Markups / Margins Tutorial
How much an integrator marks up a product when they sell it to a customer has a big impact on both the total end user cost and the profitability of the integrator. Equally importantly, markups have been going down significantly over the last decade - good news (sometimes) for end users and bad news (most of the time) for integrators. In this note, we explain the basic forces and issues in marking up products.
Calculating a Markup
Here's how to calculate a markup:
- Integrator buys a product - typically from a manufacturer, distributor or reseller. For example, the integrator pays $1,000 for an indoor PTZ camera.
- Integrator sells a product - typically to an end user. For example, the integrator sells that indoor PTZ camera for $1,500.
- The total markup is the difference between price paid and price sold. In our example, it is a $500 markup (i.e., sold for $1,500, bought for $1,000).
- Percentages are most often used to communicate markups. In our example, it is a 50% markup as the camera was sold for 50% more than it was bought.
Markups vs Gross Margins
Markups and Gross Margins should not be confused. While they track similar activities, the metrics are subtly different.
- Markup Percentage = Price Sold - Price Paid / Price Paid
- Gross Margin Percentage = Price Sold - Price Paid / Price Sold
Returning to our indoor PTZ example, the gross margin is 33% - $500 markup divided by $1500 price sold compared to a markup of 50% ($500 markup / $1000 price paid)
Neither metric is 'right' or 'wrong'. Typically, operational people will speak of markups while accountants will use gross margins. However, be sure you are consistent as confusing the two can create problems.
Factors Impacting Markups
A number of important factors impact markups:
- Competitiveness of the Region: The more suppliers in a region, the lower the margins will typically be. With more suppliers, a customer can benefit from suppliers competing and aggressive suppliers offering lower cost. For instance, large metropolitan areas typically have lower margins than remote tropical islands as the former might have dozens of suppliers while the latter may only have a few.
- Availability of the Product: In security, some products are hard to buy outside of limited, manufacturer sanctioned, channels (e.g. NICE, Verint). However, others can be bought anywhere (e.g., Axis). The Internet is an especially important force here. If a product can be price checked quickly online, it is much easier for a user to push down pricing (and therefore margins). This is why many integrators (for better or worse) prefer to recommend products with limited availability.
- Purchasing Process: Typically, customers who use formal, public bidding processes will reduce integrator markups. The extreme of this is the reverse auction. By contrast, negotiated purchases will usually result in better markups for integrators and higher costs for end users.
- Size of the Customer: The bigger the customer, the more markups will be squeezed. Wal-Mart is famous for buying security products direct from manufacturers and at tiny markups. While Wal-Mart may be the most extreme example, even mid size end users can use the lure of a few hundred thousand dollar order to reduce markups.
Included in Markup?
While end users might always prefer a lower markup, this often comes with hidden costs and problems. When examining the value of a price and the size of a markup, it is important to consider what the markup includes:
- Support: A key question when buying products, is what level and amount of support is included. Often, suppliers offering super low prices included little to no support. Equally important, a manufacturer may deny technical support as well if the product was bought through a non authorized channel.
- Maintenance: Typically, reliable integrators will include 1 year warranty for product and labor. If the product fails or needs to be repaired 6 months later, that will be done free or charge to the end user. However, this is not universal. Some suppliers with super low prices may charge additional fees or refuse to go on site to fix.
- Shipping/Handling: Some integrators will not charge separately for shipping and handling of products, simply bundling that in to the price of the product.
- Bench Testing: Often, if an integrator is also deploying the products, they will include the cost of bench testing equipment in the price of the product.
Whether a 20% vs a 40% markup is better or worse depends significantly on what associated services are included in that markup. Buyers need to carefully check these detailed points.
In the second half of this series, we examine actual real world markups based on our Spring 2012 survey results.