Why Does Revenue Increase When the Gross Profit Margin Decreases?
Revenue refers to the total amount of money that a business collects when it sells its products. Gross profit margin is the amount of money that the business earns after subtracting the cost of goods sold, but before other expenses such as taxes. When a business increases production, the cost of production for each unit will rise after a certain point since the company has limited resources. This will eventually reduce the gross profit margin.
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Labor
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The cost of goods sold includes labor costs. If a company increases production, it will incur other costs such as overtime for its current workers, as well as a cost to hire and train additional workers. The cost of each additional worker is higher than the cost of the company's current workers.
Efficiency
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The company has limited space available. Additional workers may get in the way of the current workers, reducing productivity. If the company needs to use additional electricity, water or other inputs, the utility company may charge a higher price for a watt of electricity or a gallon of water beyond a certain limit because the company is using a lot of its resources. These expenses increase the cost of goods sold per unit.
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Considerations
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Gross profit margin is a better indicator of a company's profitability than revenue. A company can collect a large amount of revenue and still have a loss on its financial statements if its labor, materials and overhead costs are high. Gross profit margin shows whether the company is actually earning a profit on the items it produces, unlike revenue.
Exception
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When the company produces a small number of products, a revenue increase may not lower the gross profit margin. If a company is not manufacturing products at full capacity, it does not incur extra costs such as overtime and training if it decides to produce more products. Other factors, such as penalty rates for high utility usage, may not apply either.
Monopoly
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If the company is a monopoly, it can only gain revenue by reducing prices so that more consumers can buy its products. The price reduction will allow the company to gain revenue overall, but it is selling each item for less money, reducing its gross profit margin even if the cost of production does not change. If the cost of production increases, the monopoly's gross profit margin will drop by even more.
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