What Is Considered a Good Gross Margin Percentage?
While effective gross margin is important to bottom line profit, a "good" gross margin is relative to your expectations. For example, 30 percent may be a good margin in one industry and for one company, but not for another. Typically, companies look at industry norms and previous company financial performance when setting gross margin goals.
Gross margin is a simple financial ratio that shows how much of your periodic revenue is left after you subtract costs of goods sold, or COGS. On a monthly revenue of $40,000 and COGS of $25,000, your gross margin is the $15,000 gross profit divided by the $40,000 revenue. This equals 0.375, or 37.5 percent. In essence, 37.5 percent of your revenue remains after COGS are removed, and before you remove operating costs and recognize irregular revenue and expenses.
You can often find typical industry margins in publications or industry reports. For public companies that publish quarterly income statements, you can also look over their financial data and compute margins of top competitors. In general, if your margin meets or exceeds that of leading providers, you are operating relatively efficiently. If not, you may need to cut variable costs, boost prices, and improve marketing efforts. Industry standards vary because some industries with few competitors and luxury items can maintain higher gross margins than more competitive industries with greater supply of necessary products.
While you compete against other industry players for profitable earnings, you also compete internally to improve your profitability over time. Some new businesses have subpar margins by industry standards because they enter at lower price points to build a customer base. Over time, you want your margins to equal prior performance or improve. This result is a common sign of financially healthy and growing businesses. A more established company with falling margins may be in a decline or on the verge of one, and in desperate need of product or market diversification.
Margins are relatively stable for some business models and very unstable for others. The expansion of big box online retailers and online retailers in general has tightened margins in many industries. The Economist notes the trend of tighter margins and free shipping expectations driven by online shoppers in a 2017 article. Product margins are more stable when attached to a service. A mechanic for example, will charge a set hourly rate plus the cost for parts. The margins on the parts are stable because they are attached to the service bill.