The concepts of gross margin and contribution margins are two important measures companies can use to determine how well they are faring in terms of profit-making. While gross margin is simply revenue less the total cost of the goods sold, contribution margin is revenue, less variable costs. According to Datar and Rajan (2018),
â€œthe gross margin measures how much a company can charge for its products over and above the cost of acquiring or producing them. Companies, such as brand-name pharmaceuticals producers, have high gross margins because their products are often patented and provide unique and distinctive benefits to consumers. In contrast, manufacturers of generic medicines and basic chemicals have low gross margins because the market for these products is highly competitive. Contribution margin indicates how much of a company’s revenues are available to cover fixed costs. It helps in assessing the risk of losses. For example, the risk of loss is low if the contribution margin exceeds a companyâ€s fixed costs even when sales are low. Gross margin and contribution margin are related but gives different insights. For example, a company operating in a competitive market with a low gross margin will have a low risk of loss if its fixed costs are small.â€
What other insights or observations do you have with regard to gross margin and contribution margin? Do those insights change depending on the industry sector being considered; if so, why?
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