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Gross margin and margin after advertising

| Article: 2 min read | Analytics

Gross margin is the share of revenue left after subtracting the cost of goods sold. Margin after advertising is what's left when you also subtract the variable costs of selling: delivery, fees, returns, advertising.

In plain words

Gross margin answers the question: "How much does the product itself earn within its price?" But an online store doesn't sell with zero costs on top: there are also packaging, Nova Poshta, payment system and marketplace fees, returns and advertising. That is why, for advertising decisions, the margin after those costs is more useful.

Formulas

Gross margin = (revenue − cost of goods) ÷ revenue × 100%.

This is how Wikipedia describes it: gross profit is the absolute amount, gross margin is the percentage. It also says that cost of goods includes direct costs, while indirect fixed costs (rent, administration) are not included (Wikipedia); there is a worked example at CFI too (CFI).

Margin after advertising = (revenue − cost of goods − delivery − fees − returns − advertising) ÷ revenue.

Example (hypothetical numbers)

The numbers are made up for the example. An order for 2,000 UAH in a home appliance store:

  • Cost of the product: 1,300 UAH, gross margin = 700 ÷ 2,000 = 35%.
  • Delivery and packaging at our expense: 100 UAH, payment fee: 40 UAH, advertising per order: 250 UAH.
  • What's left is 700 − 100 − 40 − 250 = 310 UAH, which is 15.5% of revenue.

We can see that of the 35% "paper" margin, less than half really remains.

How different sources see it

  • The accounting approach: gross margin is calculated under accounting rules.
  • The management approach: contribution margin separates variable costs from fixed ones (Wikipedia). This is closer to "margin after advertising" and better for calculating ROMI and unit economics.
  • a16z advises including in gross profit all the costs of producing, delivering and supporting the product, and being able to explain what is counted and what isn't. It also notes that LTV on gross margin gives a higher ceiling for acquisition spend than on net profit (a16z).

Common mistakes

  • Treating gross margin as "free money" and planning advertising from it.
  • Leaving out returns and unclaimed cash-on-delivery orders.
  • Confusing markup and margin. A 50% markup is a 33% margin.
  • Calculating one average margin for the whole store when categories differ greatly.

FAQ

What is gross margin in plain words? The share of the price left after subtracting the cost of the product.

How do you calculate gross margin? (Revenue − cost of goods) ÷ revenue × 100%.

How is margin different from markup? Margin is calculated from the selling price, markup from the cost. A product that costs 100 UAH and sells for 150 UAH has a 50% markup and a 33% margin.

Which margin should I use to calculate advertising? The one after variable costs: delivery, fees, returns. Then you can see how much you can really give to advertising.

Sources

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