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?