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What's the Real Meaning for This Common Metric?

Gross Margin - It's Not What You Think

"The purpose of a customer isn't to get a sale. The purpose of a sale is to get a customer." ~ Bill Glazer

Our participants learn a great deal in our seminars and simulations. Often, they are confronted with incomplete or incorrect prior learning. One common example is that professionals think that gross margin is a metric most useful for evaluating cost. Or to put it into operational terms, that if we want to improve gross margins, our company should look to cut costs.

Gross margin is calculated by dividing gross profit by sales. Gross profit is determined by subtracting cost of goods from sales. Typically, we express gross margin as a percentage.

This focus on costs in understandable. Costs are visible. Costs are clear. Costs can be determined and they can be managed. However, gross margin improvement can best be achieved by focusing on sales instead. To quote Klas Mellander, gross margin answers the question, "Are we being paid enough?"

We are much better served to focus on the reason customers pay us. They don't necessarily pay us because our costs are low. They pay us because they see value in the product or service we offer. We must focus on innovation, value, differentiation, and other factors that customers are willing to pay for. If we do this, our gross margins will improve, since customers show us their willingness to pay for our value.

So, rather than focusing on costs, focus on value, and gross margins will improve.


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