What is Gross Margin?
The percentage of revenue remaining after deducting direct costs. A key indicator of pricing power and production efficiency.
Key Takeaways
- •Gross Margin = (Revenue - COGS) / Revenue × 100
- •Measures profitability before operating expenses
- •Higher is generally better—indicates pricing power and efficiency
- •Benchmarks vary widely by industry (20% for grocery vs 80% for SaaS)
Gross Margin Definition
Gross margin (also called gross profit margin) is the percentage of revenue that exceeds the cost of goods sold (COGS). It shows how much money is left to cover operating expenses and generate profit after paying for what you sell.
Gross Margin Formula
or: Gross Profit / Revenue × 100
Example Calculation
Revenue: $1,000,000
COGS: $400,000
Gross Profit: $600,000
Gross Margin = 60%
Gross Margin vs. Other Margin Metrics
| Metric | Formula | What It Measures |
|---|---|---|
| Gross Margin | (Revenue - COGS) / Revenue | Direct product profitability |
| Operating Margin | Operating Income / Revenue | Profitability after overhead |
| EBITDA Margin | EBITDA / Revenue | Cash profitability (before D&A) |
| Net Margin | Net Income / Revenue | Bottom-line profitability |
Gross Margin by Industry
"Good" gross margin depends heavily on your industry. Compare to peers, not across industries.
| Industry | Typical Range | Notes |
|---|---|---|
| SaaS / Software | 70-85% | Low marginal cost |
| Professional Services | 50-65% | Labor-intensive |
| E-commerce / Retail | 35-50% | Depends on category |
| Manufacturing | 25-40% | Materials and labor costs |
| Distribution | 15-25% | Thin margins, high volume |
| Grocery | 20-30% | Very competitive |
| Restaurants | 60-70% | Food cost ~30% |
| Construction | 15-25% | Labor and materials heavy |
Track Trends Over Time
A single gross margin number matters less than the trend. Declining gross margin signals pricing pressure, rising costs, or product mix shifts. Investigate before it impacts bottom line.
Why Gross Margin Matters
Pricing Power
High gross margin indicates customers value your product enough to pay above cost. Low margin suggests commodity competition.
Scalability
High gross margin businesses scale better—more revenue goes to growth vs. incremental costs.
Operating Leverage
More gross profit means more cushion to cover fixed costs and invest in growth.
Valuation Driver
Higher gross margin businesses typically command higher valuation multiples.
Strategies to Improve Gross Margin
Increase Revenue Per Unit
- Raise prices (test elasticity)
- Reduce discounting
- Add premium tiers or features
- Bundle products/services
Reduce COGS
- Negotiate with suppliers
- Find alternative materials/components
- Improve production efficiency
- Reduce waste and defects
Optimize Mix
- Focus on high-margin products/customers
- Discontinue low-margin offerings
- Shift to higher-value segments
- Add services to product sales
Watch for False Economies
Cutting corners on quality may boost short-term gross margin but hurt customer satisfaction and retention. Balance margin improvement with maintaining product/service quality.
Frequently Asked Questions
What's the difference between gross margin and net margin?
Gross margin only deducts direct costs of goods/services sold (COGS). Net margin deducts ALL expenses—operating costs, interest, taxes, etc. A company might have 60% gross margin but only 10% net margin after overhead. Both matter: gross margin shows product economics; net margin shows overall profitability.
What costs go into COGS?
COGS includes direct costs to produce/deliver your product: materials, direct labor, manufacturing overhead, shipping to customers. It excludes indirect costs like sales, marketing, R&D, and G&A. For SaaS, COGS typically includes hosting, customer support, and payment processing fees.
Can gross margin be too high?
Very high gross margins (90%+) are generally good but might indicate under-investment in product quality, customer experience, or you're leaving money on the table with pricing. SaaS businesses routinely achieve 80%+ gross margins, which is healthy for the model.
How can I improve gross margin?
Key levers: raise prices (if market supports), reduce material costs (negotiate with suppliers, change specs), improve production efficiency, reduce waste/scrap, automate labor-intensive processes, optimize product mix toward higher-margin offerings, reduce shipping costs.
Related Terms & Resources
EBITDA
Operating profitability metric
Monthly Financial Review Agenda
Track margin trends
LTV:CAC Ratio
Customer profitability
Fractional CFO Guide
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