What is Gross Margin?
The percentage of revenue remaining after subtracting the cost of goods sold (COGS), indicating how efficiently a business produces its products or services.
Definition
Gross margin, also called gross profit margin, is a financial metric that shows the percentage of total revenue retained by a business after accounting for the direct costs of producing its goods or services — known as the Cost of Goods Sold (COGS). It is a key indicator of production efficiency and pricing power. A higher gross margin means a business retains more revenue from each dollar of sales before deducting operating expenses like rent, salaries, and marketing.
Understanding COGS
Cost of Goods Sold (COGS) includes the direct costs of producing what you sell: raw materials, direct labor, manufacturing supplies, shipping costs for goods, and any subcontractor costs directly tied to product delivery. For a freelancer or service business, COGS may be minimal or nonexistent — a consultant's COGS is essentially zero. For product-based businesses, COGS can be substantial and includes materials, manufacturing, and direct labor costs.
What Is a Good Gross Margin?
Gross margins vary widely by industry: Software and SaaS businesses often have gross margins of 70–90% because their COGS are minimal. Professional services (consulting, design, accounting) typically have margins of 50–80%. Construction and contracting usually run 20–35% margins. Retail businesses typically have 20–30% margins. Restaurant margins average 30–40% but can be lower. When evaluating your margin, benchmark against businesses in your specific industry, not across all businesses.
Improving Gross Margin
There are two primary ways to improve gross margin: increase revenue without proportionally increasing COGS, or reduce COGS while maintaining the same revenue. Strategies include raising prices strategically while communicating value to customers; reducing direct material or production costs through supplier negotiation or bulk purchasing; improving operational efficiency to reduce waste and labor hours; automating parts of the production or delivery process; and focusing on higher-margin products or services within your portfolio.
Gross Margin vs. Net Profit Margin
Gross margin only accounts for COGS and does not include operating expenses. Net profit margin (also called net margin) takes into account all expenses — COGS, operating expenses, interest, and taxes. A business can have a healthy gross margin of 60% but a net profit margin of only 5% if its operating expenses are very high. Both metrics are important: gross margin tells you whether your core product or service is profitable, while net margin tells you whether the overall business is profitable.