Demystifying Profit Margins and Markups

Many of the inventors I meet got started because they wanted an outlet for their creativity or sought more freedom in their careers. Rarely do I meet someone who has approached inventing from a number-crunching background. It seems that many inventors just aren't that comfortable with "the numbers." However, if you create a viable product, you've got to sell it. And pricing and profit margins are a critical part of that process.

Whether you sell directly to end-users or to a retailer or distributor who sells to customers, you need to know how to price your product to ensure everyone in the process will make their required profits. As you probably suspect, this involves a bit of art -- and a lot of science.

Common sense dictates that the price you choose should be neither too high nor too low to attract the most customers and generate the greatest amount of profit. Your price also needs to cover the cost of doing business. This is where understanding the basics of "markups" and "gross margins" can help.

Before we get into these concepts, I'd like to define a few terms that people often confuse:

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