Business owners must consider gross margin when determining how to set prices. Gross margin is the percentage of profit the business owner gets on each sale. For example, if an item costs $7 to make and the business owner sells it for $10, the gross margin is 30 percent. Businesses must monitor their sales after raising prices to ensure they are continuing to sell well; gross margin goals may not be realistic if they require the business to set a price so high that customers don't want to buy the product.
Your gross margin is related to how much profit you'd like to make each month from your business. To calculate gross margin, determine how much of your retail price for each item you sell is profit. Thus, to determine a realistic gross margin goal, you have to determine how much profit is reasonable to make, how many different types of items you hope to sell, and how much profit you hope to make off of each type of item that you are selling.
To determine what a realistic gross margin is, first determine what a realistic income is for your business. If you are first starting out in business, you'll probably make less money than someone who has been in business for years; however, you can research your market to determine what a realistic gross income is for a business of your type. Once you know what income you expect to make, you can determine the amount of expenses you expect to pay to stay in business; the result is your gross profit, which you can then use to determine your gross margin goal.
It's unrealistic to raise prices significantly above what you usually sell items for or to have far higher prices than your competitors. Thus, you won't be able to achieve a high gross margin goal if it requires you to maintain high prices. However, NTEA says that it is realistic to raise gross margin by at least 1 percent over your current gross margin and that you may be cheating yourself if you undersell goods and services.
Price and Demand
When you determine your initial gross margin goal, you're assuming that demand stays steady regardless of price, according to Computing at Work. In reality, however, the demand for your product falls as you raise the price. Thus, you have to continually monitor your sales after you set your prices to determine whether your gross margin goal is realistic and adjust prices accordingly.
- Computing at Work: How to Set Your Retail Pricing to Meet Your Financial Goals; James H. Byrd
- NTEA.com: Controlling Gross Margin and Payroll
- U.S. Securities & Exchange Commission. "Form 10-K, Apple Inc.," Page 26. Accessed July 29, 2020.
- U.S. Securities & Exchange Commission. "Form 10-K, Apple Inc.," Page 39. Accessed July 29, 2020.
Jack Ori has been a writer since 2009. He has worked with clients in the legal, financial and nonprofit industries, as well as contributed self-help articles to various publications.