A company with higher gross margins than its peers often demonstrates efficient production processes or strong pricing power, which can drive long-term profitability and shareholder value.
In this guide, we’ll cover everything you need to know about gross margins, including how to calculate them, what factors influence them, and what a good gross margin looks like across industries.
What Are Net Margins?
The gross margin is a profitability ratio that shows the percentage of revenue a company retains after accounting for the direct costs of producing its goods or services. It measures how efficiently a company turns revenue into profit before accounting for operating expenses.
Gross margin comes at the top of the Income Statement, right after revenue, and is calculated by subtracting the cost of goods sold (COGS) from revenue. It explains how effectively a company manages its production or service delivery costs.
How to Calculate Net Margins
Calculating gross margins involves two key components:
- Gross Profit: Revenue minus the cost of goods sold (COGS).
- Revenue: The total sales generated by the business.
The formula for gross margin is:
Gross Margin = (Gross Profit ÷ Revenue) × 100
Example: In 2023, Apple (AAPL) reported $383 billion in revenue and $169 billion in gross profit for 2023. That means the company had a gross margin of 44.1%:
Gross Margin = (169B ÷ 383B) × 100 = 44.1%
This means that in 2023, Apple retained $441 in gross profit for every $1,000 the company generated in revenue. This is the company’s profit before accounting for other expenses like R&D, marketing, and administrative costs.
Find stock with high net margins with TIKR >>>
Gross Margins vs. Operating and Net Margins
It’s important to understand the difference between a company’s 3 main Income Statement profitability metrics:
- Gross Margin: Profit after costs of making/delivering the product or service.
- Operating Margin: Profit after all operating costs, including rent, advertising, salaries, etc.
- Net Margin: Profit after all business costs, including taxes and interest payments.
Each metric provides unique insights, but the operating margin is particularly valuable for assessing a company’s operational efficiency.
Why Are Gross Margins Important?
Gross margins reveal a company’s overall financial health and efficiency. Here are some of the reasons why they matter:
- Measuring Profitability: Higher net margins show that a company can efficiently turn revenue into profit, which is important for sustainable growth.
- Assessing Financial Stability: Net margins offer a clear view of a company’s overall profitability and resilience during difficult times.
- Comparing Across Industries: Net margins help investors compare how profitable companies are within the same industry or peer group.
Companies that consistently maintain higher margins than their peers often have a competitive advantage, such as:
- Cost advantages
- Intangible assets (like a strong brand)
- Network effects
- High switching costs
- Economies of scale
Analyze stocks quicker with TIKR >>>
What Is a Good Gross Margin?
Gross margins vary widely across industries due to differences in cost structures, production models, and pricing power. Some industries, like technology, benefit from scalable, high-margin operations, while others, like retail or manufacturing, operate with narrower margins due to higher input costs or intense competition.
Below are examples of average gross margins for different industries:
High-Margin Industries
High-margin industries often benefit from low variable costs, scalable operations, and intellectual property advantages.
1. Software
Industry Average Gross Margins: ~65%-85%
Examples:
- Strong Gross Margins: Adobe (ADBE) maintains gross margins of ~88%, driven by its subscription-based software model and dominance in creative and digital marketing solutions.
- Poor Gross Margins: Zoom Video Communications (ZM) operates with gross margins of ~75%, incurring higher infrastructure costs and free-tier user support.
2. Luxury Goods
Industry Average Gross Margins: ~60%-70%
Examples:
- Strong Gross Margins: LVMH (MC.PA) sustains gross margins of ~68%, benefiting from premium pricing and a loyal customer base.
- Lower Gross Margins: Capri Holdings (CPRI) maintains gross margins of ~65%, as its mid-tier luxury brands face price sensitivity and higher manufacturing costs.
Moderate-Margin Industries
Moderate-margin industries often involve higher input costs or competitive pressures, but efficiencies and economies of scale can provide room for improvement.
1. Apparel Retail
Industry Average Gross Margins: ~30%-40%
Examples:
- Strong Gross Margins: Lululemon (LULU) achieves gross margins of ~57%, driven by premium pricing and strong brand loyalty.
- Lower Gross Margins: Gap Inc. (GAP) operates with gross margins of ~40%, struggling with high inventory costs and intense competition in mid-tier fashion.
2. Telecommunications
Industry Average Gross Margins: ~50%-65%
Examples:
- Strong Gross Margins: T-Mobile (TMUS) achieves gross margins of ~63% by leveraging its efficient network infrastructure.
- Lower Gross Margins: Shenandoah Telecommunications (SHEN) operates with gross margins of ~60%, facing challenges from high operational costs and competitive pressures.
3. Manufacturing
Industry Average Gross Margins: ~30%-50%
Examples:
- Strong Gross Margins: 3M (MMM) achieves gross margins of ~45%, supported by its focus on high-margin industrial and consumer products.
- Poor Gross Margins: Whirlpool (WHR) operates with gross margins of ~20%, as it faces high input costs and price sensitivity in the competitive home appliance market.
Low-Margin Industries
Low-margin industries often operate with commoditized products, intense competition, and limited pricing power, making it harder to achieve substantial gross margins.
1. Automobiles
Industry Average Gross Margins: ~10%-20%
Examples:
- Strong Gross Margins: Tesla (TSLA) achieves gross margins of ~20% by optimizing production efficiency and leveraging direct-to-consumer sales.
- Poor Gross Margins: Ford (F) operates with gross margins of ~10%, constrained by legacy production costs and reliance on less profitable segments like sedans.
2. Airlines
Industry Average Gross Margins: ~15%-20%
Examples:
- Strong Gross Margins: Delta Airlines (DAL) sustains gross margins of ~20% by optimizing fleet utilization and premium pricing on international routes.
- Poor Gross Margins: Spirit Airlines (SAVE) operates with gross margins of ~15%, constrained by its ultra-low-cost business model and intense competition.
Explore over 100,000 of the best stocks with TIKR >>>
Factors That Affect Gross Margins
Gross margins are influenced by a range of internal and external factors that impact a company’s ability to manage production costs and pricing to increase revenue.
Internal Factors:
- Cost Structure: Companies with efficient production processes or lower variable costs tend to achieve higher gross margins, as they can produce goods more economically.
- Product Mix: A focus on high-margin products or services can significantly improve gross margins, while low-margin items can dilute profitability.
- Supply Chain Efficiency: Streamlined supply chains and favorable supplier agreements can reduce the cost of goods sold (COGS), boosting gross margins.
External Factors:
- Market Conditions: Strong consumer demand or favorable raw material prices can lead to higher gross margins, while economic downturns can compress them.
- Competition: Intense competition can force companies to lower prices or invest in promotions, which can reduce gross margins.
- Input Costs: Rising costs for raw materials, energy, or labor can increase COGS, putting pressure on gross margins.
Understanding these factors helps investors identify companies that can sustain or improve gross margins, a company’s pricing power and variable costs.
How Companies Can Improve Gross Margins
Improvements to gross margins often involve optimizing production costs, enhancing pricing strategies, and focusing on high-margin products. Here are strategies that companies often use to boost their gross margins:
- Optimizing Supply Chains: Streamlining supply chains, renegotiating supplier contracts, or reducing transportation costs can lower the cost of goods sold (COGS), directly improving gross margins.
- Example: Walmart (WMT) continuously optimizes its supply chain through automation and strategic partnerships, helping to control costs and maintain stable gross margins.
- Shifting Product Mix: Prioritizing high-margin products or premium offerings can enhance gross margins by increasing the profitability of each sale.
- Example: Coca-Cola (KO) focuses on smaller, high-margin packaging sizes and premium product lines like Coca-Cola Zero Sugar, which contribute to stronger gross margins.
- Implementing Price Increases: Strategic price hikes, especially for in-demand products, can improve gross margins if the company retains customer demand.
- Example: Nike (NKE) has effectively increased prices on premium sneakers and apparel, leveraging its brand strength to sustain strong gross margins.
- Investing in Technology: Implementing automation or advanced manufacturing technologies can reduce production costs and improve gross margins.
- Example: Boeing (BA) has invested in robotics and automation in its aircraft assembly lines, reducing production costs and improving gross margins.
Why Do Gross Margins Sometimes Fall?
Gross margins can decline for many reasons, but they often stem from rising costs or pricing pressures that directly impact the cost of goods sold (COGS). Here are some common reasons:
- Rising Input Costs: Increases in the cost of raw materials, labor, or energy can drive up COGS, reducing gross margins.
- Example: General Motors (GM) has faced gross margin pressure due to rising steel and aluminum prices, significantly affecting vehicle manufacturing costs.
- Price Wars or Discounting: Intense competition or the need to discount products to drive sales can erode gross margins.
- Example: Dell Technologies (DELL) has experienced gross margin declines when engaging in aggressive pricing strategies in the competitive PC market.
- Inefficiencies in Production: Inefficient manufacturing processes or supply chain disruptions can increase costs, reducing gross margins.
- Example: Adidas (ADDYY) has faced gross margin challenges due to production bottlenecks and inefficiencies in meeting high-demand product lines.
- Currency Fluctuations: Unfavorable foreign exchange rates can increase the cost of imported materials or reduce the competitiveness of exports, lowering gross margins.
- Example: Johnson & Johnson (JNJ) has seen gross margins impacted by currency fluctuations that are affecting its international operations.
- Shift to Lower-Margin Products: A greater reliance on low-margin products or services can dilute overall gross margins.
- Example: Amazon (AMZN) has seen gross margin pressure due to its expansion in segments like groceries, which typically have lower margins compared to its e-commerce and cloud businesses.
By understanding these factors, investors can better assess whether a company’s gross margins are likely to improve or decline in the future.
Find highly profitable, high-quality stocks with TIKR >>>
Frequently Asked Questions (FAQs)
FAQ: Gross Margins
What is a good gross margin?
A good gross margin varies by industry. For example, software companies often have gross margins above 70%, while manufacturing companies typically range between 30%-50%.
How is gross margin calculated?
Gross margin is calculated by dividing gross profit (revenue minus cost of goods sold) by revenue and multiplying by 100 to express it as a percentage.
What factors influence gross margins?
Factors that influence gross margins include input costs (e.g., raw materials and labor), pricing strategies, and supply chain efficiencies.
How can companies improve gross margins?
Companies can improve gross margins by reducing production costs, optimizing their supply chain, focusing on higher-margin products, or strategically raising prices.
How is gross margin different from net and operating margins?
Gross margin measures a business’s profitability after production costs, while operating margin accounts for operating expenses, and net margin reflects a business’s total profit after all costs.
TIKR Takeaway
A company with strong gross margins shows efficient management of production costs and solid pricing power. By analyzing gross margins, investors can spot businesses with strong pricing power.
The TIKR Terminal offers industry-leading financial data on over 100,000 stocks, so if you’re looking to find the best stocks to buy for your portfolio, you’ll want to use TIKR!
TIKR offers institutional-quality research for investors who think of buying stocks as buying a piece of a business.
Disclaimer:
Please note that the articles on TIKR are not intended to serve as investment or financial advice from TIKR or our content team, nor are they recommendations to buy or sell any stocks. We create our content based on TIKR Terminal’s investment data and analysts’ estimates. We aim to provide informative and engaging analysis to help empower individuals to make their own investment decisions. Neither TIKR nor our authors hold any positions in the stocks mentioned in this article. Thank you for reading, and happy investing!
