Key takeaways
- Margin that falls quietly usually has several causes combined: product mix, discounts and costs
- A margin bridge breaks the effect of each cause into points and baht, so you can fix the right thing
- In the example, revenue grew 23% but gross profit fell by THB 1.5 million, and gross margin fell from 35.0% to 27.6%
The owner sees sales growing every year and the sales team hitting its targets, yet gross margin has slipped from 35% to around 28% in just a few years. Everyone has their own explanation. Sales blames costs, purchasing blames discounts, and accounting says the cheaper products are selling well. No one is entirely at fault. It is like a slow puncture: the car still drives, but it uses more fuel every month, until one day it cannot go on.
Margin erosion comes from three directions
| Route | Characteristics | Data to review |
|---|---|---|
| Cost Inflation | Materials, labour and freight costs rise, but selling prices do not follow | Unit cost by product |
| Discount Creep | Special discounts gradually become the normal price | Net price by customer after discounts and freebies |
| Mix Shift | Sales shift towards products or channels with lower margins | Sales mix and margin by segment |
Service businesses must also look at another dimension, cost-to-serve, because two customers paying the same price may use different amounts of resources, for example through small orders, frequent rework, long credit terms or distant deliveries. These do not show up in gross margin, but they eat real profit.
Example: margin bridge
Hypothetical example: volumes in thousand units, prices and costs in THB per unit, amounts in THB million.
| Inventory | Volume, prior year | Price, prior year | Cost, prior year | Volume, this year | Price, this year | Cost, this year |
|---|---|---|---|---|---|---|
| A Premium | 1,000 | 100 | 60.0 | 1,000 | 95 | 62.0 |
| B Economy | 1,000 | 50 | 37.5 | 1,800 | 50 | 40.0 |
Start with last year's result: revenue THB 150 million, gross profit THB 52.5 million, margin 35.0%. This year: revenue THB 185 million, gross profit THB 51.0 million, margin 27.6%. Break it down step by step, changing volume first, followed by price and then cost.
| Step | Revenue | Gross profit | Margin | Change (points) |
|---|---|---|---|---|
| Prior year | 150.0 | 52.5 | 35.00% | |
| Volume and mix | 190.0 | 62.5 | 32.89% | (2.11) |
| Discount on product A | 185.0 | 57.5 | 31.08% | (1.81) |
| Unit cost | 185.0 | 51.0 | 27.57% | (3.51) |
| Total change | +35.0 | (1.5) | 27.57% | (7.43) |
The extra volume sold generated THB 10 million of gross profit, but discounts took away THB 5 million and costs took away THB 6.5 million. So the company sold THB 35 million more but earned THB 1.5 million less gross profit.
Using a different order of changes in a bridge gives slightly different sub-totals, so set one order and use it consistently. Its value lies in showing the size of the problem, not in precision to the decimal place.
How to protect margin
- Cost: write cost-based price adjustment clauses into long-term contracts, negotiate with suppliers, and redesign products when necessary.
- Discount: set approval authority for discounts, track net price by salesperson, and always require something in exchange, such as volume or early payment.
- Mix: measure the sales team on gross profit, not on sales alone, and review products that sell well but earn little.
- Cost-to-serve: add service charges or minimums for customers who generate high costs.
For property projects, falling margin usually comes from closing discounts, commissions, freebies per unit and cost overruns. Build a bridge from the gross development margin in the original budget to the current forecast, and review it every quarter.
Digging down to the true net price
The invoice price is often not the price the company actually receives. Between the list price and the money left over there are end-of-invoice discounts, promotion costs, freebies, freight the company absorbs, channel fees and rebates when customers hit their targets. These items are spread across several accounts. Some sit in selling expenses, so they do not affect gross margin directly, but they reduce profit just the same. When building a bridge, use the net price after deducting items linked to the sale.
Once you have customer-level data, rank customers from lowest to highest margin and see what share of sales the bottom group represents. The customers asking for the biggest discounts may be large customers the company is afraid to negotiate with. The fix need not be a price increase across the board. It may be adjusting minimum order quantities, payment terms or service levels to match what is actually received.
The last point is timing. Costs usually rise immediately, but sales contracts may only allow price adjustments once a year. Set up a price review calendar and notify customers in advance with reasons. Waiting until you are losing money and then raising prices in one big step usually meets more resistance than adjusting on a predictable cycle.
Next steps
- Pull 24 months of data by product or service: volume, net price and unit cost
- Build a quarterly margin bridge using the same order each time
- Rank the causes by amount and choose the top two to fix
- Set a written discount policy and approval authority
- Add gross profit to the sales team's performance criteria
- List the lowest-profit customers, with a plan to adjust prices or service