Gross Margin: How Much Is Enough?

Always a tricky problem.

In a mature market with a mature product/service, gross margins (GM) tend to be ungenerous and well understood across the competition and value chain.

Positioning a new product/service that may disrupt an existing market or create a new one is more difficult as it tends to be based upon what the customer is prepared to pay. It is a value call that needs to be considered in terms of client need and benefit. Until competition launches its own version, the field is clear. There is time for strategy to settle down and the company can generate some cash, recover R&D, set up and launch costs. Unless you have the benefit of a highly secure, patented item, the space to make the most of this leadership is small.

So what if you are a ‘newish’ business or launching a product or service new to you but where competition exists?

This implies a business model already in operation with something else and the new thing is to add to the portfolio. The finance team is being asked to give a view on what the selling price (SP) should be to make the new product launch worthwhile. The Sales and Marketing teams will be formulating a view based upon what they think the market can stand. Operations will be able to determine the cost price(CP)  by building the bill of materials (material costs, labour content, equipment required and so on).


As the CEO or product ‘owner’, you are clear that the new product/service is able to fill a gap in your portfolio, which is a strategic issue but it needs to do this profitably. You need to know how much ‘headroom’ you may have to stop the Sales and Marketing teams ‘giving it away’. You need to feel confident that the Operations team has built a solid bill of materials, including firm prices for all bought-in items.


Then you can do the arithmetic:


SP = (CP x 100)/(100 – required GM)


So as an example: If CP = £20 and a GM of 35% is desired, the selling price, SP is


SP = (20 x 100)/(100 – 35), which reduces to 2000/65 or £30.77p


Another example: if the SP in the above case drops to £25 and the CP remains constant, the GM falls to


25(100-GM) = 20 x 100


Reducing and transforming, we get


(2000/25) – 100, or GM = 20%



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