What Is Gross Margin?

Gross margin is the percentage of revenue a company keeps after paying for the product or service itself, before office salaries, marketing, research, interest and taxes. It answers the most basic question about a business: out of every dollar of sales, how many cents are left once the suppliers who made the sale possible have been paid.

How it's calculated#

Gross margin = (Revenue - Cost of goods sold) / Revenue

The difference on top is gross profit. Say a store sells $100 million of merchandise in a year that it bought for $80 million. Gross profit is $20 million and gross margin is 20%. Twenty cents of every sales dollar are left, and rent, wages, advertising and everything else still have to come out of those twenty cents.

The trouble starts with the definition of cost. One company puts factory depreciation and shipping inside cost of goods sold, another books them lower down as operating expenses. Both report a "gross margin", but not the same one. Before comparing two companies, check the accounting notes for what each one includes in cost of sales, because a gap of several percentage points can come entirely from where a line was booked.

A real example#

Apple's fiscal 2025, which ended on September 27, 2025, brought $416.16 billion of revenue and $195.20 billion of gross profit. The company-wide gross margin was 46.9%, up from 46.2% the year before and 44.1% two years before.

That average hides two very different businesses. On hardware, the iPhones, Macs and the rest, Apple kept 36.8% of revenue as gross profit. On services, the App Store, subscriptions and payments, it kept 75.4%. So every dollar that shifts from device sales to services sales lifts the company-wide gross margin, even if neither business becomes more profitable on its own. A good part of Apple's three-year margin climb is this mix effect rather than cheaper components.

For contrast, Costco's fiscal-2025 gross margin on merchandise sales was 11.12%. That is not a weakness but the design: Costco sells at a thin markup on purpose and makes much of its profit from membership fees, which do not appear in that line at all.

What gross margin tells you, and what it doesn't#

Gross margin is the best single trace of pricing power. A company that can raise prices faster than its costs rise shows a stable or rising gross margin even in an inflationary year. A company that has to discount to keep volume shows it falling, often a quarter or two before the damage reaches net income.

What it does not show is how much it costs to keep those sales coming. A software company with an 80% gross margin can spend all of that surplus on sales staff and advertising and still finish the year with a loss. That is why gross margin is read together with operating margin, which shows how much of the surplus survives the cost of running the company.

The number that tells you most is often not the level of gross margin but how much it moves. A margin that holds steady through a whole cycle says more about the quality of a business than a high margin that swings ten points with commodity prices.

Common pitfalls#

The first pitfall is comparing gross margins across industries. A retailer at 12% and a drug maker at 75% are not a weak and a strong company; they are two business models with different cost structures.

The second is reading a margin change without management's explanation. A two-point drop can mean a price war, a one-time inventory write-down or a change in mix, and each of those means something different for the next few quarters.

The third is forgetting currency. A company that buys components in dollars and sells in euros can lose gross margin without anything changing in the underlying business.

Related terms#

Operating margin goes one step further and subtracts the cost of running the company. Net profit margin subtracts everything, interest and taxes included. EBITDA is a different measure of operating profit, taken before depreciation and amortization, with its own margin. How a price change travels through each of these levels is the subject of the pricing power test.