gross margin is the percentage of revenue left over after you subtract the direct costs of providing your product or service. direct costs include the materials and labor used in providing the product or service.
if your gross margin isn’t enough to make your business profitable, it’s time to re-evaluate your pricing.
what is gross margin?
you sell a cup of coffee for 200
cost of the beans in a single cup is 50
cost of the paper cup is 25
the gross margin for the cup of coffee is: 200 – 50 – 25 = 125
3 ways to know if your prices are too low
you’re undercutting competitors
the first step in evaluating your prices is looking at your competitors. having a price advantage over them can drive sales, but it won’t do you much good if your gross margins aren’t high enough.
it’s a good idea to have two or three competitors that you’re regularly checking up on. this includes their prices, any promotions they run, and how they position their products in marketing materials.
you’re experiencing overwhelming demand
a quick lesson on supply and demand: demand is inversely proportional to price. this means that as prices go down, demand goes up.
if you’re experiencing a large volume of orders to the point that it’s tough to keep up, you can control this demand. increasing prices will cut demand down until it’s manageable.
you can’t afford promotional pricing
sales are a fantastic way to drum up attention and acquire new customers who otherwise wouldn’t have tried your product or service. but if your prices are already low, you don’t have as many promotional options available.
ways to improve your gross margin
base your prices on a desired gross margin
a common pricing model is called “cost-plus.” it gets its name from the fact that you start with your direct costs and then add in a “plus”—your gross margin.
let’s say after adding up manufacturing and fulfillment costs, you find it takes 300 to produce the product and send it to a customer. you also know you want a gross margin of 50%. using this info, you can figure out you need to set prices at 600 (300 direct costs + 300 gross margin).
negotiate with suppliers
in some cases, suppliers are willing to provide discounts for buying in bulk, quicker payments, or other changes to the terms of exchange.
depending on who your supplier is and what your relationship is like with them, you can approach them with a suggested deal or request a change of terms in writing.
introduce upsell opportunities
a famous case of under-priced products is printers. manufacturers often sell them at a loss in order to sell ink jets, the real money makers.
upsell opportunities don’t need to be as much of a long-term play. but when done effectively, you can pair a high margin product as an upsell with a low margin product to maintain solid profitability on every order.
expand your shipping options when selling online
while flat rate shipping keeps things simple, you risk losing a large chunk of the margin you earned on shipping alone.
consider offering multiple shipping options on orders, like paying more for an expedited shipment. or alternatively, change to a strictly variable shipping rate calculated based on the customer’s address
re-evaluate your packaging
if you’re set on your product and price, the next thing to look at to reduce costs is your packaging.
loose fillers like user manuals are unnecessary in the age of hosting things online. you could switch to a qr code that users can simply point their camera at to take them to an online guide.
when making any change to your pricing or operations, it’s essential you track the results. measuring this impact tells you whether the change was successful or not.