Are you struggling to improve your business’s Gross Margin Tanking? Imagine spending hours convincing a customer to buy from your business, and in the end, you still don’t see any growth in revenue.
If your business is making great sales but the number doesn’t add up at the month’s closing, If this sounds familiar, your gross margin is taking a hit without you noticing it. The “gross profit” is not just a financial metric but a direction that indicates how efficiently you are doing business operations.
There are several reasons for experiencing a decline in the gross margin, it could be rising costs, pricing mistakes, or even inefficient business operations. The good news? You don’t need complex financial models to reach your gross margin targets. There’s a simple method that I’ve mentioned in this blog to help you get back on track.
But before we do that, let’s learn what gross margin means, and why it matters!
What Is Gross Margin?
Gross margin measures how much profit you keep after covering the direct costs of your products or services. It’s calculated using this simple formula:
Gross Margin: (Revenue – COGS) divided by (revenue) x by 100
Revenue represents the money coming in from sales, while COGS (Cost of Goods Sold) includes the direct costs of producing those goods or services. The higher your gross margin, the more efficiently your business runs.
Let’s say your business generates $100,000 in revenue, but your COGS is $60,000. Your gross margin would be:
($100,000 – $40,000) divided by ($100,000) x by 100 = 40%
It means that you secure $40 from every sale of %100 after covering the upfront cost. However, the remaining amount goes to marketing, operational costs, and growth.
The Simple Formula To Fix Your Gross Margin
Fixing a declining margin doesn’t have to be complicated, here are a few simple steps you can take!
1. Optimize Pricing
Many businesses undervalue their products and leave money on the table. If your margins are shrinking, your pricing strategy could be the issue.
Stop underpricing to attract customers. Instead, highlight the unique value of your product or service. If it delivers strong benefits, customers will pay for it. On the other hand, test small price increases. A slight 5-10% increase can significantly boost margins without affecting demand.
Use value-based pricing instead of cost-plus pricing. Instead of just marking up costs, price based on the customer’s perceived value of what you offer.
2. Reduce Cost of Goods Sold (COGS)
Improving efficiency can help you reclaim lost margins if your costs are rising.
Negotiate better deals with suppliers. If you’ve been working with the same vendors for years, it’s time to renegotiate or explore new options. Buy in bulk when possible. Larger orders often come with lower per-unit costs.
However, streamline production. Reduce waste, optimize labor, and find ways to produce more efficiently without sacrificing quality. Secondly, switch to alternative materials or methods. Look for a high-quality alternative if a specific material or process is too expensive.
3. Improve Operational Efficiency
- Beyond pricing and direct costs, inefficiencies in the way you run your business can drain profits.
- Automate repetitive tasks. Software tools can reduce manual labor, saving both time and money.
- Eliminate unnecessary expenses. Review your operating costs and cut anything that isn’t driving revenue.
- Optimize inventory management. Avoid overstocking and wasting resources on slow-moving products.
- Making small adjustments in these areas can add up quickly, boosting your margin without disrupting your business.
Common Mistakes That Keep Your Margin Low
Low margins can quickly drain your profitability even if your business is generating strong sales. Many businesses unknowingly fall into common traps that limit their ability to scale and grow profitably. Let’s detail these mistakes and understand why they hurt your margins.
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1 – Focusing On Sales Volume And Ignoring Profitability
Many business owners believe that “more sales automatically converts into more profits,” which is true to some extent. But if your business is getting a very small chunk of margins from every sale, it’s a sign that it is struggling for financial gain.
However, more sales mean more burden over production, storage, shipping, and other operational costs. You should focus more on selling at a decent margin instead of worrying about the sales volume.
Analyze your profit per unit and focus on creating more value for your products/services. This will increase customers’ willingness to pay more.
2 – Ignoring Cost Fluctuations In Raw Material And Production
Raw material prices, manufacturing costs, and supplier fees don’t stay the same. If your COGS (Cost of Goods Sold) increases but your pricing remains unchanged, your gross margin will continue to shrink over time.
Rising expenses silently eat into your margins if you don’t adjust pricing or find cost-saving solutions. Many businesses fail to renegotiate supplier contracts and end up paying more than they should.
As a business owner, you should regularly track raw materials and production costs to catch price changes early.
If costs increase, adjust your pricing accordingly to protect margins. Maintain good supplier relationships and renegotiate contracts when needed. Create connections with multiple suppliers so you’re not dependent on a single source that can dictate high prices.
3 – Not Considering Customer Acquisition Cost (CAC) When Pricing Your Product
Many businesses price their products based on COGS alone, ignoring the marketing and sales expenses required to acquire a customer. If your customer acquisition cost is too high, even a decent gross margin may not be enough to sustain profits.
If each sale requires heavy spending on ads, discounts, or commissions, your profit per customer shrinks. Without considering CAC in pricing, you could be selling at a loss without realizing it.
Ensure that your pricing strategy includes enough margin to cover CAC while still making a profit. Try working on reducing CAC over time by improving marketing efficiency, focusing on organic traffic, or using customer retention strategies
4 – Giving Too Much Discounts
Offering discounts can be a great way to attract new customers and boost sales, but when it becomes a constant habit, it destroys your gross margin. Deep or frequent discounts train customers to expect lower prices, making it harder to sell at full price later.
Heavy discounting reduces the profit per sale, meaning you need a much higher volume to compensate for the lost margin. If customers get used to discounts, they wait for sales instead of buying at full price, reducing overall revenue stability.
However, competing purely on discounts makes your business vulnerable to price wars with competitors, which can drive your margins to unsustainable levels.
Instead, use the discounting method with a proper strategy. For example, give the limited-time option to increase the scarcity. Pay more attention to value-based selling, and focus more on the product quality, its features, and how it can improve your customer’s life.
Final Words
If your gross margin is tanking, it’s not only a sign of declined profit but also indicates that something is wrong with the business and needs your attention.
Whether it’s supplier costs, production costs, or poor business operations, you should take control and fix the issue before it starts affecting your profits. Optimizing your pricing regularly and reducing COGS is the best way to improve your gross margins.
This way, you can control your spending and get more from your business without any problem. If your margins are slipping through your hand, don’t wait and take action immediately.