March 28, 2017

File Power and Gross Margin

When we apply marketing discounts and promotions to gross margin dollars, we learn a lot about how we are managing our businesses, right?

Say business is not great. So instead of selling at full price, we sell at 30% off.

At Full Price:
  • Average Order = $100.
  • Cost of Goods Sold = 40%.
  • Amount Customer Actually Pays = $100.
  • Gross Margin Dollars = $100 - ($100 * 0.40) = $60.
  • Gross Margin Percentage = $60 / $100 = 60%.
At 30% Off:
  • Average Order = $130.
  • Cost of Goods Sold = 40%.
  • Amount Customer Actually Pays = $130 * (1 - 0.30) = $91.
  • Gross Margin Dollars = $91 - ($130 * 0.40) = $39.
  • Gross Margin Percentage = $39 / $91 = 43%.
The secret to measuring File Power lies in modeling future gross margin percentages.

In my projects, there is a strong correlation between historical gross margin percentage and future gross margin percentage. If a customer generated a historically low gross margin percentage, the customer tends to generate a low future gross margin percentage ... and vice versa.

What does this mean? It means that when we offer 30% off, we lower future File Power because we push customers into lower future gross margin percentages.

Of course, File Power is a function of future profitability and future customer counts. If discounts/promotions generate incremental additional customers, then File Power can actually increase.

More on the topic tomorrow, ok?

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