Running a business involves a wide array of considerations, but few are as critical as understanding your gross margins. For small business owners and entrepreneurs, it’s an indicator of health that transcends profit-and-loss statements, offering insight into which products or services are driving revenue—and which might be quietly draining resources.

If you’re not actively evaluating the gross margins across your product or service groups, you might be leaving money on the table or, worse, investing in offerings that don’t align with your overall profitability goals. This blog will help you assess whether the gross margin for each product or service group is attractive and guide you toward smarter decision-making:

What is Gross Margin?

Before we dig in, let’s start with a clear definition. Gross margin reflects the percentage of revenue that remains after deducting the direct costs of producing or delivering your product or service. It’s essentially a measure of your efficiency—and one of your best tools for evaluating whether a particular product or service group is worth the effort.

The formula for gross margin is straightforward:

Gross Margin (%) = (Revenue – Cost of Goods Sold) / Revenue x 100

For example, if you generate $10,000 in revenue from a product group and the direct costs (cost of goods sold, or COGS) amount to $6,000, your gross margin would be:

($10,000 – $6,000) / $10,000 x 100 = 40%

This means that 40% of your revenue is available to cover indirect costs, such as marketing, salaries, and rent, and ideally, contribute to profit.

Why Gross Margin Matters

Gross margin isn’t just an abstract percentage you check during budget reviews. It’s a highly actionable metric that can shape your entire business strategy. Here’s why it matters:

1. Profitability Assessment: High gross margins usually indicate efficient operations and desirable products or services, while low margins can signal inefficiencies or uncompetitive pricing.
2. Better Resource Allocation: Once you understand which products or services have the highest gross margins, you can focus your marketing, operations, and resources more effectively.
3. Sustainable Growth: Growing businesses require healthy cash flow. A healthy gross margin supports reinvestment in key areas such as product development or customer acquisition while ensuring resilience in challenging times.

Now, the question becomes this: Is the gross margin for your product and service groups attractive enough to justify your time, energy, and investment?

Steps to Evaluate Gross Margin Across Product or Service Groups

1. Gather Your Data

Start by compiling revenue and direct cost data for every product or service group you offer. For companies with multiple revenue streams, you’ll want to separate these by category—such as product types, subscription services, or one-off projects.

Make sure your calculations are accurate by only including direct costs in your COGS. These might include:

• For products: Raw materials, manufacturing, packaging, or shipping costs.
• For services: Staff wages, software costs, or expenses directly tied to delivering the service.

2. Calculate Gross Margins for Each Group

Using the formula above, calculate the gross margin for each product or service group. You may find surprising differences across your offerings. Some might perform exceptionally well with minimal costs, while others could eat into your profits despite high revenues.

For instance:

• Product A generates $50,000 in revenue but costs $25,000 to produce. Its gross margin is 50%.
• Service B generates $30,000 in revenue but incurs $20,000 in direct costs. Its gross margin is just 33%.

While Service B is still profitable on the surface, a lower gross margin provides less breathing room to cover indirect costs.

3. Benchmark Against Industry Standards

To determine whether your gross margins are “attractive,” compare them to industry benchmarks. Certain industries, such as software or consulting, naturally operate with higher gross margins (70% or more), while others, like retail or manufacturing, may see margins closer to 20%-40%.

If you’re significantly below the standard in your industry, you may need to re-evaluate pricing, cut costs, or even phase out certain offerings.

4. Identify Patterns and Outliers

Look for trends across product or service groups. You may discover that certain segments consistently outperform others or that specific offerings are chronically under-performing. For example:

• Are niche products yielding better margins than your broader offerings?
• Do high ticket services deliver lower gross margins than expected?

5. Adjust Pricing or Costs

If your gross margins aren’t where they need to be, you have two primary levers to pull:

• Raise Prices: Evaluate whether your pricing reflects the value you provide. Many businesses under-price themselves in a bid to undercut competitors, missing out on higher margins in the process.
• Reduce Costs: Investigate ways to lower production or delivery expenses. This might involve renegotiating supplier contracts, finding efficiencies in your operations, or automating manual processes.

6. Reallocate Focus to High-Margin Offerings

Once you’ve identified your most attractive gross margin performers, channel your energy and investments into growing those segments. Promote them more heavily in marketing efforts, expand production capacity, and ensure they receive operational support. At the same time, consider whether it’s worth continuing with under-performing offerings—or if those resources could be redirected elsewhere.

A Cautionary Note on Gross Margin

While gross margin is critical, it should not be the sole factor driving your decisions. You’ll also need to consider:

• Customer Demand: High margins are great, but they mean little if nobody’s buying.
• Strategic Importance: Some offerings might serve as loss leaders to bring in new customers or encourage upsells to higher-margin products later.
• Long-Term Goals: A product with tight margins today might expand your market position and deliver higher returns down the road.

Final Thoughts

Gross margin is like the pulse of your business—giving you an indication of financial health and providing direction for future growth strategies. It allows you, as a small business owner or entrepreneur, to ensure every product or service group aligns with—and contributes to—your ultimate profitability goals.

If you’ve identified unbalanced margins, now is the time to act. Review your pricing, cut unnecessary costs, and focus on scaling high-margin offerings. By continuously evaluating your gross margins, you’ll not only increase profitability but also set your business on a path to sustainable success.

Want to learn more? Our team is here to give you a roadmap to successful product offerings!

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