Gross Margin Math

What is the difference between 75% gross margin and 50% gross margin? That's easy, 25%.  So you might be tempted to jump to the incorrect conclusion that if you currently have 50% gross margin and want to grow that number to 75%, you simply raise your price by 25%. To go from 50% to 75% gross margin you have to double your price (assuming costs don't change of course). Let's go through an example. The formula for gross margin is (Price-cost)/Price You have a product that costs 1 dollar to make.  You sell it for 2 dollars.  Use the above formula (2-1)/2=0.5 or 50%. If you double the price to 4 dollars, the new gross margin is (4-1)/4=0.75 or 75%. These graphs shows what the gross margin % is at different prices for a product that costs  $1 to make. The lesson is to not be fooled into thinking a certain percentage change in price results in a similar change in gross margin percent.  When your gross margin is very small, small changes in price make large changes in gross margin %.  When your gross margin % is very large, it takes large price moves to change the gross margin % even a little. This is only important though if you are thinking in terms of gross margin %.  Why would you think in terms of gross margin % and not gross margin dollars?
Mark Stiving

Mark Stiving

Mark Stiving is chief pricing educator with Impact Pricing LLC. Connect with him on LinkedIn

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