Margin Creep

Key Takeaways

• Margin creep is the slow decline of a company's profit margins.
• Rising costs without price hikes lead to margin erosion.
• Focus on high-margin products can lower market share and profits.
• Companies may resist price increases to maintain customer demand.
• Profit margins in stock indexes can fluctuate with economic conditions.
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What Is Margin Creep?

Margin creep is the gradual decline of a company's profit margins over time, often due to increasing costs incurred without matching price increases. It can also happen when a company leans too heavily on high-margin products, which can cost it market share and reduce overall profitability.

Companies need pricing and product strategies that fit how sensitive customers are to price, while investors and analysts should track margin trends across firms, sectors, and the broader market to gauge wider economic effects.

How Margin Creep Affects Business Profitability

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 absorb 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 that 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.

Examples of Margin Creep in Stock Indexes

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 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.1 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 its sales/pricing strategy to accommodate 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.