Gross Margin

Gross margin compares gross profit with revenue and is expressed as a percentage. It shows how much of revenue remains after deducting the costs of products or services sold. A high gross margin means that a product is sold with a strong markup.

Which costs are included is decisive for the assessment, because the boundary is not uniformly defined: production wages, freight, depreciation on production equipment or the cost of running software infrastructure may or may not be included, which makes the metric hard to compare between companies. Production costs include appropriate production overhead as well as directly attributable materials and labour. A company's total materials and personnel expenses are therefore not a reliable substitute, because they can also relate to other functions and to output not yet sold. The margin is informative as an indicator of pricing power and differentiation: a supplier of interchangeable services works structurally on low markups, while protected technology, brands and network effects allow higher levels. In growth businesses it is also the basis for customer lifetime value and acquisition cost payback calculations, because what counts there is gross profit per customer rather than revenue.

Gross margin should be distinguished from contribution margin, which expressly separates fixed from variable costs. For comparisons between companies it is therefore advisable to recalculate the margin on a consistently defined basis rather than adopting reported figures. Only then are statements about pricing power possible. Development at rising volume also deserves attention, since a margin falling as volume grows points to increasing price pressure or a shift into lower-margin segments. In software businesses it should additionally be checked whether infrastructure operating costs are included. For sellers it pays to prepare a breakdown by product and customer group, because a margin that is stable across several segments supports the multiple.