How to Conduct a Pricing and Margin Analysis

You know your overall gross margin is 35%, but which products are actually profitable? That high-volume product everyone loves—is it generating acceptable margin or subsidizing other products? Should you raise prices on slow-moving items or focus sales efforts on high-margin products?

Without systematic pricing and margin analysis, you're flying blind. You might be pushing products that barely break even while neglecting ones that drive profitability. Your pricing might not reflect current costs, competitive positioning, or customer value perception.

For manufacturing business owners, pricing and margin analysis is one of the most valuable financial exercises you can conduct. It reveals which products, customers, and markets generate real profitability—and which consume resources without adequate return.

Here's how to conduct a comprehensive pricing and margin analysis that drives better business decisions.

Why Pricing and Margin Analysis Matters

Pricing affects profitability more directly than almost any other business decision. A 5% price increase with constant volume typically improves profit by 20-50% or more. Conversely, underpricing by just 10% can eliminate profitability entirely.

Yet many manufacturers set prices based on:

• What competitors charge (without knowing their cost structure)
• Cost-plus formulas established years ago
• "What the market will bear" (guessing)
• Historical pricing adjusted for inflation
• Sales team negotiations without guardrails

Systematic margin analysis reveals:

• Which products drive profitability and deserve sales focus
• Where price increases are justified and likely accepted
• Which products are underpriced relative to value or costs
• Where costs have crept up without corresponding price adjustments
• Which customers are most/least profitable after full cost allocation

Understanding margin analysis in manufacturing provides the foundation for this strategic work.

Step 1: Gather Comprehensive Cost Data

Accurate margin analysis requires accurate cost data. Garbage in, garbage out.

Direct Material Costs

Identify actual material costs per unit, including:

• Raw materials and components
• Packaging materials
• Inbound freight and duties
• Purchase price variances
• Scrap and waste

Use current costs, not outdated standard costs. If steel prices increased 15% but your costing system hasn't updated, your margins are overstated.

Direct Labor Costs

Calculate actual labor costs including:

• Base wages for production workers
• Payroll taxes and benefits
• Overtime premiums
• Labor efficiency variances

Understanding how to calculate labor costs ensures you're capturing the true cost of production.

Manufacturing Overhead

Allocate overhead appropriately:

• Facility costs (rent, utilities, maintenance)
• Equipment depreciation
• Indirect labor (supervision, quality control)
• Factory supplies and tooling
• Insurance and property taxes

Choose allocation bases that reflect actual resource consumption. Machine hours work better than revenue for capital-intensive manufacturing. Labor hours suit labor-intensive operations.

Understanding how to determine cost of goods sold (COGS) helps establish accurate product costs.

Selling, General & Administrative (SG&A)

While not included in gross margin, understanding full profitability requires allocating SG&A:

• Sales commissions and support
• Marketing and advertising
• Customer service
• Shipping and logistics
• Administrative overhead

Some manufacturers allocate SG&A; others analyze gross margin then evaluate SG&A separately. Either approach works if applied consistently.

Step 2: Calculate Multiple Margin Measures

Different margin metrics reveal different insights:

Gross Margin

Formula: (Revenue - COGS) ÷ Revenue

What it shows: Profitability after direct manufacturing costs, before operating expenses.

Example:

• Selling price: $100
• COGS: $65
• Gross margin: $35 / $100 = 35%

Contribution Margin

Formula: (Revenue - Variable Costs) ÷ Revenue

What it shows: How much each unit contributes toward fixed costs and profit.

Example:

• Selling price: $100
• Variable costs: $55 (materials + variable labor)
• Contribution margin: $45 / $100 = 45%

Understanding gross profit vs. contribution margin reveals why both metrics matter for different decisions.

Operating Margin

Formula: (Revenue - COGS - Operating Expenses) ÷ Revenue

What it shows: Profitability after all operating costs, the true bottom-line picture.

Example:

• Revenue: $100
• COGS: $65
• Operating expenses: $25
• Operating margin: $10 / $100 = 10%

Margin Per Unit vs. Margin Dollars

Track both percentage margins and absolute margin dollars:

Product A:

• Price: $1,000
• COGS: $700
• Margin: 30% ($300)

Product B:

• Price: $500
• COGS: $300
• Margin: 40% ($200)

Product B has higher percentage margin but Product A generates more absolute dollars. Which matters more depends on constraints (capacity, customer demand, strategic priorities).

Step 3: Segment Your Analysis

Calculate margins across multiple dimensions:

By Product or Product Line

Which specific products are most/least profitable? Often, you'll find:

• 20% of products generate 80% of profit
• Some high-volume products barely break even
• Low-volume specialty products may have exceptional margins

By Customer or Customer Segment

Calculate profitability by customer, including:

• Product mix they buy (high vs. low margin products)
• Volume discounts or special pricing
• Service requirements (custom engineering, frequent small orders)
• Payment terms (net 30 vs. net 90)

You may discover your largest customer is among your least profitable after full cost allocation.

By Sales Channel

Compare margin across distribution channels:

• Direct sales vs. distributors
• Online vs. traditional retail
• Domestic vs. export

Different channels have different cost structures affecting net profitability.

By Geography or Market

Regional pricing variations, freight costs, and market dynamics affect margins differently by geography.

By Order Size

Small orders often have disproportionately high overhead per dollar of revenue. Large orders may command volume discounts but spread fixed costs efficiently.

Step 4: Conduct Competitive Pricing Analysis

Understand how your pricing compares to competition:

Direct Price Comparison

For comparable products, what do competitors charge? Sources include:

• Published price lists
• Distributor/dealer feedback
• Customer discussions
• Mystery shopping
• Industry reports

Value-Adjusted Comparison

If your product differs from competition (quality, features, service), adjust for value differences:

Example:

• Competitor price: $90
• Your price: $100
• Your product includes feature worth $15 to customers
• Value-adjusted comparison: You're $5 cheaper ($100 vs. $90 + $15)

Market Positioning Analysis

Where does your pricing position you in the market?

• Premium tier (>20% above average)
• Mid-market (±10% of average)
• Value tier (<10% below average)

Ensure positioning aligns with your brand strategy and product positioning.

Step 5: Analyze Pricing Opportunities

With cost and competitive data, identify opportunities:

Products with Margin Below Target

If target gross margin is 40% but certain products deliver only 30%, investigate:

• Are costs higher than expected? (Address cost issues)
• Is pricing too low? (Consider price increase)
• Is product mix wrong? (Upsell to higher-margin configurations)

Products with Pricing Power

Indicators of potential price increase opportunity:

• No price increase in 18+ months despite cost inflation
• Significantly below competition on value-adjusted basis
• Unique features or capabilities competitors lack
• High customer satisfaction/loyalty
• Supply constrained or limited competition

Products with Volume Opportunity

High-margin products with low volume deserve sales focus. Marketing and sales resources should prioritize these opportunities.

Products to Exit or De-emphasize

Products with persistently low margins despite optimization efforts may warrant discontinuation, especially if:

• They consume limited production capacity
• They require specialized equipment or skills
• They create service burden disproportionate to revenue

Understanding strategies for profit includes knowing when to walk away from unprofitable business.

Step 6: Consider Pricing Strategies

Different pricing approaches suit different situations:

Cost-Plus Pricing

Add target margin percentage to costs:

Example:

• COGS: $60
• Target gross margin: 40%
• Price: $60 ÷ (1 - 0.40) = $100

Pros: Simple, ensures margin targets, transparent Cons: Ignores customer value perception and competitive positioning

Value-Based Pricing

Price based on value delivered to customers, not your costs:

Example:

• Your product saves customer $50,000 annually in operating costs
• Charge $30,000 annually (customer nets $20,000 benefit)
• Your costs might be only $5,000

Pros: Captures fair share of value created, can dramatically improve margins Cons: Requires understanding customer economics, harder to justify/defend

Competitive Pricing

Price relative to competition:

• Match competitors for commodity products
• Premium pricing for superior offerings
• Discount pricing for positioning as value alternative

Pros: Market-driven, considers customer alternatives Cons: Assumes competitors price optimally (often wrong assumption)

Tiered Pricing

Offer good/better/best options:

• Base model at competitive price
• Enhanced models at higher margins
• Premium model at premium price

Pros: Captures different customer segments, natural upsell path Cons: Requires distinct product versions, more complex to manage

Most manufacturers use hybrid approaches—cost-plus as floor, value and competition as ceiling, with strategic positioning in between.