Gross vs. net margin for a service business

Margin analysis was built for businesses that buy materials and sell products, so it can feel slippery when what you sell is time and expertise. But margin still matters enormously for service businesses — it just requires thinking clearly about which costs are 'direct' when you are the product. Get that right and margins become a powerful gauge of whether your pricing, your subcontracting, and your overhead are actually working.

What is COGS when you sell time

In a product business, cost of goods sold is obvious — the materials in the thing you sold. In a service business, direct costs are whatever it took to deliver that specific engagement: subcontractors you paid to help on the project, project-specific software or licenses, payment processing fees, and, in many models, the direct labor cost of the people doing billable work. Overhead — your marketing, general software, insurance, admin — is not COGS; it is what you carry regardless of any single project.

The two margins, service-style

For an agency that subcontracts, gross margin suddenly means a lot: if you bill a client $100/hour for work you pay a contractor $60/hour to do, your gross margin on that work is 40%, and that spread has to cover all your overhead and profit. Too thin a markup and a busy agency can still lose money — high revenue, no margin.

Reading the signals

• Falling gross margin in an agency means your subcontractor costs are rising faster than your prices — a signal to raise rates or renegotiate.
• Healthy gross margin but poor net margin means overhead is eating the business — the problem is your fixed costs, not your pricing.
• For a solo freelancer, a low net margin usually means either underpricing or bloated overhead relative to a one-person operation.
• Rising both-margins over time is the sign of a maturing business: better pricing power and better cost control at once.

The bottom line

For service businesses, gross margin measures the spread between what you charge and the direct cost of delivering it — often near 100% for a true solo, but decisive for anyone who subcontracts. Net margin measures what survives your overhead, and for solo owners it is usually the more honest health number. Watch both over time: falling gross margin points at pricing and subcontractor costs, while a gap between healthy gross and weak net margin points at overhead. Together they tell you whether your business is genuinely profitable or just busy.