MBA MONDAYS: Margins (Continued)

Last week in MBA Mondays we talked about margins, which I defined as:

Margin is the amount of money you make on each incremental sale or unit of revenue before factoring in the “fixed costs” of your business.

That led Amish Shah to leave me this comment:

While you focused this post on margin from “incremental sale” (gross margin), I think it’s important to acknowledge that there are other margins in the business. And they shouldn’t be ignored.

Operating Margin, for example, is another one I like to look at (and you have previously mentioned it is the most interesting line in a P&L). There’s a lot of info in there… Salesforce’s gross margin looks great at 80% but operating margin is a lot less glamorous at 0-10%, depending on which quarter you look at.

As Amish points out there are other kinds of margins in a business. I like to focus on “gross margin” because I think it tells you a lot about the scalability of a business (as I detailed in last week’s post). But operating margin which is gross margin less all the operating costs is another really important metric.

There are relatively low gross margin business (like Apple which has gross margings of 38.5%) which have relatively high operating margins (Apple has operating margins of 29.2%). And as Amish points out, you can have a relatively high gross margin business like Salesforce have relatively low operating margins.

It is important to pay attention to these metrics. You might have two businesses with identical operating margins but one has high gross margins and high operating costs (like Salesforce) and the other has low gross margins and low operating costs (like Apple). The businesses will be very different to manage and will require different teams, strategies, and financing requirements.