What Is Margin Creep?
Margin creep has multiple meanings in finance. In both of the cases, margin creep refers to a slow reduction over time of a company's overall profit margin. A product's margin is the difference between the cost of the good or service and the retail price. The greater the difference between the cost of the good sold and the price at which it is sold, the higher the margin.
- Margin creep can refer to a gradual erosion of a company's profit margins over time. Often, this can be due to increasing costs incurred by the company without increases in price that cover the increased cost of the good sold.
- Margin creep can also refer to the behavior of a company that chooses to focus only on the high-end, high-margin products, even if customers show an inclination towards more value-oriented products and/or services. By focusing all or most of its efforts on the high-margin products, the company may lose market share of the value-priced, lower-margin products, thus reducing its overall sales and potentially reducing the company's total profit margin.
Understanding Margin Creep
Margin creep refers to the gradual reduction of a company's profit margins over time. The tendency for margin creep within a company can have long-term implications on its sustainability.
Companies will often eat increases in costs for the inputs to their products in order to avoid raising the price of their end product. They are concerned that if other companies are not raising their prices as well, customers will be driven towards substitute goods and the company will lose market share. This tendency to absorb input price increases can lead to margin creep. It is most common in companies who produce products for which there is an elastic consumer demand, meaning that the amount of a product purchased by a consumer is heavily influenced by changes in the product's price.
While any products or services that are successfully marketed and sold may result in a solid margin, other potential sales will be lost if value-minded consumers are price-sensitive. Therefore companies that deal with multiple products need to be aware of how their pricing strategies affect demand, sales, and ultimately their own profitability.
Example of Margin Creep in a Stock Index
Companies have profit margins, and many publicly traded companies are included in indexes. An index, such as the S&P 500, will have an average profit margin for the all the stocks in the index.
For the S&P 500, profit margins rose between quarter one of 2016 (9.4%) and quarter three of 2018 (12%), according to FactSet. In the quarters immediately prior to Q1 2016, profit margins had been falling. Therefore, an entire sector, industry, or the stock market as a whole will see profit margins expand and contract based on economic conditions. Investors and businesses who are analyzing profit margins will want to consider the overall market environment in addition to the individual company.
Margin creep is sometimes temporary, as it may take a company some time to adjust their sales/pricing strategy to accommodate for rising input costs. Other times there may be a sustained trend. Looking at profit margins, and their trend, in other companies, indexes, or competitors may provide further insight.