How to Calculate and Use Material Margin to Drive Competitive Pricing
May 5, 2021 - When determining manufacturing costs and pricing, you can look at a number of different margins to determine efficiency and profit. These metrics often factor in many costs like overhead, labor, and more. Material margins, on the other hand, are a simple metric that can contextualize your manufacturing costs to help you price competitively for your market.
How Material Margin Helps Manufacturers Set Competitive Pricing
Your material margin is essentially the money you have to work with after you buy the materials you need to create a product. Unlike other metrics (gross margin, gross profit, operating margin, or contribution margin), material margin accounts only for the costs of the materials you use and not direct labor, overhead, or any costs other than direct materials.
Material margin is useful because it can help you determine the right price for the right product at the right volume to stay competitive in the marketplace. For example, high-volume jobs typically have less complexity in terms of overhead, so applying overhead using traditional methods could overstate cost and price you out of the market.
If you have excess capacity (idle equipment, no additional labor, or expense outlay), you may be able to take on smaller, more complex jobs, as long as the material margin is high enough to cover fixed costs.
How to Calculate Material Margin
Material margin dollars are revenue less material costs. When calculating your material margin and material margin percentage, be careful not to include direct labor, overhead, or any costs other than direct materials.
This is the simple formula to calculate your manufacturing material margin:
Material Margin (MM) = Revenue (R) - Material Costs (C)
Material Margin % = (MM) / (R)
[Save this material margin formula as a handy infographic!]
If the material margin percentage is greater than 40%, you typically have sufficient margin to be profitable even in a complex costing structure and there is potential opportunity to drop more to the bottom line. For example, if revenue is $100 and material cost is $40, your material margin is $60, and your material margin percentage is 60%.
$60 (MM) = $100 (R) - 40 (C)
60% = $60 (MM) / $100 (R)
This means there is enough margin to be profitable and an opportunity to increase efficiency through product volume without a significant increase to non-material costs. We know the higher the material margin, the more profitable that job could be since overhead is a factor of complexity, not pricing.
If you suffer from low material margins, you have only two options to improve your bottom line: raise prices or lower material costs. If either of those options aren’t viable, your pricing will not allow you to be profitable or competitive in the market. Material margin analysis allows manufacturers to approach pricing from a different perspective, which eliminates the complexity when looking at the overall profitability potential.