How Pricing Affects Gross Margin, and Vice Versa
What is the difference between a 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%.
However, to go from 50% to 75% gross margin, you actually have to double your price (assuming costs don’t change).
How to Understand Gross Margin Percentages and Pricing
Let’s go through an example.
Let’s remind ourselves of the formula for gross margin:
(Price-cost) / Price
Let’s say your product costs $1 to make. You sell it for 2 dollars. Using the above formula, your gross margin is (2-1)/2 =0.5 or 50%. If you double the price to $4, the new gross margin is (4-1)/4=0.75 or 75%.
The lesson here is to not be fooled into thinking that a particular percentage change in price results in the same change in gross margin percentage. When your gross margin is small, small changes in price make large changes in gross margin percentage. However, when your gross margin percentage is large, it takes significant price changes to move the gross margin percentage even a little.
At the end of the day, this is only important if you are thinking in terms of gross margin percentage. Ask yourself: do you need to think in terms of gross margin percentage and not gross margin dollars? Why/why not?
SLP
4 年If you do the same math on discount you’ll find the same effect but the opposite. ??
Commercial Strategy l Product Management | Value Management | Business Development | Pricing Strategy I Leadership I Product Development I Go-To-Market I Project Management l UX l ONO
4 å¹´Ask yourself: do you need to think in terms of gross margin percentage and not gross margin dollars? Why/why not? It depends on the game played in the market because gross margin procents and gross margin dollars are both measures. The first is a generic measure while the second is a specific measure ( money ). By game I am thinking in terms of how your competitors respond to your actions and how it affects your ability to raise or decrease your Price?
Recruitment & Executive Search for Pricing, Commercial Excellence, Strategic Marketing , Market Access, Consulting
4 å¹´Pivotal point Gabe ??
Digital & Technology Consultant
4 å¹´Easy math, but still confused many who do not take the time to understand the formula and rely on just percentages on a sheet!
Senior Manager - Brand & Activations | Alcon | India | Brand Management | Dry Eye | Contact Lenses | NMIMS
4 å¹´Mark Stiving, Ph.D. thank you for sharing this article. beautifully and succinctly explained the concept of gross margin. perhaps there cannot be a better and a easy way to explain this concept.