Turning a juicy profit is a worthy goal, and it starts with the gross profit margins you earn on the products or services you sell. Gross margins aren't the only or even the main indicator of your company's health, though. All things being equal, you want your gross margins to be good, but don't let them lull you into thinking you're bulletproof.
Mostly, It's a Good Thing
Except for a few specific cases – nonprofits, obviously, or businesses you run at a loss to offset your profits somewhere else – turning a profit is the main point of running a business. That's what covers your payroll and pays the bills. It's what gives you the resources to keep growing, and it's what will make your company attractive when you want to sell out and retire. That said, if your gross margins are high, it just means your production costs are reasonable relative to the selling price of your product. It's possible to have excellent gross margins and still face some challenges.
It's Not the Only Thing
All things being equal, it's good to have high gross profit margins, but even a moment's thought shows that it's not the ideal way to measure performance. If you don't sell enough of your product or service to cover the bills, for example, it doesn't matter how good your gross margins are.
It's often more useful to look at your net margins, which take into account all of the other expenses your business incurs outside of production costs: Taxes, operating expenses, salaries for nonproduction staff, and the cost of servicing your debts all come into play. If your sales are high enough, your costs low enough, and your margins good enough, your net profits or retained earnings will be positive. That's a more realistic measure of how well you're doing.
The Risk of Complacency
One potential problem with earning consistently high margins is that you can become complacent. Making a big profit on the products or services you sell can hide problems with the way your company works. If your labor costs are elevated, for example, or your purchasing process is inefficient, good margins and the resulting profits might mean you don't give your operations as much scrutiny as they need. After all, "if it ain't broke, don't fix it" has always been a persuasive argument.
Good Times Don't Last Forever
The unfortunate reality is that your ability to earn high gross margins isn't entirely under your control. If they come from a patented process that only you know, you can bet competitors will try to reverse-engineer the process and come up with something equal or better.
If you depend on high prices to support your margins, you're vulnerable to price-cutting competitors who are either more efficient than you or betting they can operate at a loss long enough to outlast you. If your industry as a whole enjoys large gross margins, there might be a room full of hoodie-wearing programmers somewhere in Silicon Valley right now wondering how they can get rich by disrupting your business model. Bad times don't last forever, but neither do good times.
The Challenge of Measuring Up
The certainty of change over time can also lead to a subtler but larger challenge, which is the need to keep your momentum. Ten years down the road, your margins might still be good and even better than most of your competitors can boast, but if they aren't as high as they are now, you might be judged on that difference. That's not necessarily fair, especially if you're still a high performer, but you'll be judged by your own previous standard. It's the reason top athletes sometimes retire after a championship, or CEOs move on to another challenge after a successful turnaround effort. Sometimes, the toughest challenge is outperforming your own younger self.
