Are Operating Margin, Markup and Unit Margin Good for Profit? An Approach Based on Microeconomic Theory

Abstract

Managers often say that they want to make their company more profitable by increasing the unit margin, operating margin, or margin rate, making these strategic objectives. There is some confusion in their language, as these three metrics seem to be equivalent to maximum profit. We use simple microeconomic theory to show that they are inconsistent with the objective of maximum profit: the output is lower, and the price is generally higher, when these alternative objectives are chosen instead of the maximum profit. Output is lowest when the unit margin is chosen; the highest output corresponds to maximum profit; the output derived from maximizing operating margin or markup is the same and lies between the two previous maximums. Prices are in the reverse order under imperfect competition for normal goods. Maximizing margin metrics results in lower profit than maximizing profit. This has implications for how companies communicate, both internally and externally, and for their governance.