How to Calculate and Use Material Margin to Drive Competitive Pricing

Editor's note: This piece was originally published in 2021 and has been updated to include additional resources. 

When calculating manufacturing costs and pricing, you can look at several 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 and help you price competitively for your market.

How Material Margin Helps Manufacturers Set Competitive Pricing

Essentially,  material margin is the money you have to work with after you buy the materials you need to create a product. Unlike other metrics (gross profit margin, operating margin, or contribution margin), material margin accounts only for the costs of the materials you use. It does not include costs for direct labor, overhead, or any costs other than direct materials.

Material margin can help you determine the right price for the right product at the right volume to stay competitive. For example, high-volume jobs typically have less overhead complexity, so applying overhead with traditional methods could overstate cost and price you out of the market.

If you have excess capacity (from idle equipment, lack of additional labor, or expense outlays), 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, do not include direct labor, overhead, or any costs other than direct materials.

Here is a  simple formula to calculate your manufacturing material margin:

Material Margin (MM) = Revenue (R) - Material Costs (C)
Material Margin % = (MM) / (R)

If the material margin percentage is greater than 40%, you typically have sufficient margin to be profitable, even with complex costing structures. You also may have an 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 you have enough margin to be profitable and an opportunity to increase efficiency through product volume without a significant increase in non-material costs. 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 you cannot use either option,  your pricing will not allow you to be profitable or competitive in the market. 

A material margin analysis allows manufacturers to approach pricing from a different perspective, which eliminates the complexity when looking at the overall profitability potential.

The Impact of Inflation

Inflation can impact material margins across various industries, causing a chain reaction down various distribution paths. Manufacturing companies, in particular, face significant challenges as they heavily rely on raw materials such as metals, plastics, chemicals, and energy to produce their goods. 

To cope, companies often have to make a tough choice–they can either absorb the increased costs and accept reduced profit margins, or pass the higher costs to their customers through product price increases. 

Price hikes can make them less competitive in the market, so it is best to use the current or predicted cost of raw materials when making pricing decisions when inflation is high. Inflation can also disrupt supply chains, causing additional delays, higher transportation costs, and other logistical challenges, further impacting material margins.

As a result, businesses must closely monitor inflation rates, adopt effective cost management strategies, explore alternative sourcing options, and consider price adjustments to navigate the impact on their material margins successfully.