Secrets to Improve Gross Margin

Driving gross margin; as easy as 1,2,3,…..4?

We are not just going to understand about gross margin but how to improve the margin for your business.

What is gross margin?

Gross margin is the difference between revenue and cost of goods sold (COGS), divided by revenue. Expressed as a percentage to sales.

So let’s imagine you have a coffee shop.

You sell one product: a INR 300 Americano and 1,000 units per month.

Cost of beans: INR 100 per cup

You employ 2 people working with salary of INR 25k per month.  

Let’s break down the margin. We’ll ignore taxes to keep things simple and assume labor is directly attributable to sales.

Here is the calculation of the gross margin of the business:

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Levers of Gross Margins

There are 4 levers to impact the gross margin of any business:

1. Selling Prices – How much you are charging to your customer; it is the most direct lever on gross margin. Increase in price lead to increase in your margins!
2. Input Cost Prices  - Cost of procuring your raw material and in our case coffee beans, If your input prices go up, that will reduce your margins. Unless you mitigate it with one of the other three margin levers.
3. Sales Mix  - Mix of High margin and low margin product to improve overall margins
4. Efficiency – Most ignored area. Gross margin conversion is about how to make more output with less inputs. Making your internal process efficient.

Bringing it Together

Once you understand the levers in gross margin, you can work out how to combine them.

For example, let’s say you do all of the following:

1. Reduce sales price to INR 50 per cup
2. Agree lower bean prices (INR 80 per cup)
3. Launch pastries at INR 150 and sell 500 units per month with 70% margin
4. Improve Efficiency; Reduce labor from 2 to 1 with increase in salary to 40k

Let’s see how this looks on the Income Statement:

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In this scenario you have increased our gross margin from the base 50% to 56%, and gross profit per cup from INR 150 to 182 and this is despite reducing the selling price by INR 50 per cup, which will lead to stronger volumes in the future.

You have made your business more efficient and reinvested some of that saving into lower selling prices, still earning higher margins overall.

This shows the power of using gross margin levers together to deliver a better result for the customers, and business.

Everyone’s a winner.

Stay financially savvy!