Tag Archives | Pricing

Supplier Power (one of Porter’s Five Forces)

See also:
Supplier Power Analysis
Porter’s Five Forces of Competition
Threat of New Entrants
Buyer Bargaining Power
Threat of Substitutes
Intensity of Rivalry

Supplier Power Definition

In Porter’s five forces, supplier power refers to the pressure suppliers can exert on businesses by raising prices, lowering quality, or reducing availability of their products. When analyzing supplier power, the industry analysis is being conducted from the perspective of the industry firms, in this case referred to as the buyers. According to Porter’s 5 forces industry analysis framework, supplier power, or the bargaining power of suppliers, is one of the forces that shape the competitive structure of an industry. The idea is that the bargaining power of the supplier in an industry affects the competitive environment for the buyer and influences the buyer’s ability to achieve profitability. Strong suppliers can pressure buyers by raising prices, lowering product quality, and reducing product availability. All of these things represent costs to the buyer. A strong supplier can make an industry more competitive and decrease profit potential for the buyer. On the other hand, a weak supplier, one who is at the mercy of the buyer in terms of quality and price, makes an industry less competitive and increases profit potential for the buyer.

Download the External Analysis whitepaper to gain an advantage over competitors by overcoming obstacles and preparing to react to external forces, such as it being a buyer’s market.

Supplier Power – Determining Factors

The supplier power Porter has studied includes several determining factors. If suppliers are concentrated compared to buyers – if there are few suppliers and many buyers – supplier bargaining power is high. If buyer switching costs – the cost of switching from one supplier’s product to another supplier’s product – are high, the bargaining power of suppliers is high. If suppliers can easily forward integrate – or begin to produce the buyer’s product themselves – supplier power is high. If the buyer is not price sensitive and uneducated regarding the product, supplier power is high. If the supplier’s product is highly differentiated, supplier bargaining power is high. If the buyer does not represent a large portion of the supplier’s sales, the bargaining power of suppliers is high. If substitute products are unavailable in the marketplace, supplier power is high.

And of course, if the opposite is true for any of these factors, supplier power is low. For example, low supplier concentration, low switching costs, no threat of forward integration, more buyer price sensitivity, well-educated buyers, buyers that purchase large volumes of standardized products, and the availability of substitute products. Each of the four mentioned factors indicate that the supplier power Porter’s five forces emphasize is low. To help determine the level of supplier power in your industry, start by performing an external analysis. This tool will easily help you determine the level of all of Porter’s Five Forces. Download the free External Analysis whitepaper by clicking here or the image below.

supplier power

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supplier power

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Markup Percentage Calculation

See Also:
Margin vs Markup
Margin Percentage Calculation
Retail Markup
Gross Profit Margin Ratio Analysis
Operating Profit Margin Ratio Analysis

Markup Percentage Definition

The markup percentage can best be defined as the increase on the original selling price. The markup sales are expressed as a percentage increase as to try and ensure that a company can receive the proper amount of gross or profit margin. Markups are normally used in retail or wholesale business as it is an easy way to price items when a store contains several different goods.

Looking to price for profit? Download your free Pricing for Profit Inspection Guide now.

How to Calculate Markup Percentage

By definition, the markup percentage calculation is cost X markup percentage, and then add that to the original unit cost to arrive at the sales price. The markup equation or markup formula is given below in several different formats. For example, if a product costs $100, the selling price with a 25% markup would be $125.

Gross Profit Margin = Sales Price – Unit Cost = $125 – $100 = $25.

Markup Percentage = Gross Profit Margin/Unit Cost = $25/$100 = 25%.

Sales Price = Cost X Markup Percentage + Cost = $100 X 25% + $100 = $125.

One of the pitfalls in using the markup percentage to calculate your prices is that it is difficult to ensure that you have taken into consideration all of your costs. By using a simple rule of thumb calculation, you often miss out on indirect costs.

(NOTE: Want the Pricing for Profit Inspection Guide? It walks you through a step-by-step process to maximizing your profits on each sale. Get it here!)

Markup Percentage Example

Glen works has started a company that specializes in the setup of office computers and software. Glen has decided that he would like to earn a markup percentage of 20% over the cost of the computers to ensure that he makes the proper amount of profit. Glen has recently received a job to set up a large office space. He estimates that he will need 25 computers at a cost of $600 a piece. Plus, Glen will need to set up the company software in the building. The cost of the software to run all the computers is around $2,000. If Glen wants to earn the desired 20% markup percentage for the job what will he need to charge the company?

(Looking for more examples of markup? Click here to access a retail markup example.)

Step 1

Glen must calculate the total cost of the project which is equal to the cost of software plus the cost of the computers.

$2,000 + ($600*25) = $17,000
Step 2

Glen must find his selling price by using his desired markup of 20% and the cost just calculated for the project.The formula to find the sales price is:

Sales Price = (Cost * Markup Percentage) + Cost
or
Sales Price = ($17,000 * 20%) + $17,000 = $20,400

This means that to earn the return desired Glen must charge the company $20,400. This is the equivalent of a profit margin of 16.7%. For a list of markup percentages and their profit margin equivalents scroll down to the bottom of the Margin vs Markup page, or they can be found using the above markup formula.

Using what you’ve learned from how to calculate your markup percentage, the next step is to download the free Pricing for Profit Inspection Guide. Easily discover if your company has a pricing problem and fix it.

markup percentage calculation

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Margin vs Markup

See Also:
Gross Profit Margin Analysis
Retail Markup
Chart of Accounts (COA)
Margin Percentage Calculation
Markup Percentage Calculation

Markup vs Margin Differences

Is there a difference between margin vs markup? Absolutely. More and more in today’s environment, these two terms are being used interchangeably to mean gross margin, but that misunderstanding may be the menace of the bottom line. Markup and profit are not the same! Also, the accounting for margin vs markup are different! A clear understanding and application of the two within a pricing model can have a drastic impact on the bottom line. Terminology speaking, markup percentage is the percentage difference between the actual cost and the selling price, while gross margin percentage is the percentage difference between the selling price and the profit.

So, who rules when seeking effective ways to optimize profitability?. Many mistakenly believe that if a product or service is marked up, say 25%, the result will be a 25% gross margin on the income statement. However, a 25% markup rate produces a gross margin percentage of only 20%.

(NOTE: Want the Pricing for Profit Inspection Guide? It walks you through a step-by-step process to maximizing your profits on each sale. Get it here!)

Markup vs Gross Margin; Which is Preferable?

Though markup is often used by operations or sales departments to set prices it often overstates the profitability of the transaction. Mathematically markup is always a larger number when compared to the gross margin. Consequently, non-financial individuals think they are obtaining a larger profit than is often the case. By calculating sales prices in gross margin terms they can compare the profitability of that transaction to the economics of the financial statements.

Steps to minimize Markup vs Margin mistakes

Terminology and calculations aside, it is very important to remember that there are more factors that affect the selling price than merely cost. What the market will bear, or what the customer is willing to pay, will ultimately impact the selling price. The key is to find the price that optimizes profits while maintaining a competitive advantage. Below are steps you can take to avoid confusion when working with markup rates vs margin rates:

  • Use a pricing model or pricing tool to quote sales. Have the tool calculate both the markup percentage and the gross margin percentage
  • Relate gross margin percentage per sales invoice to income statement
  • Organize your chart of accounts to compare gross margin rate to sales quotes
  • Educate your sales force on the differences. By targeting the gross margin percentage vs the markup percentage you can throw an additional 2 – 3 percent profit to the bottom line!

Still deciding whether to use margin or markup to establish a price? Easily discover if your company has a pricing problem and fix it with either margin or markup. Download the free Pricing for Profit Inspection Guide to learn how to price profitably.

margin vs markup

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margin vs markup

Margin vs Markup Chart

15% Markup = 13.0% Gross Profit
20% Markup = 16.7% Gross Profit
25% Markup = 20.0% Gross Profit
30% Markup = 23.0% Gross Profit
33.3% Markup = 25.0% Gross Profit
40% Markup = 28.6% Gross Profit
43% Markup = 30.0% Gross Profit
50% Markup = 33.0% Gross Profit
75% Markup = 42.9% Gross Profit
100% Markup = 50.0% Gross Profit

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Margin Percentage Calculation

See Also:
Margin vs Markup
Markup Percentage Calculation
Retail Markup
Gross Profit Margin Ratio Analysis
Net Profit Margin Analysis

Margin Percentage Definition

Gross margin defined is Gross Profit/Sales Price. All items needed to calculate the gross margin percentage can be found on the income statement. The margin percentage often refers to sales or profitability which may help lead to several key understandings about the company’s business model as well as how successful the company is at maintaining its cost structure to gain the proper amount of sales. Analysis of margins within a business is often useful in controlling the price in which you need to sale as well as a control on the cost associated to make the sale.

(NOTE: Want the Pricing for Profit Inspection Guide? It walks you through a step-by-step process to maximizing your profits on each sale. Get it here!)

How to Calculate Margin Percentage

In this example, the gross margin is $25. This results in a 20% gross margin percentage:

Gross Margin Percentage = (Gross Profit/Sales Price) X 100 = ($25/$125) X 100 = 20%.

Not quite the “margin percentage” we were looking for. So, how do we determine the selling price given a desired gross margin? It’s all in the inverse…of the gross margin formula, that is. By simply dividing the cost of the product or service by the inverse of the gross margin equation, you will arrive at the selling price needed to achieve the desired gross margin percentage.

For example, if a 25% gross margin percentage is desired, the selling price would be $133.33 and the markup rate would be 33.3%:

Sales Price = Unit Cost/(1 – Gross Margin Percentage) = $100/(1 – .25) = $133.33

Markup Percentage = (Sales Price – Unit Cost)/Unit Cost = ($133.33 – $100)/$100 = 33.3%

Margin Percentage Example

Glen charges a 20% markup on all projects for his computer and software company which specializes in office setup. Glen has just taken a job with a company that wants to set up a large office space. The total cost needed to set up the space with computer and the respective software is $17,000. With a markup of 20% the selling price will be $20,400(see markup calculation for details). The margin percentage can be calculated as follows:

Margin Percentage = (20,400 – 17,000)/20,400 = 16.67%

Using what you’ve learned from how to calculate your margin percentage, the next step is to download the free Pricing for Profit Inspection Guide. Easily discover if your company has a pricing problem and fix it.

margin percentage calculation

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Access your Strategic Pricing Model Execution Plan in SCFO Lab. The step-by-step plan to set your prices to maximize profits.

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margin percentage calculation

 

18

Intensity of Rivalry (one of Porter’s Five Forces)

See also:
Porter’s Five Forces of Competition
Threat of New Entrants
Supplier Power
Buyer Bargaining Power
Threat of Substitutes
Complementors (Sixth Force)

Porter’s Intensity of Rivalry Definition

The intensity of rivalry among competitors in an industry refers to the extent to which firms within an industry put pressure on one another and limit each other’s profit potential. If rivalry is fierce, competitors are trying to steal profit and market share from one another. This reduces profit potential for all firms within the industry. According to Porter’s 5 forces framework, the intensity of rivalry among firms is one of the main forces that shape the competitive structure of an industry.

Porter’s intensity of rivalry in an industry affects the competitive environment and influences the ability of existing firms to achieve profitability. High intensity of rivalry means competitors are aggressively targeting each other’s markets and aggressively pricing products. This represents potential costs to all competitors within the industry.

High intensity of competitive rivalry can make an industry more competitive and decrease profit potential for the existing firms. On the other hand, low intensity of competitive rivalry makes an industry less competitive and increases profit potential for the existing firms.

Conducting an competitor analysis can be overwhelming and confusing. Download the External Analysis whitepaper to gain an advantage over competitors by overcoming obstacles and preparing to react to external forces. 

Porter’s Intensity of Rivalry Determining Factors

Several factors determine the intensity of competitive rivalry in an industry. If the industry consists of numerous competitors, Porter rivalry will be more intense. If the competitors are of equal size or market share, the intensity of rivalry will increase. If industry growth is slow, the intensity of rivalry will be high. If the industry’s fixed costs are high, competitive rivalry will be intense. If the industry’s products are undifferentiated or are commodities, rivalry will be intense. If brand loyalty is insignificant and consumer switching costs are low, this will intensify industry rivalry. If competitors are strategically diverse – they position themselves differently from other competitors – industry rivalry will be intense. An industry with excess production capacity will have greater rivalry among competitors. And finally, high exit barriers – costs or losses incurred as a result of ceasing operations – will cause intensity of rivalry among industry firms to increase.

And of course, if the opposite is true for any of these factors, the intensity of Porter rivalry among competitors will be low. For example, a small number of firms in the industry, a clear market leader, fast industry growth, low fixed costs, highly differentiated products, prevalent brand loyalties, high consumer switching costs, no excess production capacity, lack of strategic diversity among competitors, and low exit barriers all indicate that the Porter intensity of rivalry among existing firms is low.

Porter’s Intensity of Rivalry Analysis

When analyzing a given industry, all of the aforementioned factors regarding the intensity of competitive rivalry Porter placed among existing competitors may not apply. But some, if not many, certainly will. And of the factors that do apply, some may indicate high intensity of rivalry and some may indicate low intensity of rivalry. The results will not always be straightforward. Therefore it is necessary to consider the nuances of the analysis and the particular circumstances of the given firm and industry when using these data to evaluate the competitive structure and profit potential of a market.

Intensity of Rivalry is High if…

• Competitors are numerous

• Competitors have equal size

• Competitors have equal market share

• Industry growth is slow

Fixed costs are high

• Products are undifferentiated

• Brand loyalty is insignificant

• Consumer switching costs are low

• Competitors are strategically diverse

• There is excess production capacity

• Exit barriers are high

Intensity of Rivalry is Low if…

• Competitors are few

• Unequal size among competitors

• Competitors have unequal market share

• Industry growth is fast

• Fixed costs are low

• Products are differentiated

• Brand loyalty is significant

• Consumer switching costs are high

• Competitors are not strategically diverse

• There is no excess production capacity

• Exit barriers are low

Porter’s Intensity of Rivalry Interpretation

When conducting Porter’s 5 forces industry analysis, low intensity of rivalry makes an industry more attractive and increases profit potential for the firms already competing within that industry, while high intensity of rivalry makes an industry less attractive and decreases profit potential for the firms already competing within that industry. The intensity of rivalry among existing firms is one of the factors to consider when analyzing the structural environment of an industry using Porter’s 5 forces framework.

Start preparing your external analysis so you can react in realtime when the intensity of rivalry threatens your company. Don’t loose out because of an external force. Download the free External Analysis whitepaper by clicking here.

buyer bargaining power

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buyer bargaining power

Sources on Porter’s Intensity of Rivalry

Harrison, Jeffrey S., Michael A. Hitt, Robert E. Hoskisson, R. Duane Ireland. (2008) “Competing for Advantage”, Thomson South-Western, United States, 2008.

Porter, M.E. (1979) “How competitive forces shape strategy”, Harvard Business Review, March/April 1979.

Porter, M.E. (1980) “Competitive Strategy”, The Free Press, New York, 1980.

Porter, M.E. (1985) “Competitive Advantage”, The Free Press, New York, 1985.

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