What is Gross Profit 3 (GP3)? GP3, also called Variable Profit, is what remains of Net Revenue after product cost, fulfilment cost, and all variable marketing spend have been subtracted: the last margin figure before fixed overhead is applied. It’s the single most diagnostic number in the gross profit walk, whether a business’s customer acquisition is structurally profitable, or only looks that way because fixed costs haven’t been counted yet.
GP3 is the last of three layers, GP1, GP2, and GP3, that make up the full gross profit walk from Net Revenue to EBITDA. The GP3 Waterfall piece maps the shape of that framework: three layers, each one a gate a target’s real margin has to pass through. This piece is the walk itself, laid out line by line, with a precise definition for every cost that makes up each layer. It’s the reference to work from once the question stops being “what is this target’s gross margin” and becomes “which specific line item is doing the damage.”
How to Read the Walk
Every figure in the walk below is illustrative: an example percentage of Net Revenue chosen to show how the mechanics work, not a benchmark for any category or business model. Two kinds of rows appear. A running total (Net Revenue, GP1, GP2, GP3, EBITDA) is what remains after everything above it has been subtracted, always measured from zero. A cost item is a single deduction: what it removes, not what remains.
GP1: Product
What remains after the direct cost of the product itself, before it has moved an inch toward the customer.
- COGS. The direct unit cost of the product, paid to the manufacturer or supplier. The baseline cost before anything else touches it.
- Duty. Import tariffs and customs duties owed to bring the product across a border into the market it’s sold in.
- Inbound Freight. The cost of shipping product from the manufacturer to the business’s own warehouse or fulfilment point, before it’s ready to sell.
- GP1 / GM1. Net Revenue less COGS, Duty, and Inbound Freight combined, sometimes called Landed Cost. Answers whether the target is a price taker or a price maker on its core product economics: whether it can pass sourcing volatility through to the consumer or has to absorb it.
Two specific regulatory drivers compress this layer in ways worth isolating on their own: EU product-safety non-compliance (see GPSR Due Diligence) and, for white-label China-sourced portfolios, Digital Product Passport exposure (see You Are the Manufacturer Now).
GP2: Fulfilment
What remains after getting the product from the warehouse into the customer’s hands, and supporting them once it arrives.
- Outbound Freight & 3PL. The cost of shipping product to the end customer, plus third-party warehousing and fulfilment labor.
- Platform Fees. Marketplace or channel fees charged for selling through a given platform: referral fees, commission, listing fees.
- Payment Processing. Card and payment processor fees charged per transaction.
- Customer Service. The cost of staffing and running post-purchase support: order tracking, returns handling, inquiries. A support cost that looks efficient can be manufactured rather than earned: see The Chatbot That Never Lets You Leave on unreachable support, and Cheaper to Bin Than to Return on return fees priced to suppress the return rate itself.
- GP2 / GM2. GP1 less all of the above. Measures whether growth requires proportional capital injection into logistics, or whether the target has genuine density and infrastructure efficiency.
GP3: Marketing
What remains after the cost of acquiring the customer in the first place, variable spend only, before a single dollar of fixed overhead is applied.
- Performance Marketing. Paid acquisition spend across channels (search, social, display) directly tied to driving a sale.
- Brand Marketing. Upper-funnel spend on awareness and demand generation, not directly tied to a single transaction: sponsorships, brand campaigns, out-of-home.
- Marketing Tools & Software. Variable, usage-based martech spend that scales with marketing activity: attribution platforms, creative tools, analytics.
- Agency Fees. Fees paid to external agencies for campaign management, creative production, or media buying.
- GP3 / GM3 (Variable Profit). GP2 less all of the above. The single most diagnostic number in the walk: 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, shows a GM3 that degrades as volume scales, not one that holds or improves.
Fixed Costs and EBITDA
What remains after the costs that don’t move with volume: the ones a target carries regardless of how much or how little it sells.
- G&A. General and administrative overhead not tied to a specific department: legal, finance, administrative functions.
- Salaries. Fixed, non-variable headcount cost, distinct from the variable labor already counted inside GP2’s fulfilment cost.
- Rent. Office, warehouse, or facility lease cost that doesn’t scale with sales volume.
- SaaS. Fixed-fee software subscriptions, distinct from the variable, usage-based marketing tools inside GP3.
- EBITDA. Variable Profit (GP3) less all Fixed Costs. Earnings before interest, tax, depreciation, and amortization: the number that answers whether the business is actually profitable once every cost, variable and fixed, has been accounted for.
Reference Table
| Line item | Layer | Type |
|---|---|---|
| Net Revenue | Start | Running total |
| COGS | GP1 | Deduction |
| Duty | GP1 | Deduction |
| Inbound Freight | GP1 | Deduction |
| GP1 / GM1 | GP1 | Running total |
| Outbound Freight & 3PL | GP2 | Deduction |
| Platform Fees | GP2 | Deduction |
| Payment Processing | GP2 | Deduction |
| Customer Service | GP2 | Deduction |
| GP2 / GM2 | GP2 | Running total |
| Performance Marketing | GP3 | Deduction |
| Brand Marketing | GP3 | Deduction |
| Marketing Tools & Software | GP3 | Deduction |
| Agency Fees | GP3 | Deduction |
| GP3 / GM3 (Variable Profit) | GP3 | Running total |
| G&A | Fixed | Deduction |
| Salaries | Fixed | Deduction |
| Rent | Fixed | Deduction |
| SaaS | Fixed | Deduction |
| EBITDA | Final | Running total |
The Pre-LOI Question Every PE Fund Should Ask
Not “what is this target’s gross margin.” A single blended figure survives being asked almost nothing. The question is: can the target break its own number down to every line above, with real figures behind every row, or does “gross margin” stop being a real number the moment someone asks what’s actually in it?
A target that can produce this walk has a finance function that actually knows its own unit economics. A target that can only produce one blended gross margin figure is asking the acquirer to trust a number nobody inside the business has ever broken apart.
This is the full definitions reference behind Tronvik’s GP3 Waterfall methodology. Nothing in this article constitutes financial or investment advice. To initiate an outside-in GP1–GP3 margin reconstruction on a specific acquisition target, contact info@tronvik.com.