Startup OS #5 | Why you need a 80% Gross Margin like Hermès

Welcome to level 5 🚀 

Startups can only scale if they get their gross margin right.

From small CPG brands to luxury powerhouses like LVMH and Hermès, gross margin is the cornerstone of profitability. It fuels everything from customer acquisition to reinvesting in growth.

Without a strong gross margin, it’s hard to stay competitive and invest in the future.

So, what exactly is gross margin, and how can you optimize it to scale your startup?

Understanding Gross Margins and Their Importance for CPG Startups: Lessons from LVMH, Hermès, and the Tech World

In the world of business, gross margin is a critical metric that determines a company’s ability to grow, scale, and ultimately, succeed. For startups, especially those in the consumer packaged goods (CPG) space, understanding gross margin is key to making informed decisions about pricing, marketing, and product development. In this article, we’ll explore what gross margin is, examine the impressive gross margins of luxury giants like LVMH and Hermès, suggest ways for startups to enhance their margins, and look at how gross margins in tech companies differ. We’ll also discuss the relationship between gross margin and customer acquisition cost (CAC), as well as other important profit and loss (P&L) metrics crucial for CPG startups.

What is Gross Margin?

Gross margin is the percentage of revenue a company retains after subtracting the cost of goods sold (COGS), which includes all direct expenses related to producing a product. In simple terms, it represents how much profit a company makes on each product sold before covering other operating expenses like marketing, rent, and salaries. The higher the gross margin, the more revenue a company has left to cover other business expenses and reinvest in growth. For example, if a company sells a product for $100 and it costs $40 to produce, the gross margin is 60%, meaning the company retains $60 for every product sold. Gross margin is a crucial indicator of a company’s pricing power, product quality, and operational efficiency. Startups must pay close attention to this metric, as a healthy gross margin provides the financial runway needed to invest in customer acquisition, marketing, and scaling.

Gross Margins of Luxury Giants: LVMH and Hermès

When examining gross margins, the luxury goods sector offers a masterclass in profitability. Two of the most successful luxury companies in the world, LVMH (Moët Hennessy Louis Vuitton) and Hermès, consistently maintain extraordinarily high gross margins, largely due to their brand power and pricing strategies.

• LVMH: This global luxury conglomerate, which owns brands like Louis Vuitton, Christian Dior, and Dom Pérignon, regularly posts gross margins around 65-70%. LVMH’s success in maintaining these margins comes from its ability to create products that are not just commodities but symbols of status and exclusivity. Additionally, its vertically integrated model—where LVMH controls everything from raw material sourcing to final retail—helps lower production costs while maximizing pricing power.

• Hermès: Known for its iconic Birkin bags and artisanal craftsmanship, Hermès has gross margins that are often above 70%, sometimes reaching as high as 80%. This is due to the brand’s perceived value and tight control over production quality. Hermès maintains exclusivity through limited supply and impeccable craftsmanship, allowing the company to charge premium prices while keeping production costs relatively low.

The key lesson for CPG startups here is that brand positioning and perceived value can drastically influence gross margins. While luxury brands are unique in their ability to command such high margins, CPG startups can still learn from their strategies by focusing on product differentiation, premium positioning, and operational efficiency.

Enhancing Gross Margin in a CPG Startup

For CPG startups, aiming for gross margins of 40-60% is a solid goal. The ability to retain a significant portion of revenue after production costs gives the business the flexibility to invest in growth while maintaining profitability. However, improving gross margin is not just about cutting costs; it’s about optimizing your entire business model. Here are several ways to enhance gross margins:

1. Increase Pricing Power: One of the simplest ways to improve gross margin is by increasing prices. This can be done by positioning your brand as premium, offering added value, or targeting a more affluent market segment. A compelling brand story, unique product benefits, or superior quality can justify higher prices.

2. Reduce Production Costs: This involves finding ways to lower COGS without sacrificing quality. Options include negotiating better terms with suppliers, optimizing manufacturing processes, or sourcing materials more cost-effectively. In the CPG world, even a slight reduction in production costs can significantly boost margins.

3. Introduce Premium Product Lines: Offering a higher-end version of your product can improve overall gross margin. For example, a skincare brand might launch a luxury line with premium ingredients, allowing it to charge significantly more while only slightly increasing production costs.

4. Vertical Integration: Like LVMH, controlling more of your supply chain can help reduce costs. For instance, owning or directly managing aspects of production, such as packaging or distribution, can improve efficiency and lower costs, boosting your overall gross margin.

5. Subscription Models: Offering a subscription service for your products can stabilize revenue and reduce the need for constant customer acquisition. With recurring revenue, you can plan inventory and production more effectively, which can reduce costs and improve gross margin over time.

What is an Ideal Gross Margin?

The ideal gross margin depends on the industry and business model. For CPG startups, margins typically range from 25% to 50%, with higher margins found in premium or niche markets. In highly competitive and commoditized sectors, gross margins may lean toward the lower end, while brands that focus on quality, innovation, or exclusivity can aim for higher margins.

For most CPG startups, a gross margin of 40-60% is considered healthy. At this level, there’s enough room to cover operating expenses, customer acquisition costs, and other essential investments. A higher gross margin gives your business more flexibility, allowing you to spend more on marketing, product development, and customer retention while still maintaining profitability.

Gross Margins and Customer Acquisition Costs (CAC)

Gross margin plays a critical role in determining how much you can afford to spend on acquiring new customers. The relationship between gross margin and CAC is vital for any startup looking to scale. Ideally, your gross margin should be high enough to comfortably cover your CAC, leaving you with enough profit to reinvest in growth.

Let’s say your CPG startup has a gross margin of 50% and an average order value (AOV) of $100. After subtracting the cost of goods sold, you’re left with $50 per sale. If your customer acquisition cost is $30, you have $20 left over to cover other expenses like overhead, marketing, and product development. However, if your CAC rises to $50, you break even and have no margin left to cover additional costs, which limits your ability to scale profitably.

In this scenario, improving your gross margin through pricing, cost reduction, or product strategy becomes essential to maintaining profitability while scaling customer acquisition efforts.

Other Key P&L Metrics for CPG Startups

While gross margin is a crucial metric, it’s important to also track other profit and loss (P&L) metrics to ensure your business remains financially healthy. Here are a few core metrics CPG startups should focus on:

• Operating Margin: This reflects the percentage of revenue left after all operating expenses are deducted from gross profit. It provides a clear picture of how much profit the business is making from its core operations. For CPG startups, keeping operating expenses under control while scaling is essential for maintaining a healthy operating margin.

• Net Margin: Net margin is the percentage of revenue left after all expenses, including taxes, interest, and other non-operating costs. It’s the ultimate measure of a company’s profitability. A low or negative net margin in the early stages is common for startups, but as the company matures, improving this metric is key to long-term success.

• Customer Lifetime Value (CLV): CLV measures the total revenue you can expect from a customer over their lifetime. A high CLV allows you to spend more on customer acquisition while still being profitable. Improving CLV through retention strategies, upselling, or product expansion can enhance the overall financial health of your startup.

• Break-Even Point: This metric calculates how much revenue you need to generate to cover all your costs. It’s a crucial figure for startups, as it defines the minimum sales target needed to stay afloat.

• Burn Rate: For startups that are not yet profitable, burn rate measures how quickly the company is spending its capital. Monitoring burn rate in relation to gross margin helps gauge how much financial runway your business has before it needs additional funding.

Gross Margins in the Tech Industry: A Different Story

While gross margins are essential for CPG startups, the tech industry often operates with different dynamics. Many software companies, particularly those that sell SaaS (Software-as-a-Service) products, boast extraordinarily high gross margins—sometimes above 80% or even 90%. This is because the cost of delivering software to an additional customer (once the software is developed) is relatively low compared to the revenue generated from subscriptions or licenses.

In tech, gross margins can remain high due to economies of scale. For example, once a software product is built, there are minimal costs associated with distributing it to more customers. The initial investment in development is high, but as the customer base grows, the marginal cost of serving each additional customer decreases significantly. This contrasts sharply with CPG startups, where each additional product sold requires materials, manufacturing, and shipping costs, keeping gross margins lower by comparison.

However, high gross margins in tech don’t automatically mean lower customer acquisition costs. Many tech companies, especially early-stage startups, invest heavily in acquiring users, spending large amounts on marketing and sales to capture market share. This is why some tech startups, despite their high gross margins, still struggle to turn a profit in the early years.

Conclusion

Gross margin is a foundational metric for any business, but it is especially important for CPG startups. Maintaining a healthy gross margin between 40-60% allows a company to cover its production costs, invest in marketing, and scale sustainably. By studying the high gross

Thank you for reading. I hope this becomes useful reading before the work week starts again.

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Have a great week,

Robert