The Game with Alex Hormozi - Gross Vs. Net Margin | Ep 246

Episode Date: November 3, 2020

The slightest difference can make the biggest change. Today, Alex (@AlexHormozi) talks about one of the number one issues he faces when he talks to small to medium-sized business owners: knowing the difference between gross vs. net margin. By knowing the difference between these two, you will instantly shift how you view money and the growth of your business.Welcome to The Game w/Alex Hormozi, hosted by entrepreneur, founder, investor, author, public speaker, and content creator Alex Hormozi. On this podcast you’ll hear how to get more customers, make more profit per customer, how to keep them longer, and the many failures and lessons Alex has learned on his path from $100M to $1B in net worth.Timestamps:(0:47) - Difference between gross and net margin & calculation involved(2:11) - Gross margin creates net margin. Alex's example explains why.(4:38) - Increasing gross margin: decrease fulfillment cost, increase price now.(6:42) - Greatly increasing margins scales and yields enormous profit.Follow Alex Hormozi’s Socials:LinkedIn | Instagram | Facebook | YouTube | Twitter | Acquisition

If you've ever struggled at the end of the month and worked all the way there to only to look at the bank account and find that there was nothing there, there was too little for you to take out, and then been like, I literally just worked for an entire month for nothing, then this video is for you. Welcome to the game where we talk about how to get more customers, how to make more per customer, and how to keep them longer, and the many failures and lessons we have learned along the way. I hope you enjoy and subscribe. So one of the number one issues that I see when I talk to small business owners or medium-sized business owners is that they don't have an adequate grasp on the different. between gross and net margin. And the reason I'm coloring the background green and I'm using my green pen is that margin is about the money.

So this is a topic that people do not talk about. It is also probably the number one thing that I look at in a business to determine its health and whether I would be interested in investing or any of those types of things. So let me break down the difference between gross margin and net margin and then I'm going to tell you the functional ways

that I use to fix a business. All right? So gross margin, gross margin is what the direct cost of fulfilling your goods or services are. And so the equation for it, don't get, everyone's like, I don't like math. It's subtraction, all right? It's not math that you're confused about if you, like, zone out at this moment.

It's because you don't want to do the thinking to understand the words. I want to be really clear. I'm literally going to use subtraction here. All right? It's the revenue, how much money you're making, minus the cost of goods sold. All right, that's the cogs. Now, the thing is, if you're in a service business,

your cost of goods sold isn't the physical product. that you're selling because you're not selling those you're selling people you're selling payroll hours all right and so the cost of goods sold for a service business which is what the majority people are listening to this are using is the incremental cost of the additional unit which means that that doesn't count your front desk girl that doesn't count your HR director it doesn't count your rent none of that stuff counts it's just the cost of one additional unit all right very important your net margin and i'm going to give you the examples in a second. Your net margin is your chop, right? That's what you, it's the juice at the

end of the month. It's what you get after everything is paid what's left over. That's what you end up taking home. But the gross margin, in my opinion, well, they're both obviously very important. But the gross margin is the one that begets, that creates the net margin. And this is the one where I always focus, and this is the thing that I fix, and this is what I help people fix, and this is the game. All right? So, my revenue minus cost. So let's say, We're selling a service for $60 per hour. That's what, let's just say you know, you're a hairstylist or your trainer, it doesn't matter, right?

You're selling $60, right, in your business. And your cost of goods sold, let's say is 20 bucks, right? You're paying somebody $20 for the $60 thing. You're like, that sounds good, there's $40 left over for me. This makes sense, right? Wrong, all right? And I'll get to why in a second in what number I use. But let's just do this so you

can understand what the gross margin is here. So the gross margin on this, and that's assuming we're not using any product to work on this if you were like a hairstylist, for example. But let's just say simply here, $60 is what you're charging, $20 is what it costs, and $40 is left over. Now, what you do to figure out your margins, you take that $40, right, what's left over, divided by the $60 of revenue, which is what you got gross, and what that does is it gets 66%. That's the gross margin. you'd be like oh that that sounds reasonable that's not that much you know that's not that bad the thing is is each incremental gross margin point is enormous and so let me show you the difference so let's say at the end of the year you're running a business that runs on 66% gross margins and let's say at the very

end of the year now we're in the net margin category you uh you end up with 12% margins all right now most brick and mortar businesses run around there crazy right but that's what most brick and mortar businesses run around. So if you're at 12% margins and I say listen you got to be at 80, people are like well 80 and 66 it's not that different. If you bumped your margins to 80% what happens at the end of the year? That's 14. All right? So what that does is you now have 26% net margins at the year. We more than doubled we, 2.2x how much you make. So do you think this is important? Can I double how much you make simply by changing this one number yes all right so let's use the 80% example which by the way is my

rule of thumb this is the number that I get any service-based business over all right doesn't matter what you're selling this is what you have to get over all right now I'll show you the difference between 80 90 95 100 in a second but this is important all right so if 80% gross margins what I need there's two ways I can do it one I can decrease this cost right I could say that I get this to 12 twelve dollars right this becomes twelve bucks across that out and now my my new take home on this is forty eight dollars right and so forty eight dollars over sixty equals eighty percent so one way you can increase your margins decrease

your cost gross margin the cost of actually doing the thing right the second way is by increasing how much you charge this guy right and so let's say instead of sixty and we have this twenty So what is how do we get 80% loath over if we have a $20 cost? Well, it's easy with this number because 20 is 20%, right? And so that means that you'd have to charge $100 for your $20 thing to have an 80% margin. And so way number one, you decrease the cost of fulfilling the thing. Way number two, you increase the price, right?

Now, this is why this is so important. Obviously, I showed you at the end of the year you'd have a lot of money. But besides that, if you're making $100 or you're charging $100 or something, right, and it cost you $20, you got $80 left over, all right? Now, from that $80, and here's what's important, you have to pay for everything else in the business and have enough money to market to acquire more customers and you have to have enough money to have a profit, right? And so it seems like you're like 80%, Alex, that's crazy.

And so by the way, all successful businesses, the biggest businesses in the world, they're not running 80% margins. They're running 99% gross margins. And you're like, well, that's only 19% more. It's actually not. It's so much more than that. So let me break down this difference real quick, and then I'll finish this example. So the difference between 80% margins, 90% margins, 95% margins, right? I'll just go all the way to 100, right?

and 100, let's do this, is that difference between 80 and 90 is that this is twice as profitable as this. Why? Because it's half the cost. It means I took that 20 and made it 10. That's the difference. You're looking at this side of the equation, not all of this. The difference between 90 and 95% gross margins, again, twice as profitable. And what I mean by that is that you can sell twice as many people for the same cost. That is the magic and that is how you scale. That is how you get something that's enormously profitable, allows you to acquire customers, and has tons of profit kicking off every single month. And so this is where a lot of entrepreneurs get messed up because they feel bad about charging a lot for their services or a lot for their products or whatever, right? The thing is that if you do not do this, you will make no profit and you will not be able to scale,

you will not help more people unless you get this right. So you've got to get over this mental barrier that you have around what you're able to charge for things that don't cost you a lot of money. Hey guys, real quick, if you're new to the podcast, I have a book on Amazon. It's called $100 million offers that over $8,000 five-star reviews and it has almost a perfect score. You can get it for 99 cents on Kindle. The reason I bring it up is that I put over 1,000 hours into writing that book. And it's my biggest gift to our community.

So it's my very shameless way of trying to get you to like me more. And ultimately make more dollars so that later on in your business career, I can potentially partner with you. So that's my give. Go check it out, Amazon, and back to the show. Right? Right. Okay, so back to this example. So if I have $80 left over,

that means that it depends on what my cost of acquisition is. So let's say, you know, there's a certain percentage of my revenue that I'm willing to give for cost of acquisition. Let's say it's 20%, right? So if 20% of this, I'm willing to give, that means that $16 is what I have left to market this, right? Because you see, like you can only use it off of what's left here. And you still, after you pay your marketing, right?

you still have the rest of your costs you still have rent you still have payroll you still have you know payroll for all the non-essential stuff you still have software still have all these other costs of doing business all right that have to come out of just the remainder between here and here all right this is the game and so in in some total here if I'm looking at a business the big number that I'm looking at is 80% and that's what I I target I target any business, especially for service, that's over 80%. And so if I'm trying to invest in something, like this is the game that we get to. And so you can do this for any brick and mortar business,

for your business, for anything, you got to be over 80. And ideally, pushing from 80 to 90 or 90 to 95 at each of these increments doubles the productivity of the business again. Right. And that's where it gets magical. And so the two ways you can do it, just as a quick recap, to increase your gross margin is number one you can decrease the cost and number two you can increase the price and that is how you can increase your gross margin percentage all right so I hope that was valid before you hope that made sense I hope if you look at your own services and you're like well like what's my gross margin break it down what's the additional cost for one more person right if I like I said earlier if I was selling something for $60 and if you don't know let's say you've

one person I'll give you one more example for this let's say you've got the type of business where one person fulfills for many people because you're like I don't know what my cost would be so I actually had this example not that long ago I was that a mastermind and a guy said he's got coaches and they coach people right and so I said well what are you know what are your gross margins he's like I have no idea I was like well let's walk through it together so he was paying his coach $4,000 a month all all right that's what he was paying his coach and I said cool how many clients can your coach handle

well my my coach can handle 40 people all right 40 clients I was like okay what do you charge your clients per month he said well I sell packages and I was like all right what are your packages cost he's like if they're $1,200 packages I was like okay what does $1,200 get me he said it gets you three months I'm gonna give you a real word example here so if you guys dig this all right which means that it's $400 per month if you spread it out right so he's got 40 clients $400 a month is what they're what they're charging all right which means 40 times 400 hopefully my math is right here is 160,000 hopefully am I messing something I'm here I think it's 160,000 is it zero four times four thousand no 16,000 I was like whoa is 16,000 dollars per month right

that's cool right that's neat so 16,000 dollars per month and the cost of the coach which is 4,000, right? Everyone following with me? So it means that there's 12,000 left over. So that's what's left over after the cost. And then we're just dividing it by the total revenue, right? Which is this guy. You just bring it back down.

So it's just 12 divided by 16, right? Which in this instance, be 75%. So he's close to 80, but he's like, well, you know, I don't wanna change anything because I'm already at 75. But remember, at the end of the year, the end of the year, let's say you've got 15% margins, right? to say at the end of the year you got 15%. Bumping the extra five takes you to 20, right?

And you're like, oh wow, that doesn't seem like a big difference. 15 to 20% net margins at the end of the year is a 25% increase in how much money you make. That is how important this is. And so anyways, so what do he need to do? He either has to pay this guy less or he's got to charge more money here. And so the way to figure this out backwards,

if you wanted to, if you didn't want to change, if you did want to change your your price to get it over 80% then you simply basically increase what this number needs to be until it's 80%. So gosh what's the it's 1.6 times 8 whatever that is 8 and then God it's 12.8 yeah so that would mean that he have to get to 12,800 if you wanted to get over 80% which means he either needs to charge the extra 40 clients an extra $200, no, $20? Yeah.

You need to charge an extra $20 here, right, per month, or he could pay this coach $3,200 per month. And that is how he would get from 75 to 80%. And that, my friends, is the game. So hope you found this useful. Hopefully you like this. Hopefully you thought this was awesome. And if you didn't, well, please tell me,

I just want to make stuff that you guys find valuable. This is the game. This is the stuff that I dive super deep into. I'm trying to fix a business model or I'm consulting with somebody. And I hope you find that valuable too. So anyways, keeping awesome. Please leave a post or review or any of that good stuff. And I will see you on the next one.

Bye.