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.
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:
Systematic margin analysis reveals:
Understanding margin analysis in manufacturing provides the foundation for this strategic work.
Accurate margin analysis requires accurate cost data. Garbage in, garbage out.
Identify actual material costs per unit, including:
Use current costs, not outdated standard costs. If steel prices increased 15% but your costing system hasn't updated, your margins are overstated.
Calculate actual labor costs including:
Understanding how to calculate labor costs ensures you're capturing the true cost of production.
Allocate overhead appropriately:
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.
While not included in gross margin, understanding full profitability requires allocating SG&A:
Some manufacturers allocate SG&A; others analyze gross margin then evaluate SG&A separately. Either approach works if applied consistently.
Different margin metrics reveal different insights:
Formula: (Revenue - COGS) ÷ Revenue
What it shows: Profitability after direct manufacturing costs, before operating expenses.
Example:
Formula: (Revenue - Variable Costs) ÷ Revenue
What it shows: How much each unit contributes toward fixed costs and profit.
Example:
Understanding gross profit vs. contribution margin reveals why both metrics matter for different decisions.
Formula: (Revenue - COGS - Operating Expenses) ÷ Revenue
What it shows: Profitability after all operating costs, the true bottom-line picture.
Example:
Track both percentage margins and absolute margin dollars:
Product A:
Product B:
Product B has higher percentage margin but Product A generates more absolute dollars. Which matters more depends on constraints (capacity, customer demand, strategic priorities).
Calculate margins across multiple dimensions:
Which specific products are most/least profitable? Often, you'll find:
Calculate profitability by customer, including:
You may discover your largest customer is among your least profitable after full cost allocation.
Compare margin across distribution channels:
Different channels have different cost structures affecting net profitability.
Regional pricing variations, freight costs, and market dynamics affect margins differently by geography.
Small orders often have disproportionately high overhead per dollar of revenue. Large orders may command volume discounts but spread fixed costs efficiently.
Understand how your pricing compares to competition:
For comparable products, what do competitors charge? Sources include:
If your product differs from competition (quality, features, service), adjust for value differences:
Example:
Where does your pricing position you in the market?
Ensure positioning aligns with your brand strategy and product positioning.
With cost and competitive data, identify opportunities:
If target gross margin is 40% but certain products deliver only 30%, investigate:
Indicators of potential price increase opportunity:
High-margin products with low volume deserve sales focus. Marketing and sales resources should prioritize these opportunities.
Products with persistently low margins despite optimization efforts may warrant discontinuation, especially if:
Understanding strategies for profit includes knowing when to walk away from unprofitable business.
Different pricing approaches suit different situations:
Add target margin percentage to costs:
Example:
Pros: Simple, ensures margin targets, transparent Cons: Ignores customer value perception and competitive positioning
Price based on value delivered to customers, not your costs:
Example:
Pros: Captures fair share of value created, can dramatically improve margins Cons: Requires understanding customer economics, harder to justify/defend
Price relative to competition:
Pros: Market-driven, considers customer alternatives Cons: Assumes competitors price optimally (often wrong assumption)
Offer good/better/best options:
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.
Don't change all pricing at once. Test and phase implementation:
Test price increases on low-volume products, products with strong competitive position, and new customers. Measure customer response, win rates, and volume impact.
Implement in phases: new customers first, then small, medium, and finally large customers with advance notice. This allows course correction if needed.
Emphasize value, give advance notice, explain cost pressures when relevant, and offer options at different service/price levels.
Understanding pricing metrics CFOs track helps monitor impact of pricing changes.
Pricing and margin analysis isn't one-time exercise:
Every quarter, review:
Annually, conduct full pricing and margin analysis:
Track leading indicators monthly:
Using outdated cost data. Update costs regularly—standard costs from years ago don't reflect reality.
Allocating overhead arbitrarily. Poor allocation obscures true profitability. Use activity-based principles.
Ignoring pricing power differences. Unique solutions support premiums that commodities can't.
Confusing margin percentage with margin dollars. Lower-margin products might generate more absolute profit through volume.
Neglecting customer lifetime value. Analyze total customer profitability, not just individual transactions.
Fearing price increases. Most manufacturers can increase 3-5% annually with minimal resistance.
Effective pricing and margin analysis benefits from appropriate tools:
Spreadsheets work for basic analysis with small product catalogs. ERP systems provide cost data, though often requiring manipulation. Pricing software (Vendavo, Zilliant, PROS) automates analysis for complex businesses. BI tools (Tableau, Power BI) visualize margin data across dimensions.
Start simple and add sophistication as needed. Working with a fractional CFO or financial controller experienced in pricing analysis accelerates results.
Pricing and margin analysis transforms gut-feel pricing into data-driven strategy. By understanding which products, customers, and markets drive profitability, you can:
Conduct comprehensive analysis at least annually, with quarterly updates. Track both percentage margins and absolute margin dollars across multiple dimensions (product, customer, channel, geography).
Start with accurate cost data, calculate multiple margin measures, segment the analysis, and use insights to drive pricing decisions. Test changes carefully, communicate effectively, and monitor results.
Pricing is the fastest path to improved profitability. Small improvements—3% price increase, 2% margin improvement on key products—compound into significant bottom-line impact. The investment in systematic margin analysis returns multiples in improved profitability.