Gross Margin: The Lifeblood of a Consumer Goods Company
Gross Margin Formulas
Unit Gross Margin = Average Sale Price - Product Cost
Gross Margin = Revenue - COGS
Gross Margin Percentage = (Revenue - COGS) / Revenue
These are three of the most important formulas for a consumer goods company. What is a product sold for and what is it bought/produced for? If these numbers are not in balance within a business the business will fail, or at best growth will be severely restricted.
Gross margin is the lifeblood of a business. High gross margins give a company operational flexibility and more room for experimentation and mistakes. Low gross margins require companies to be much more efficient and disciplined.
The first portion of a Profit & Loss (P&L) deals with a company’s gross margin. First the company’s revenue or net sales is outlined and then a company’s COGS or cost of sales are outlined to find the gross margin. All other expenses within a company come after this important calculation is made.
Credit: https://www.wallstreetprep.com/knowledge/profit-loss/
COGS make up the foundation of a consumer goods company’s variable costs. This cost is incurred no matter the nature of the sale: size, customer, sales channel, etc. Other variable costs may or may not apply for certain sales made. For example, if a company engages in extensive online advertising the cost of this advertising will not necessarily apply to a purchase made by a wholesale customer or to a purchase made by a customer that visited the website through a means other than an ad. There is no escaping COGS.
Revenue can be fickle and elusive for a consumer goods company. When online there are hundreds (thousands) of companies competing for the attention of consumers with finite money to spend. Wholesale buyers are constantly inundated with new product pitches. This is why I advise companies to take control of the part of gross margin they can control: COGS. I have yet to encounter a company that cannot do more to lower their COGS. Playing with this part of the gross margin equation allows companies to increase the blood flow to their business by giving themselves more money to invest in assets such as inventory and other return-yielding expense categories (marketing, R&D, salaries & wages) further down the P&L.
How to reduce COGS?
Source Multiple Suppliers
One of the biggest mistakes I see early-stage consumer goods companies make is to settle down with the first supplier they find to produce their products. Competition is key to reducing COGS. Unless a product is incredibly specialized, there will always be multiple suppliers that can produce it.
Price from suppliers can be simplified to the following three pieces:
Material Costs - including cost of sourcing & shipping materials
Labor Costs - direct labor of production line workers & indirect labor (think office workers/overhead salaries)
Supplier Markup - the amount suppliers profit from producing and selling the product
When suppliers are made to compete with each other they are unable to charge a high supplier markup. By encouraging competition companies will see quotes for their product that comprise material + labor costs and a smaller supplier markup. I’ve had experiences when suppliers have slashed their initial quotes by over 50% once they are forced to be competitive with other suppliers. Companies must do the extra work to find multiple suppliers. The benefits are enormous. See our post Sourcing Goods from Overseas: Guide for Beginners for help in sourcing suppliers.
Improve Inventory & Demand Planning
Many consumer goods companies have poor inventory and demand planning processes, electing to be very reactionary instead of planning in advance. Because of this companies often resort to air freight to import their goods. According to Cargoflip, the cost of air freight tends to be 12 to 16 more than sea freight. That will drastically increase the COGS of a product. There are pros to air freight, but it is very costly and companies should do their best to avoid needing to utilize it. I have found that through an efficient S&OP process companies can centralize planning and get ahead of demand, ensuring that products are delivered on time and in the most cost-effective manner possible, typically by sea.
Effective inventory and demand planning processes also allow businesses to maintain high gross margins by reducing the need for gross margin-reducing discounts. When a company overstocks on inventory, which stresses cash flow, they often need to run promotions to quickly turn excess inventory into cash. This happens often with consumer goods companies of all sizes and was common in 2022 as companies, like Target, looked to reset their inventory positions.
Conclusion
Consumer goods companies can position themselves for success by focusing on gross margin as the lifeblood of the business. Improvements to gross margin can be made by sourcing multiple suppliers for products and improving inventory and demand planning. At SCG we help consumer goods companies increase gross margin through both of these methods, boosting profitability and growth potential. If your company is interested, please contact us.
