Gross margin is an often confused concept but a powerful tool in figuring out how to market your business (and decide what to make, who to hire and how to fund it). Few people understand it, while others use a definition I don't find very useful.
I like to think of margin as the money left over after you've paid the direct costs for making an item, the last one of the day.
If you run a pizza place and a large pie costs $10, your gross margin is $10 minus the cost of flour, water, yeast, tomatoes and cheese. And maybe salt. That's it.
If you're not operating at capacity, the key word here is margin. The marginal profit of one more pizza is high. You've already paid for the rent, the oven, the sign, the ad in the Yellow Pages, the hourly wage, the uniforms, all of it. Whether you sell that last pizza of the day or not, all those costs are fixed. So, if your ingredients cost $2, your gross margin is $8.
This is vital to understand, because it tells you how flexible you can be with a promotional strategy. Some people (like me) prefer businesses with high gross margins, even if we're less busy. Others make billions on companies that run on the tiniest of margins.
If someone offers to run a coupon in the Welcome Wagon envelope that goes to new residents, and the rules are, "one per customer, new customers only", and the coupon offers a large pizza for $2, is it worth it for you to run it? That's 80% off! Surely, this is too expensive. You can't afford 80% off.
On the margin, of course you can. You got a new customer for free. Unless your store is at capacity, with people waiting in line, one more pizza sold at cost is a great way to build your business (unless there are too many coupons and unless it changes your positioning as a high-end place, but that's a story for a different day).
You probably already guessed this part: for digital goods, the gross margin is 100%. Cell phone calls? The same.
One more customer costs you nothing. That doesn't mean you should price accordingly, but it surely means you should understand how high your margins are.