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Margin Creep What It is How It Works Example

Margin Creep What It is How It Works Example

Margin Creep: What It is, How It Works, Example

What Is Margin Creep?

Margin creep has multiple meanings in finance. In both cases, margin creep refers to a gradual reduction of a company’s overall profit margin. A product’s margin is the difference between its cost and the retail price. The greater the difference between the cost and the price, the higher the margin.

  1. Margin creep can refer to a gradual erosion of a company’s profit margins over time. Often, this is due to increasing costs incurred by the company without corresponding price increases to cover the cost.
  2. Margin creep can also refer to a company focusing solely on high-margin products, even if customers prefer value-oriented products/services. By neglecting lower-margin products, the company may lose market share and reduce its overall profit margin.

Understanding Margin Creep

Margin creep is the gradual reduction of a company’s profit margins. It can have long-term implications on a company’s sustainability.

Companies often absorb increases in input costs to avoid raising the prices of their products. They fear losing market share if competitors do not raise prices as well. This tendency contributes to margin creep, especially for products with elastic consumer demand, where price changes heavily influence consumer purchases.

While successfully marketed products may yield solid margins, companies risk losing potential sales if value-minded consumers are price-sensitive. Therefore, companies offering multiple products must consider how pricing strategies impact demand, sales, and profitability.

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Example of Margin Creep in a Stock Index

Profit margins vary among companies, and publicly traded companies are part of stock indexes like the S&P 500.

Based on FactSet data, the S&P 500’s profit margins increased from 9.4% in Q1 2016 to 12% in Q3 2018. Prior to Q1 2016, profit margins had been declining. Economic conditions affect profit margins for entire sectors, industries, or the stock market. Analysts should consider both the overall market environment and individual companies when analyzing profit margins.

Margin creep can be temporary, while companies adjust their sales/pricing strategy to accommodate rising input costs. In some cases, the trend is sustained. Analyzing profit margins and trends in other companies, indexes, or competitors can provide further insight.

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