What Are the Causes of a Decrease in Gross Profit Margin?

by Neil Kokemuller; Reviewed by Michelle Seidel, B.Sc., LL.B., MBA; Updated January 25, 2019

Gross profit margin is the percentage of your periodic revenue that you convert to gross profit. Gross profit is simply revenue minus costs of goods sold (COGS). Declining gross profit margin is a significant problem for a for-profit business. Understanding factors that contribute to margin decreases puts you in a better position to react positively.

Higher Supplier Costs

One of the simplest factors that can lead to declining margin is higher costs of goods sold. Over time, your suppliers naturally want to increase their own revenue and margins. Their own costs to produce or supply may go up.

These factors may lead to them negotiating or simply charging you higher rates on goods. If higher COGS negatively affects your gross profit margin, you may have to negotiate harder or look for alternative providers.

Lower Prices

Lowering your prices to generate sales can also reduce gross profit margin. Some companies routinely offer discounts and promotions to attract buyers. While you may get a sale, large price cuts minimize the gross profit you get on it. Over time, maintaining a strong brand image allows you to maintain stable price points, or even increase prices.

If you constantly discount, you run the risk that customers get comfortable with the lower price and won't pay top rates. In an industry with many competitors forcing prices down, reducing the cost of good sold through the acquisition of cheaper supplies or cutting labor costs may be necessary

Ancillary COGS

Along with higher supplier pricing, ancillary costs contribute to higher COGS. If your business moves to more environmentally friendly packaging, for instance, you can either pass the costs on to customers or take a hit on gross profit margin. Distribution or transportation costs can also increase your COGS. Again, figuring out ways to minimize gains in these product-related areas or passing on the costs to customers are possible protective measures.

Intense Competition

New competitors or increased rivalry from competitors also impact your gross profit margin. The more attractive customer offerings become to the market, the more difficult it is to get customers to pay desirable prices for your solutions. An indirect result is that when your sales transactions decline, you reduce your purchases from suppliers. In this scenario, you may not get the some economic advantages of buying bulk lots from suppliers.

Industry Changes

In industries where change is the order of the day, the development of new technology and products in the field impacts the bottom line. For example, the introduction of smartphones disrupted the market for flip phones and numerous other tech products. In these instances, the cost of developing products embracing new technology must be weighed against potential returns.

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