Gross margin is an essential profitability metric for consumer brands. Understanding your margins can help you make informed decisions about pricing, cost-saving, and investment opportunities for your brand.
In this guide, we'll explain what gross margin is, how you can calculate it, and what it says about your company's financial health. We'll also explore how brands can use gross margin to optimize their pricing strategy, improve production efficiency, and make data-driven decisions around marketing and merchandising.
What Is Gross Margin, and Why Does it Matter?
Gross margin, also known as gross profit margin, enables businesses to understand how much money they're making, and how much they need to charge for their products to stay profitable. It can be expressed as a dollar amount or as a percentage.
Businesses can track overall gross margin as well as the gross margin for individual products or SKUs. By looking at the margin per item, businesses can determine which products are most profitable and which ones are dragging down the bottom line. They can then use this information to adjust pricing, run promotional strategies, and optimize inventory management to maximize profitability.
It’s necessary to measure gross margin over time. By tracking changes in gross margin, brands can quickly identify when costs are increasing, sales are slowing, or pricing needs adjustment. This can help them proactively address issues before they become major problems and ensure long-term profitability.
Calculating Gross Margin & Gross Margin Percentage
How to Calculate Gross Margin
To calculate gross margin as a dollar value, subtract SKU cost (i.e., full cost of purchase and/or manufacturing) from net sales. You may input a fully landed cost as your SKU cost, or just elements, such as manufacturing.
First, calculate net sales:
Then, subtract your SKU cost:
Important note: If you’re inputting totals from across your org + product catalog, you’ll end up with an aggregate calculation, showing gross margin across your entire brand for a time period. While this is interesting and tells you a lot about overall profitability, it’s important to analyze gross margin at the individual SKU level as well to track your highest-margin and lowest-margin products.
How to Calculate Gross Margin Percentage
Gross margin percentage includes the same numbers as in gross margin, and the same note applies as above: you can calculate gross margin percentage at the brand level, or down to the SKU level:
How to Increase Gross Margin
We’ll go through some key strategies to increase and protect your brand’s gross margin. Each requires an entire article (or articles) to cover, but we’ll summarize some main points.
Drill into Returns
TLDR: Returns are often the #1 gross margin killer for brands, and baking returns into your overall brand strategy (rather than treating returns as exceptional behavior) will pay off.
1. Return rates vary by vertical within commerce: for example, an intimates brand (or any product reliant on highly personal sizing) will likely have a much higher return rate than a cookware brand. However, they can be mitigated.
- Some returns can be mitigated by pre-purchase surveys that provide sizing and product recommendations, as Harper Wilde offers.
- By collecting other zero-party data, you can mitigate returns among new or existing customers, armed with more information about their preferences and sizing.
2. Some products end up having a much higher return rate than others (e.g., unclear product info manufacturing issues, products being damaged in transit, unexpected sizing issues).
- Ensure that your PDP copy isn’t just fluff: make sure it’s abundantly clear and detail rich.
- On-page reviews that include sizing scales and questionnaires give customers a better understanding of what they’re buying ahead of time.
- Be transparent with customers about potential product issues.
- If products are being damaged in or prior to transit, is one of your warehouses or 3PLs inadvertently causing problems?
3. Understand that return fraud is an (extremely) unfortunate cost of doing business.
4. For brands with physical retail presence, it may be better for overall revenue to offer the option to return items to a store. This also reduces further transportation costs if a product can be repackaged and sold in-store.
Target Your High-Value Customers
Nearly without exception, consumer brands’ profitability is driven by relatively small portions of their customer base: their high-value customers.
At Daasity, we highly recommend leveraging RFM Analysis to rank order your high-value customers on an RFM x LTV basis. In doing so, you’ll almost certainly be left with a chart that looks like this:
Through the lens of RFM, the top 10% of this brand’s customers are spending almost 3x as much as their next 10% best customers. And those top 10% of customers are spending almost 40x as much as their worst 10%.
Send your high-value customers your best offers, loyalty/membership opportunities, and experiences. This segment is already highly engaged, so they are more likely to respond positively to special offers, resulting in improved AOV and gross margin.
Increase Average Order Value
Generally, the larger the order, the more profitable it is (and if it isn’t, that is something to investigate and fix yesterday). Therefore:
Increasing your average order value will bless your gross margin with growth.
There are plenty of tactics and strategies to boost AOV, including cross-selling, gifts with purchase, or free shipping above a certain threshold, are effective ways to incentivize customers to purchase more items per transaction.
Negotiate with suppliers
It may not necessarily be easy, but depending on your POs and relationships with your suppliers, you may be able to negotiate better deals with suppliers, which will mean better margins.
While there is no guarantee that suppliers will agree to drop their prices, they might be amenable to buying in bulk or agreeing to longer payment terms.
Raising prices is a risky move, but if done correctly, it can increase your margins. To determine if a price increase is viable, consider market demand, competitor pricing, and your target customers' price sensitivity.
- The flipped version of this, and another possible place to start, is to reduce discount offers to customers who seem to be less price sensitive (i.e., they have never used a discount even if they have been regular purchasers).
You can also offer premium features or benefits to justify the price increase. However, it's important to monitor customer feedback and adjust prices accordingly.
How to Leverage Gross Margin for Merchandising and Marketing
It’s critical to understand which products have the highest and lowest margins, because this can inform a great deal of your merchandising and marketing strategies.
Consider different variables around sales volume x gross margin.
Low sales & low margin
Products that have few sales and a low gross margin per unit (shown in the graph above as small circles and low on the Y axis) are poor performers. You may want to think about removing these products from your assortment, since they are driving little to no value.
High sales & low margin
Products that drive a lot of sales but a low gross margin (large circles low on the Y axis) are valuable due to their popularity, but they don’t deliver much profit. You might want to consider raising the price, bundling them with other products, or running a cross-selling campaign.
Low sales & high margin
Products that generate few sales and a high gross margin per unit (small circles higher on the Y axis) are a key opportunity, if you can increase their popularity. You might want to promote these products via email or retargeting campaigns, or feature them more prominently on your website.
High sales & high margin
Products with high sales and a high gross margin per unit (large circles high on the Y axis) are your top performers! Be sure to push them in relevant campaigns and promotions to drive even more sales.
What Is a Good Gross Margin in 2023?
So, you might be wondering: what is a good gross margin?
The average gross margin percentage across all industries is 36.28%, according to a 2023 study conducted by NYU Stern School of Business.
However, what constitutes a "good" margin varies greatly depending on your vertical. Different verticals have wildly different operation expenses, purchase rates, company sizes, suppliers, and other factors, which have a significant impact on margins.
Here are averages across several verticals:
The data also reflects what we tend to see: food brands almost always have higher operating costs and more complicated (and expensive) supply chains, whereas healthcare and beauty brands may have incredibly high margins (80-90%).
Tracking Gross Margin with Daasity
At Daasity, we enable consumer brands to centralize, analyze, and report on their data across eCommerce/DTC, Amazon, retail, and wholesale channels to give a single and unified view of data and performance.
Daasity makes it easy to track your gross margin—both overall and at the SKU level. Depending on the specific types of costs and set up your business has, you can customize how your gross margin is calculated via our brand supplied data sheet.
To monitor your overall gross margin, just take a look at your Daasity orders & revenue dashboard:
Want to drill down further? Daasity shows you the gross margin percentage of each of your SKUs, so you can easily track how different products are impacting your bottom line.
For more about Daasity and how we can help you with your data, you can check out our on-demand demo here.
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