentage. Take that total and add it to the original cost of service.
This sum is your final selling price with a markup, allowing you to cover the total cost of the job and generate healthy revenue numbers.
Remember to account for your indirect costs either by including a daily average on top of your service cost or by increasing your profit margin percentage.
How Much Money Should You Charge for Hourly Costs?
For service-based business owners, you may be wondering if hourly costs should be factored into your pricing as well.
With jobs in industries such as HVAC and plumbing often changing quickly and requiring more material and labour than initially expected, it’s a good idea to charge per project to ensure all of your operational costs are accounted for.
That way, you can have revenue left to pay yourself and your employees — not to mention have money left over to keep improving your business.
Keep Your Net Profit Margin (And Your Payments) in Check
When you know how to calculate your costs — both direct and indirect — and the difference between margin vs markup, it can help you get a better idea of what you might need to charge to increase revenue.
However, that’s not the only factor at play.
You’ll also need to consider the sales prices charged by your local competition. And it’s important that you check with your customer base to make sure they’re OK with the sales price you’re setting.
Once you’ve done those two steps, the final thing is to determine your margin percentage. The standard accepted margins for service businesses is around 10%. With that in mind, you can calculate your markup percentage in no time.
Establishing the cost of services for your business can be tricky, but managing the influx of these payments can be even harder. Fortunately, it doesn’t have to be.
Using FieldPulse’s field service management software, service-based business owners can send invoices, collect customer payments and record sales minus cost on the go with the touch of a button.
With the help of FieldPulse, you can calculate your gross margins for any project by looking at a product’s selling price minus your costs.
You can even keep track of lost sales, net sales and operating expenses to get a look at the bigger picture.
Schedule a demo with FieldPulse today to learn what our field service inventory management software can do for your service-based business.
