You know gross margin impacts your net profit, but have you considered the impact it has on the value of your company? Gross margin impacts two of the eight key drivers that determine your company’s value– financial performance and monopoly control.
Gross profit margin is the difference between a company’s revenue and its cost of goods sold. Acquirers and investors size up gross profit margin because it can indicate that a company has established pricing power through marketing differentiation and possesses a competitive advantage. A strong competitive moat is an indicator of a company’s long-term sustainability, making it more appealing to potential investors.
When a company’s gross margin shrinks, it indicates to investors that the company may be competing on price. This is typically a sign that the business lacks a unique value proposition or marketing differentiation and that competing on price is the only way to attract customers. A shallow moat leaves the company vulnerable to competitive threats and makes it less appealing to potential acquirers.
Gross margin can also say something about service delivery efficiency. For example, in the managed IT industry, tools, automation and training will lower costs of goods sold, particularly billable hours, and therefore improve gross margins. Best-in-class Managed Service Providers (MSPs) are operating near 40% gross margin.
24 vs. 6 Times Earnings
To illustrate the impact of gross margin on a company’s value, let’s compare two companies: Apple and Dell. Apple has a strong competitive advantage and a healthy gross margin, whereas Dell’s competitive moat is weaker and its gross margin is lower. In 2022 Apple’s average gross margin was 43%, compared to just 23% for Dell.
Apple has a highly differentiated brand and controls the buying experience through its Apple Stores. Additionally, Apple has invested in a range of high-margin subscription offerings, such as Apple TV and Apple Music. The market is willing to pay more than 24 times Apple’s 2023earnings forecast, and the company has a market capitalization of over $2trillion.
By contrast, Dell offers commoditized technology products, which puts them in a weaker competitive position, requiring them to compete on price and resulting in a lower gross margin. The market is only paying around six times Dell’s 2023 earnings estimates, giving it a total market capitalization of around $30 billion.
Taking Action
Just as gross margin impacts the world’s largest publicly traded companies, it also impacts smaller businesses. Apart from raising prices or reducing input costs, an often-overlooked approach to improving gross margin is to invest in carving out a point of differentiation for your business in the minds of your customers. When your customers see your business as unique, you are less likely to have to compete solely on price. Charge a premium for a differentiated product or service, and you’ll beef up your gross profit margin—and the value of your company.
Most MSPs provide commodity services to customers who cannot tell the difference between one MSP and another. MSPs market their services the same way as their competition and focus on the same attributes – reliability, availability and service. Noe of this matters to customers because these attributes are expected, required, and they don’t standout.
So how can MSPS differentiate themselves? You already know its’ not a walk in the park. Her are some tips that might spur some ideas:
- This article, The 2 Best Ways to Make Your Company Special, plants the seed for standing out through specialization in two ways 1)The services yup provide and 2) the customers you serve.
- In this article, Four Ways to Protect Your Turf, you’ll get great ideas on how to protect yourself from competition.
- The eBook below will help generate ideas on how you can up your productization game. You may be doing some of these things, but I ask you to take an honest look at the things that are not working to separate yourself from the pack.
If you’re ready to be more proactive, contact us to explore a Value Builder Engagement where we will work on the eight value drivers that can propel your business. We will align your strategy to specific MSP metrics for the size and stage of your company.
