In this guide:
Profit Margin vs. Markup · Finding Your Real Costs · Cost of Your Time · Mistakes & Returns · Marketing · Discounts · Scalability · Industry Examples · Overhead · Sales Volume · Competitor Pricing · Pricing Checklist
Setting a selling price can look deceptively simple.
You know what a product costs. You add some profit. You put it on the shelf or list it online.
But a business can sell products at what appears to be a healthy markup and still struggle to make money.
The problem is that the invoice from your supplier is rarely the true cost of making a sale.
Your price may also need to absorb employee time, packaging, payment processing, advertising, damaged products, returns, discounts, shipping problems, inventory losses, customer service and dozens of other small costs that are easy to overlook.
A sustainable selling price should do more than recover the obvious cost of a product. It should leave enough room for the business to operate, make mistakes, grow and ultimately generate a worthwhile profit.
Profit Margin and Markup Are Not the Same Thing
Before setting prices, it is important to understand the difference between profit margin and markup.
Suppose something costs you $75 and you sell it for $100.
Your profit before other expenses is:
$100 − $75 = $25
Your markup is based on the $75 cost:
$25 ÷ $75 = 33.33% markup
Your profit margin is based on the $100 selling price:
$25 ÷ $100 = 25% margin
Those numbers are not interchangeable.
This becomes particularly important when someone says, “We need to make 30% on this product.” Do they mean a 30% markup or a 30% margin?
The difference can materially affect the selling price.
You can use our Profit Margin Calculator
to compare revenue, cost, profit margin and markup before deciding on a price.
Start With the Real Cost of the Product
If you buy an item from a supplier for $40, it is tempting to think your cost is $40.
It may not be.
Depending on the business, your actual cost could include:
- purchase price
- freight or shipping to your business
- customs, duties or brokerage
- packaging
- labels
- storage
- payment-processing fees
- commissions
- marketplace fees
- spoilage
- damaged products
- returns
- warranty replacements
- labour required to prepare the product for sale
Some costs happen on every sale. Others happen only occasionally.
Both matter.
Imagine you purchase an item for $40 and sell it for $60. On paper, you have $20 left over.
But suppose you also spend $3 on packaging, $2 on payment and platform fees, and an average of $4 per sale on advertising.
Your real contribution from that sale is already closer to $11 than $20, before considering overhead.
A pricing decision based only on the supplier’s invoice can therefore create a very misleading picture.
Do Not Forget the Cost of Your Time
This is one of the most common problems in small businesses.
An entrepreneur may say:
“It only costs me $15 in materials and I sell it for $50.”
That sounds excellent.
But what if it takes 90 minutes to make, package and process the order?
Your time has a cost even if you are not currently paying yourself an hourly wage.
Consider all the labour involved:
Production time
How long does it take to actually make or prepare the product?
Order processing
Do you have to review orders, print paperwork, prepare shipping labels or arrange pickup?
Customer communication
How much time is spent answering questions before and after the sale?
Purchasing and inventory
Someone has to place orders, receive products, count stock and deal with suppliers.
Administrative work
Bookkeeping, banking, scheduling and recordkeeping all consume time.
A business owner working for free can make an unprofitable product look profitable.
That may be acceptable temporarily while building a business. It should not be mistaken for a sustainable business model.
Ask yourself:
If I eventually had to hire somebody to do everything I currently do myself, would this price still work?
That is a very useful test.
Your Margin Has to Pay for Mistakes
No business operates perfectly.
Products break.
Orders are shipped twice.
Customers receive the wrong size.
Food spoils.
A contractor has to return to a job.
A manufacturer has to remake something.
A package disappears in transit.
A customer disputes a credit-card charge.
These things are not necessarily signs of a poorly managed business. Some level of error, waste and loss is simply part of operating.
Your pricing should have enough breathing room to survive normal mistakes.
For example, imagine you earn $8 of profit from every product sold.
If one damaged order costs you $80 to replace, the profit from ten successful sales may be required just to recover that one mistake.
The thinner your margin, the more sensitive your business becomes to small problems.
This does not mean you should simply increase every price dramatically. It means the expected cost of errors should be considered when deciding whether a product is financially worthwhile.
Leave Room for Marketing
A product sitting in a warehouse does not generate profit.
Getting somebody to buy it often costs money.
That might include:
- Google advertising
- Facebook or Instagram ads
- influencer commissions
- marketplace advertising
- affiliate commissions
- email marketing software
- photography
- graphic design
- promotional samples
- trade shows
- sales commissions
A product may look extremely profitable before marketing and mediocre afterward.
This is especially important for e-commerce businesses.
Suppose:
Selling price: $80
Product and fulfilment costs: $45
You appear to have $35 remaining.
But if acquiring a customer costs an average of $20, only $15 remains before paying the rest of the company’s overhead.
Marketing does not necessarily make the product a bad business. It simply needs to be included in your economics.
A business with repeat customers may also be able to tolerate a higher acquisition cost on the first purchase because that customer could purchase again.
That is a very different model from a business where almost every customer buys once.
Your Regular Price Should Leave Room for Discounts
This is an area entrepreneurs frequently overlook.
Suppose a product costs $60 and normally sells for $100.
At full price:
Revenue = $100
Cost = $60
Profit = $40
Margin = 40%
Now offer a 10% discount.
The customer pays $90.
Your cost is still $60.
Profit becomes $30.
Your margin becomes 33.33%.
But something even more interesting happened:
You reduced the selling price by only 10%, yet your profit dollars fell from $40 to $30.
That’s a 25% reduction in profit.
Discounts come directly out of the portion of the sale that was available to cover overhead and profit.
That doesn’t mean discounts are bad. Discounts can increase volume, attract new customers, clear inventory or encourage larger orders.
But if you expect to routinely offer:
10% off sales
20% holiday promotions
bulk discounts
wholesale pricing
coupon codes
loyalty discounts
then your standard selling price needs enough room to accommodate them.
A product priced at the absolute minimum acceptable price gives you very little flexibility later.
Think About Scalability Before You Choose a Price
A business can be profitable at 20 orders per month and surprisingly difficult at 2,000 orders per month.
Growth creates costs.
You may eventually need:
- employees
- supervisors
- warehouse space
- inventory systems
- better accounting software
- insurance
- additional equipment
- customer-service staff
- outsourced fulfilment
- professional services
- financing for inventory
This leads to another useful question:
Would this business model still make sense if sales were ten times higher?
Sometimes scaling improves margins.
For example, a manufacturer might receive better pricing when ordering larger quantities.
But sometimes scaling exposes hidden costs.
A person selling handmade products from home may initially have almost no rent or labour expense. At sufficient volume, they may need employees and commercial space.
A price that worked extremely well as a hobby may not work for a real operating company.
Different Industries Need Different Thinking
There is no universal “correct” profit margin.
The economics of a grocery store are nothing like those of a software company.
Rather than starting with a percentage somebody on the internet says is normal, look at how your particular business earns and spends money.
Retail
A retailer needs to consider more than wholesale product cost.
There may also be rent, employees, theft, damaged goods, unsold inventory, payment-processing fees and seasonal markdowns.
Inventory that does not sell is particularly important.
A product with an attractive margin that sits on a shelf for two years may be less valuable than a lower-margin product that sells every week.
Retailers should think about both margin and inventory turnover.
E-Commerce
Online businesses need to pay particular attention to costs that happen after the product is purchased.
These can include:
- advertising
- marketplace commissions
- credit-card fees
- packaging
- shipping
- returns
- refunds
- chargebacks
- fulfilment
Free shipping also isn’t actually free. Someone pays for it.
If the business pays the shipping company, that cost ultimately needs to be supported by product margins.
Handmade Products and Crafts
Materials may represent only a small portion of the true cost.
Your own labour can be the largest expense.
Consider time spent:
- making the item
- designing it
- purchasing supplies
- packaging it
- communicating with customers
- photographing products
- listing products online
A handmade item with $10 of materials may not be profitable at $30 if it takes two hours to produce.
Restaurants, Bakeries and Food Businesses
Food businesses face additional risks such as spoilage, portion variations and waste.
The ingredients in a meal are only one part of the cost.
There may also be:
- kitchen labour
- front-of-house labour
- delivery-platform commissions
- packaging
- utilities
- equipment
- discarded food
- complimentary replacements
Small changes in ingredient prices can also matter when products are sold in large quantities.
Manufacturing
Manufacturers should consider costs beyond raw materials.
Production can involve:
- machine time
- employee labour
- scrap
- quality control
- maintenance
- factory overhead
- packaging
- freight
- warranty claims
A product that requires frequent rework may have a very different true margin from one that moves smoothly through production.
Wholesaling and Distribution
Wholesale businesses may operate with smaller margins but higher volume.
Cash flow becomes especially important because inventory may need to be purchased long before customers pay.
A business can be profitable on paper but still experience serious cash problems if large amounts of money are tied up in inventory and accounts receivable.
Service Businesses
Profit-margin thinking applies to services too.
Instead of inventory, your major cost may be time.
For a consultant, designer, cleaner, contractor or bookkeeper, consider:
- billable labour
- non-billable administration
- travel
- software
- insurance
- rework
- customer support
- employee downtime
An employee might be paid for eight hours even if only six hours can realistically be billed to customers.
Pricing should account for that.
Contractors and Trades
Jobs rarely go exactly according to estimate.
Materials may cost more than expected.
Employees may need additional hours.
A worker may need to return to fix something.
Travel can take longer than anticipated.
A quote with no contingency can turn a minor estimating error into a loss.
Software and Digital Products
Digital businesses are unusual because producing one additional copy of a digital product can cost very little.
But that does not mean the business has no costs.
Software businesses may spend heavily on:
- development
- servers
- technical support
- payment processing
- advertising
- cybersecurity
- ongoing updates
The economics can become extremely attractive at scale, but only if customer acquisition and ongoing support costs remain under control.
Fixed Costs Still Need to Be Paid
Profit margin on an individual product does not automatically mean the company itself is profitable.
Suppose you sell a product for $100 and have $40 remaining after the direct costs associated with that sale.
That $40 may still need to help pay for:
- rent
- insurance
- bookkeeping
- management salaries
- websites
- subscriptions
- telephone
- utilities
- professional fees
- equipment
These are often called overhead or fixed costs.
The business needs enough total contribution from all of its sales to cover those costs.
Only after that point does the remaining amount become true business profit.
This is why volume matters.
A product generating $20 toward overhead may be perfectly worthwhile if you sell 100,000 of them.
It may not support a business if you sell 20.
Consider Your Expected Sales Volume
Higher margin is not automatically better.
Imagine two products.
Product A
Profit per unit: $50
Units sold: 100
Total contribution: $5,000
Product B
Profit per unit: $10
Units sold: 2,000
Total contribution: $20,000
Product B has much less profit per sale but contributes substantially more money overall.
The goal is not necessarily to achieve the highest possible margin percentage.
The goal is to develop a pricing and sales model that produces enough total profit to justify the resources and risk involved.
Do Not Price Solely Based on Competitors
Competitor pricing is useful information.
It should not be your entire pricing strategy.
You do not know your competitor’s economics.
They may:
- purchase inventory more cheaply
- own their building
- have more efficient equipment
- operate at much greater volume
- accept lower margins
- make most of their profit from another product
- be deliberately selling something at a loss
- simply have bad pricing
Matching somebody else’s price does not mean matching their profitability.
Know your own costs first.
Then use the market to determine whether customers are likely to accept the price your business requires.
If they will not, the solution may be to reduce costs, change the product, improve the value proposition or abandon the product entirely.
Sometimes the Right Answer Is Not to Sell the Product
This is worth emphasizing.
Entrepreneurs can become emotionally attached to an idea.
But every possible product does not need to exist.
If customers will realistically pay $50 and your business needs to charge $70 for the economics to work, you may not have a pricing problem.
You may have a business-model problem.
Walking away from an unprofitable product can be an excellent business decision.
Build a Margin That Gives You Options
A healthy business needs flexibility.
You may eventually want to:
- hire employees
- increase advertising
- offer promotions
- pay sales commissions
- sell wholesale
- replace damaged products
- improve packaging
- invest in equipment
- absorb supplier price increases
A razor-thin margin makes every one of those decisions harder.
Pricing should therefore consider not only:
“Can I make money selling this today?”
but also:
“Does this price give me enough room to operate the business I want to have?”
That is a much better question.
A Simple Pricing Checklist
Before deciding that your margin is sufficient, ask yourself:
Have I included the actual cost of the product?
Have I accounted for my time and employee labour?
What happens when a product is returned, damaged or replaced?
How much might I need to spend to acquire a customer?
Can I afford to offer a 10% or 20% discount?
Will wholesale pricing still work?
What happens if my supplier raises prices?
Does each sale contribute enough toward overhead?
Would the model still work if I had to hire people to perform the work I currently do myself?
Can the business scale at this price?
Is the resulting selling price realistic in the marketplace?
If you cannot answer those questions yet, that is usually a sign that more work should be done before setting the final price.
The Best Margin Is the One That Makes the Business Work
There is no magic profit-margin percentage that applies to every business.
A company selling thousands of standardized products can operate very differently from a custom manufacturer, restaurant, consultant or online retailer.
What matters is understanding what happens to each dollar of revenue.
Your selling price needs to cover the costs directly related to the sale, contribute toward the costs of operating the business, provide room for normal problems and still leave enough profit to make the business worthwhile.
That is what makes a margin sustainable.
Before setting or changing prices, calculate what your current numbers actually produce. Our Profit Margin Calculator can help you compare your revenue, costs, profit margin and markup so you can see how much room your pricing really gives you.
