Dear Executive,

Many times we automatically calculate in our head what the impact on our business would be, before we make a purchase. Assuming that we need to buy a new desk for $1,000 and our average Gross Margin (GM) is 50%—we need need to generate an additional $2,000 in revenue to offset that expense. If the Average Selling Price (ASP) for our product is $10—we need to sell an additional 200 units.

This simple ‘break-even’ analysis has played out more recently, as companies saw revenues drop precipitoulsy, with no foreseeable short-term recovery; the only way to maintain ‘break-even’ was to reduce headcount. Particularly hard-hit are companies with low GM. If your company had a GM of 20% and the average salary was $50,000, each person that was eliminated would reduce the required revenue by a quarter million dollars.

The chart on the left shows the change in Revenue for each $1,000 in Expense. High gross margins provides significant positive leverage for your company. You might be surprised to see the chart list GM levels as high as 80%, but the next chart provides examples of companies that do have GM approaching that level.

The chart below shows some industries and companies that I am familiar with, and you can see they range the gamut from a small single-digit, to almost 80%.

In the Semiconductor sector, analog devices have always had superior GM, but as you can see their size is dwarfed by one of the industry leaders selling microprocessors—Intel. The electronics Distributors have been led alternately by Avnet and Arrow for many years and you can see they are close in both revenue and GM. The Electronics Manufacturing Services (EMS) are behemoth worldwide operations; intensive in both capital equipment and labor costs. Their GM are at the bottom of the companies listed. It is probably no surprise that Software has such tremendous GM, with Microsoft at almost 80%. The Internet companies are dwarfed by Google, and who wouldn't want to have a GM of ~65%!

Your industry or sector pretty much defines the range of GM that you can probably achieve. However, don't stop trying to constantly maximize your GM, even if it is by a fraction of a point.

(Usually published on the first Wednesday of each month...)