Operating margin and cost structure: where the revenue goes at Apple and Microsoft
Two companies can report the same kind of profit and earn it in completely different ways. Apple and Microsoft are both American, both report in dollars under the same accounting rules, and both are worth roughly three trillion dollars, yet Microsoft keeps about 14 more cents of operating profit from every dollar of revenue. This lesson takes the margin gap apart into its pieces, and uses a calculator to put Microsoft's revenue through Apple's cost structure.
- Level
- Beginner
- Reading time
- About 19 minutes
- Know this first
- Why profitable businesses run out of cash
By the end you will be able to:
- split an operating margin into cost of sales, research and development, and selling and administration
- explain a margin gap between two companies as a gross margin gap and an operating cost gap
- turn percentage points of margin into dollars at different company sizes
- say what a cost structure comparison can and cannot show
The same profit, earned two ways
The lesson on profitability ratios introduced three margins, each after more costs. This lesson uses them for one purpose: finding out why two companies differ. A margin on its own says how good a result is. It does not say where the result comes from, and where it comes from decides whether it will last and how it will respond when conditions change.
Apple and Microsoft make a good pair for the exercise. Both are American, both report in US dollars under US GAAP, and both are worth roughly three trillion dollars on the stock market. Their fiscal years end in September and June, a quarter apart. Revenue is $416.2 billion at Apple and $281.7 billion at Microsoft. Yet Apple kept 32.0 cents of operating profit from each dollar of revenue and Microsoft kept 45.6, a gap of 13.6 points. Where did it come from?
Where each dollar of revenue went
Divide every cost line by revenue and the income statement becomes a set of shares that add to 100. Cost of sales is what it cost to make and deliver what was sold. Revenue less cost of sales is the gross margin. Research and development and selling, general and administrative costs, together called operating costs, come out of the gross margin, and what is left is the operating margin. Apple reports selling and administration as one line. Microsoft reports sales and marketing, and general and administrative, separately, and the table adds them so the two can be compared.
| Share of revenue, fiscal 2025 | Apple | Microsoft | Microsoft less Apple, points |
|---|---|---|---|
| Cost of sales | 53.1% | 31.2% | −21.9 |
| Gross margin | 46.9% | 68.8% | +21.9 |
| Research and development | 8.3% | 11.5% | +3.2 |
| Sales, general and administrative | 6.6% | 11.7% | +5.1 |
| Operating margin | 32.0% | 45.6% | +13.6 |
The gap splits into two parts that pull in opposite directions. Microsoft's gross margin is 21.9 points wider, 68.8% against 46.9%. Its operating costs are 8.3 points heavier, 23.2% of revenue against 14.9%: research and development 3.2 points more and selling and administration 5.1 points more. The net of the two is the 13.6-point gap in operating margin, since 21.9 less 8.3 is 13.6. In plain terms, what Microsoft sells costs far less to make and deliver per dollar of revenue, and it spends a bigger share of what is left on running the business.
One fact about the mix may help explain the first part. Apple reports 74% of its revenue as products and the rest as services, while Microsoft reports 77% as service and other revenue. A business that builds and ships physical goods carries a cost of making each one. A business that sells software and cloud access largely carries the cost of the facilities that serve many customers. The filings used here do not split cost of sales by line, so this lesson cannot say how much of the 21.9-point gap the mix accounts for, and does not claim to.
The opposite is true of the dollars. Apple spent $34.6 billion on research and development in the year and Microsoft $32.5 billion, so Apple spent more in dollars while spending less as a share of its revenue. On selling and administration, Apple spent $27.6 billion against Microsoft's $32.9 billion. A share of revenue and an amount of money are different measures, and a comparison needs both.
Put Microsoft's revenue through a different cost structure
The calculator holds Microsoft's fiscal 2025 revenue of $281.7 billion and lets the cost shares change. It starts at Microsoft's own shares, rounded to one decimal place, so the first answer is almost exactly what it reported. Move the shares to Apple's and watch the profit fall. The left page shows Microsoft's operating profit and the profit left after tax at the rate chosen. The right page sets the margin against Apple's and the profit against what Microsoft actually reported. Tax is applied to operating profit only, so the after-tax figure is not the reported net income, which also includes interest and other items.
At these cost shares Microsoft's operating profit would be $128.5 billion, a margin of 45.6%, which is 13.6 points above Apple's 32.0%. That is about what it actually reported.
Four experiments. First, set the cost of sales to Apple's 53.1%, research to 8.3%, selling and administration to 6.6% and tax to 15.6%. Microsoft's revenue would earn a margin of 32.0% and an operating profit of $90.2 billion, which is $38.4 billion less than it reported. Second, change only the cost of sales, to 53.1%, and leave the operating costs at Microsoft's levels. The margin drops to 23.7%, below Apple's, and profit to $66.8 billion. Third, do the reverse, keeping Microsoft's 31.2% cost of sales and taking Apple's operating costs of 8.3% and 6.6%. The margin rises to 53.9% and profit to $151.8 billion. Fourth, change only the tax rate to 15.6%: after-tax profit rises by $2.6 billion. The first three show the same thing from different directions. Microsoft's margin is a combination of a low cost of sales and a heavy operating cost, and neither alone gives Apple's.
The same point of margin, different dollars
A percentage point of margin is a share of revenue, so its worth in dollars depends on the size of the company. One point of Apple's revenue is $4.2 billion. One point of Microsoft's is $2.8 billion. If each company improved its cost of sales by a single point, Apple would gain nearly half as much again as Microsoft would from the same improvement. The reverse is also true: a cost that rises by a point costs Apple more in dollars than it costs Microsoft.
This matters when someone says a company could lift profit by trimming a few percent off a cost line. The size of the prize depends on which line and on which company. Cutting a point from a 53% line is a far smaller proportional change than cutting a point from a 7% line, which is why it helps to look at the lines in proportion as well as in points.
What a cost structure comparison does and does not say
It says where the revenue went. It does not say which structure is better, because the two companies sell different things. Apple's margin comes from a business with a large manufactured-goods element and Microsoft's from one built on software and cloud services, and each cost structure fits its business.
What a comparison does give is a set of questions. If the gross margin is widening, is it because prices are rising, or because the cost of making things is falling, or because the mix is changing? If operating costs are growing faster than revenue, is the spending building something? The calculator's answer for Microsoft at Apple's structure is $38.4 billion less operating profit, which says nothing about whether Microsoft should change anything. It shows how much of its result rests on its structure.
What this comparison cannot tell you
- Companies classify costs differently. What one company counts in cost of sales another may put in operating costs, so gross margins are never perfectly comparable.
- A year is a single point. A margin can move a good deal from year to year. The shares in the table are fiscal 2025 only.
- Costs are not all variable. The calculator changes shares of revenue freely. In practice a company cannot cut research or administration as sales change, and those costs behave more like fixed amounts than shares.
- Tax is applied simply. The after-tax figure uses one rate on operating profit and leaves out interest and other items.
- Two companies are two companies. A gap between Apple and Microsoft says nothing about technology companies in general.
Common mistakes
Comparing margins without comparing what is sold
A margin gap can come from the product mix as easily as from efficiency. Ask what each company sells before asking who is better run.
Reading a share of revenue as an amount of money
A company can spend a smaller share and more dollars, as Apple does on research. Use both.
Ignoring the opposite pull of the two parts
A wide gross margin and a heavy operating cost partly cancel. Looking at either alone gives a wrong picture of the margin that remains.
Treating costs as proportional to revenue
The calculator uses shares for simplicity. If revenue falls, costs that are fixed in dollars rise as a share, and the margin falls by more than a proportional model suggests.
Assuming one year is the structure
A single year can include unusual items. Check at least two years before describing a company's structure.
Try it yourself
1. A company has revenue of $200 million, cost of sales of $120 million, research and development of $20 million and selling and administration of $30 million. What are its gross margin and its operating margin?
Show the working
Gross profit is 200 − 120 = $80 million, a gross margin of 40%. Operating profit is 80 − 20 − 30 = $30 million, an operating margin of 15%.
2. Revenue then falls to $180 million. Cost of sales falls in proportion to $108 million, but research and administration stay at $50 million. What is the operating margin now?
Show the working
Gross profit is 180 − 108 = $72 million. Less $50 million is $22 million, and 22 ÷ 180 = 12.2%. Revenue fell 10% and the margin fell almost three points because part of the cost did not move.
3. How many dollars is one point of operating margin worth at a company with revenue of $281.7 billion?
Show the working
One per cent of $281.7 billion is $2.8 billion, which is the figure for Microsoft's fiscal 2025 revenue.
4. One company has a gross margin of 68.8% and a larger operating cost, another has 46.9% and a smaller one. Why can't you tell from this alone which is better run?
Show the working
The two may sell different things, with different costs of making and delivering them, and may classify some costs differently. The numbers show where revenue went, and a judgement on management needs more than that.
Where this is used
- An analyst explains a margin change by splitting it into gross margin and operating costs before forecasting either.
- A board sets targets for cost of sales and operating expenses as shares of revenue and tracks them each quarter.
- An investor compares two companies in the same industry to see which parts of their cost structures differ.
- A lender tests how far a borrower's margin would fall if sales dropped and part of its costs stayed fixed.
Key terms
- Cost structure
- How a company's revenue is divided among its main costs and the profit that remains.
- Cost of sales
- The cost of making and delivering what was sold.
- Gross margin
- Revenue less cost of sales, as a share of revenue.
- Operating costs
- Costs of running the business other than cost of sales, here research and development, and selling and administration.
- Operating margin
- Operating profit as a share of revenue.
- Percentage point
- The unit for the difference between two percentages: 45.6% less 32.0% is 13.6 points.
Questions people ask
Is a higher operating margin always better?
Not by itself. A company may keep its margin high by under-investing in research or sales, and pay for it later. It is a measure of the result, and needs a view of what was given up to get it.
Why do the companies group costs differently?
Accounting rules set out what must be reported and leave companies some choice in how to arrange and name the lines. The lesson on the income statement shows the usual layout, and the filings give each company's own definitions.
Why use revenue as the base for every share?
It is the one figure every line can be set against, which makes companies of different sizes comparable. It is a convention, and a share of revenue can hide what happens to the amounts.
Does this say anything about the share prices of the two?
No. A margin is one input to a valuation, and the valuation module shows how it combines with growth and risk.
Sources and review
- Apple Inc., Form 8-K, Exhibit 99.1: fourth quarter and full-year fiscal 2025 results, filed with the US Securities and Exchange Commission. Source of Apple's statements.
- Microsoft Corporation, Form 8-K, Exhibit 99.1: fourth quarter and fiscal year 2025 results, filed with the US Securities and Exchange Commission. Source of Microsoft's statements.
How the numbers were checked: every cost line, subtotal and margin for both companies was rebuilt from the filed income statements and tied to the reported operating income. The rounded shares in the table add to 100 for each company, and the calculator, which runs separately, was compared with plain code across a grid of cost shares and tax rates.