The Power of Gross Margin

January 25, 2018

Is Your Business Focused More on Revenue or Gross Margin?

“Revenue is vanity, and profit is sanity.”

I once heard these truthful words from Alan Miltz during a presentation at a Gazelles coaching conference. He wanted to drive home the idea that focusing on revenue alone is misguided. Instead, he stressed that entrepreneurs should turn their focus toward gross margin.

In my “Ask Rob” video about setting appropriate profit targets, I relayed a story from business thought leader, Greg Crabtree. He's a fascinating and clever guy who calculates gross margin with this formula:

 Revenue - All "Non-Labor" Direct Costs

Using this definition, you can truly begin to determine the economic top line for your business.

Gross margin as an indicator for real growth

According to Verne Harnish in the book Scaling Up, gross margin is actually the most powerful indicator of an effective sales team, a differentiated strategy, and real growth. Harnish states that, as a company scales up, the market demands better pricing.

When you combine this with the complexities and increasing costs that come with being a larger company, we often see gross margins shrink by 3% to 4%. And when your company grows from the $10 million to $100 million level, such a dip in your gross margins means that, instead of $300,000 becoming unavailable to use, it’s now $3 million.

Improving Gross Margin

You have two options available if you want to see a change in these numbers for your business:

1.     Refine your strategy so that you can hold your line on pricing; OR

2.     Utilize a cost-led pricing strategy.

What’s a cost-led pricing? Simply put, if the market tells you the price customers are willing to pay (and it’s different than what you think it should be), you have to find a way to make your costs fit and still turn a profit.

If you need help giving gross margin the respect it deserves, contact me and let’s talk. Your business and your bottom line will appreciate it.