Most e-commerce targets present a single gross margin figure. It tells a PE fund almost nothing about where that margin actually comes from, or where it breaks under institutional ownership. A target can show a healthy blended gross margin while its product economics, fulfillment economics, and acquisition economics are each degrading in ways that only surface after close.
The Tronvik GP3 Waterfall exists to separate those three questions before the LOI is signed.
Why a Single Gross Margin Number Isn’t Enough
Standard financial reporting aggregates costs into broad functional categories — COGS, opex, marketing — that follow accounting convention rather than operational behavior. That aggregation is exactly what lets sellers optimize the story ahead of a process: variable costs get reclassified as fixed, marketing spend gets buried in G&A, and founder compensation gets set below market rate. None of this is illegal. All of it inflates the number an acquirer models against.
The GP3 Waterfall re-maps the P&L by cost behavior — volume-dependent variable cost versus time-dependent fixed overhead — rather than by accounting label. That reclassification is where the real risk becomes visible.
The Waterfall: GP1, GP2, GP3, and EBITDA
Starting from Net Revenue, four cost layers are peeled off in sequence:
- Direct Material (COGS, inbound freight, duties) is subtracted to produce GP1 / GM1
- Fulfillment (outbound logistics, 3PL, warehouse) is subtracted to produce GP2 / GM2
- Marketing (performance spend, growth agency fees) is subtracted to produce Variable GP3 / GM3
- Fixed Costs (G&A, salaries, rent, SaaS) are subtracted to produce EBITDA
Each layer produces two numbers: a GP figure (the absolute margin remaining after that layer’s costs) and a GM figure (that margin expressed as a percentage of net revenue). The dollar figure shows scale; the percentage shows trend and comparability across periods and against category benchmarks. Reading GP without GM — or GM without GP — hides half the picture.
GP1 / GM1 — Product and Material Margin
What remains after direct material costs: product COGS, inbound freight, customs duties and tariffs. GM1 answers whether the target is a price taker or a price maker — whether it can pass sourcing volatility through to the consumer or absorbs it. Single-source suppliers, manufacturing concentrated in volatile geographies, and unhedged commodity inputs all compress GM1 in ways a blended gross margin line will never isolate.
GP2 / GM2 — Fulfillment and Distribution Margin
What remains after outbound freight, 3PL fees, warehouse labor, and transactional customer support (order tracking, returns processing). GM2 measures whether growth requires proportional capital injection into logistics or whether the target has genuine density and infrastructure efficiency. A single-carrier dependency or inefficient multi-hop shipping network shows up here first — usually after volume has already scaled past the point where it’s cheap to fix.
Variable GP3 / GM3 — Unit Contribution and Scalability
What remains after performance marketing spend and variable growth agency fees. GM3 is the single most diagnostic number in the waterfall: it confirms whether customer acquisition is structurally profitable before a single dollar of corporate overhead is applied. A target renting its customers via constantly escalating ad spend — rather than owning a genuine brand moat — will show a GM3 that degrades as volume scales, not one that holds or improves.
For targets that sell D2C alongside retailers, that degradation often has a specific, identifiable cause rather than a generic one — see Bidding Against Yourself for how an ungoverned brand-retailer search auction shows up directly in GM3.
How Sellers Move Costs Across the Waterfall
The Tronvik framework exists specifically to catch three recurring reclassification patterns at the general ledger level:
- The Marketing Camouflage — external agency retainers or growth-focused salaries parked in fixed G&A instead of the Marketing layer, making GM3 look artificially strong.
- The Warehouse Shift — variable 3PL labor or shipping overages moved into fixed overhead to protect the headline gross margin, understating true GM2 pressure.
- Founder Wage Re-baselining — below-market founder compensation or distributions in place of W-2 salary, inflating EBITDA until a market-rate replacement hire is priced in.
Each of these narrows the gap between the reported number and the number that survives institutional ownership. None of them are visible from a single blended gross margin line.
What Outside-In Analysis Can Detect Before the Data Room
Before LOI, Tronvik’s waterfall mapping uses public and semi-public signals to build a directional GP1–GP3 / GM1–GM3 profile:
- Supplier concentration and sourcing geography (product listings, brand registrations, import records)
- Fulfillment footprint and carrier dependency (shipping policy language, delivery time patterns, warehouse job postings)
- Acquisition channel mix and saturation signals (traffic trend proxies, ad transparency libraries, promotional discount frequency)
- Reclassification indicators consistent with the Marketing Camouflage and Warehouse Shift patterns above
None of this replaces formal due diligence. It establishes a directional range for GM1, GM2, and GM3 before the acquirer commits time and capital to a full process — and it flags exactly which waterfall layer the formal DD team should stress-test first.
The Pre-LOI Question Every PE Fund Should Ask
The question is not “what is this target’s gross margin.” It’s: which layer of the waterfall is that margin actually coming from, and which layer breaks first under institutional ownership?
A target with strong GM1 but collapsing GM3 has a sourcing advantage and a customer-acquisition problem. A target with strong GM3 but weak GM2 has a brand and an infrastructure problem. Both can report the same blended gross margin. Only the waterfall tells them apart — and only telling them apart before the LOI gives the acquirer leverage on price instead of a post-close surprise.
This analysis is part of Tronvik’s GP3 Waterfall methodology. To initiate a GP1–GP3 / GM1–GM3 mapping on a specific acquisition target, contact info@tronvik.com.