Your Gross Margin (Gross Profit)
Your Gross Margin is the direct result of how you choose to price your product or service and how well you negotiate terms from your suppliers. Your Gross Margin does not include your Overheads, such as rent, office supplies and marketing costs etc.
Discounting your price to your customers will have a huge impact on your margin - so think long and hard and definitely crunch the numbers before you decide to go down this road.
For Products
If you buy widgets from your supplier for $10 and sell them to your customer for $20
Your Gross Margin is $10 - 50%
...Not to be confused with your Mark-Up - which is 100%
For Services
A little more complicated...say, as a Web Developer your charge $2000 to design and build a website of upto 10 web pages. Out of your $2000 you need to pay your Graphic Designer $50/Hour to create the graphics - you estimate it will take them 8 hours. You value your Web Development time at $100/Hour - and estimate it will take you 10 hours to code and test the site.
Your Client Pays $2000
Graphic Designer gets $400
Your time is valued at $1000
Leaving you a Gross Margin of $600 - 30%
Service Providers - How do you decide what's included in the price?
If you charge out your services by the hour and there's travel involved to service your client - do you charge your clients for the traveling time?
There's no right or wrong answer but this could have a huge bearing on your margin. If it took you 3 hours of your day to travel between clients and you weren't charging at least something for your travel time or not factoring it into your hourly rate - you may only be getting paid for half a day! Not great if your business plan requires that you bill at least 5 hours per day just to break even. You would be making any profit and you'd probably be out of business in a very short period of time.
Don't Make this Common Mistake
Price is not just the actual dollar amount - to ensure your margin is protected - you have to also state the terms under which the price you set.
Protect your Margin - Product Businesses
Have you absorbed any price rises from your suppliers - not passing them onto your customers?
Do you make CPI price rises each year?
In the early phase of starting your business it's fairly normal to want to keep prices down and try to grab some market share off the bigger and longer established players. That said, it's not a sustainable way to run your business in the long term.
A small 2-3% price increase each year probably wont be noticed by the majority of your customers - especially if you're giving great customer service. The few you do lose - wish them well and don't give them a second thought. Customers who are only purchasing from you for the price are always going to be looking elsewhere for a cheap deal anyway.
You can guarantee though, if you leave your prices low for so long that your business starts to feel the pinch - the first thing you'll want to do is increase your prices. At that point you'll have to make a 10% or perhaps even a 15% price increase to even start to get yourself out of hot water - even your loyal customers will notice that. No matter how good your service is!
Your Suppliers are part of the Answer
What you pay to your suppliers can be the crucial difference to your margin - especially when you're in a particularly price-sensitive market. No matter how new or small your business is - it pays to shop around. Every cent you save on buying products and materials will increase your margin by the same amount.
A quick word about Overheads
There's loads of useful information on Bean-Talk relating to Overheads and how to get them under control. Once you've protected your margin - do your homework on what you can do to reduce your Overheads. No point having a good Gross Margin if you undo all your good work by running your Overheads too high. That'll leave you with little to no Profit - and of course to make a Profit is reason you're in business - right?
For more help read >> Setting your Price
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