Gross Margin

Gross margin is the percentage of revenue remaining after deducting cost of goods sold (COGS). It measures the profitability of products or services before accounting for operating expenses. Higher gross margin indicates stronger unit economics and more room to cover fixed costs and generate net profit.

Formula

Gross Margin = [(Revenue - COGS) / Revenue] \times 100

Or: Gross Margin = (Gross Profit / Revenue) × 100. COGS includes direct costs of producing or delivering the product (materials, labor, shipping for goods). It excludes selling, general, and administrative (SG&A) expenses.

Example

A company has $500,000 in revenue and $300,000 in COGS. Gross profit = $200,000. Gross margin = ($200,000 / $500,000) × 100 = 40%. For every dollar of revenue, 40 cents remains after direct production costs.

Relationship to LTV and ROI

In LTV calculations, gross margin (as a percentage or decimal) is applied to revenue to estimate profit per customer. LTV formulas often use ARPU × Gross Margin to get gross profit per user. Higher gross margin increases LTV and improves the return on customer acquisition. Gross margin also affects net profit and thus ROI on business investments.

Gross Margin vs. Net Margin

Gross margin considers only COGS. Net margin (net profit / revenue) deducts all expenses including SG&A, interest, and taxes. A business can have high gross margin but low or negative net margin if operating expenses are large. See net profit and EBITDA for related metrics.

Caveats

COGS definition varies by industry. Software companies may have minimal COGS; retailers have significant inventory and shipping costs. Allocation of shared costs to COGS can affect the result. Gross margin should be compared within similar business models.