Your profit margin is a metric that should always be on your radar, and for good reason: it answers critical questions about your business, like whether or not you’re making money or if you’re pricing your products correctly.
It’s important to note, though, that your profit margin isn’t just something you should measure; it’s a metric that you should continuously improve. As author Doug Hall said, “If your profit margins aren’t rising, chances are your company isn’t thriving.”
To help you better understand how to increase profit margins in your business, we’ve put together some tips and expert advice on retail profitability. You will learn the following:
- What gross profit is and how to calculate it
- What gross profit margin is and how to calculate it
- What net profit is and how to calculate it
- The factors that contribute to profit margin
- What the ideal profit margin is
- 11 actionable ways to increase profit margins
Let’s dive in!
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What is gross profit?
Gross profit is your total revenue minus the cost of generating that revenue. Simply put, gross profit is your sales minus the cost of goods sold (COGS). Your gross profit tells you how much money your business has before paying for other expenses like payroll, marketing, utilities, etc.
Gross profit formula
Your gross profit is calculated by subtracting the cost of goods sold from your sales. Expressed as a formula, it looks like this:
Understanding gross profit
Let’s say that Johnny’s Bikes sold $20,000 worth of a Bike #1 in one month. Their inventory cost them $10,000. Bike #1’s gross profit is $10,000.
In that same month, Johnny’s Bikes sold $15,000 worth of Bike #2 and its COGS was only $2,000. Bike #2’s gross profit is $13,000.
Although Bike #2 sold for less than Bike #1, its gross profit is higher, therefore the bike is more profitable to sell.
What is gross profit margin?
Gross profit margin is when you express gross profit as a percentage. The higher the percentage, the more profitable an item is for a business to sell.
Gross profit margin applies to a specific product a business sells. Calculating gross profit margin enables businesses to set prices that make selling the product worthwhile.
Gross profit margin formula
Your gross profit margin is calculated by first subtracting the cost of goods sold from your sales, then dividing that amount by sales. Expressed as a formula, it looks like this:
Understanding gross profit margin
Taking the same example as we did for gross profit, let’s explore the gross profit margin of Bike #1 and Bike #2 at Johnny’s Bikes.
Bike #1 sold for $20,000 and its gross profit was $10,000.
Bike #1’s gross profit margin is 50%.
Bike #2 sold for $15,000 and its gross profit was $13,000.
Bike 2’s gross profit margin is 115%. Since its cost of goods sold is less than Bike #1, it’s more worthwhile for Johnny’s Bikes to sell Bike #2 than it is Bike #1 because they’re making more profit on each sale.
What is net profit margin?
Let’s say you wanted to express your entire business’s profitability rather than just one product; that’s your net profit margin. A business’s net profit margin is expressed as a percentage.
The higher the percentage, the more profitable the business is. A low net profit margin is a signal that there are issues impacting your business’s profitability potential, from high expenses (rent, utilities, labor, etc), issues with productivity or even management issues.
Net profit formula
To calculate net profit margin, you first need to find your net profit by subtracting your total expenses from your total revenues.
Net profit margin formula
Next, divide your net profit into your total revenue and multiply the result by 100 to express the value as a percentage.
Understanding net profit margin
Let’s say Johnny’s Bikes’ gross sales are $500,000 and their total expenses are $250,000. Their Net profit would be $250,000.
To express your business’s net profit as a percentage, do the following:
What contributes to profit margins?
There are many things that factor into a retailer’s profit margins, including markdowns and promotions.
When you sell an item for less than your initial markup (IMU), you’re effectively lowering your profit margin on that item. That’s why having the right markdown strategy is so important. You never want to arbitrarily attribute a discount to a product; always pinpoint a retail price that will be both interesting for deal-hunters and profitable for your business.
Your point of sale system can also help. One of the main reasons retailers discount products is to liquidate old inventory that wasn’t selling at full price. A retail POS system with inventory management capabilities will keep you from ordering too many units of a product, preventing you from having to discount its price to get rid of excess inventory in the first place.
What is the ideal profit margin?
Profit margins vary greatly depending on a retailer’s sub-sector and what products or services they sell.
For instance, a fashion and apparel store’s profit margins will vary greatly based on what type of clothing it sells (is it fast fashion, mid-level or luxury goods?). If we were to compare the profit margins of a clothing store to that of a hand-made furniture store, they would vary greatly even if their respective profit margins are healthy for their respective sub-sector or niche.
Based on our data, we found that the average gross profit margin in retail is 53.33%. When comparing profit data across multiple industries, we found that beverage manufacturers, jewelry stores, and cosmetics had some of the highest profit margins, with 65.74%, 62.53%, and 58.14%, respectively. Meanwhile, alcoholic beverages, sporting goods stores, and electronics had some of the lowest margins at with 35.64%, 41.46%, and 43.29% respectively.
11 ways to increase your profit margins
Now that you know what gross profit is and how to use it to attribute a product’s monetary value for your business, let’s look at eight tried-and-true ways on how to increase profit margins in retail.
- Bring your brick-and-mortar store online
- Avoid markdowns by improving your inventory purchasing
- Plan ahead for each season
- Find ways to reduce operating expenses
- Increase your average transaction value (ATV)
- Elevate your brand and increase the perceived value of your merchandise
- Increase your prices
- Optimize vendor relationships
- If you must discount your products, be smart about it
- Inspire your staff to do more
- Get more sales from your existing customers
1. Bring your brick and mortar store online
It’s imperative that your customers are able to find your retail business online.
This can be as simple as creating a Google My Business profile to help more local customers find your store either through Google Search or Google Maps. According to Google, 88% of people that search for a local business online either call or visit that business within 24 hours. Setting up a GMB profile helps businesses convert online visibility into in-store transactions.
If you want to take it a step further, consider launching an online store. While getting started may seem like a daunting task, you can always start small and work your way up as you have time and resources.
Even a basic (but well-designed) website that features your business name, location and contact information is beneficial for helping customers find your store. But the real benefit of setting up an online store is creating a secondary sales channel to complement brick-and-mortar sales.
With Lightspeed eCom, you can build a transactional website using handy templates, sync your physical store’s inventory with your online store and manage both from the same backend.
An online store can increase your exposure and sales while costing far less than opening a second physical location.
2. Avoid markdowns by improving your inventory purchasing
Whenever you lower the price of an item, you’re also lowering that item’s profit margins. That’s why it’s best to avoid markdowns whenever possible.
The most effective way to avoid markdowns is to improve your inventory management, the merchandise you have on hand, the products sell quickly at full price and the ones that don’t. That information (which you can typically find in your POS system’s sales reports) will help you decide which products to stock up on and how much to buy to fulfill customer demand, prevent overstocking and avoid the need for markdowns and promotions altogether.
3. Plan ahead for each season
Most retail businesses have a season where their sales peak. A retailer’s peak season will vary based on their sector, product-type and their location. Even then, most retailers in the US will experience a fluctuation in sales from one month to another.
Retailers should get into the habit of looking at their annual sales reports, broken down month-by-month. Which months do they make the most sales in? Does that pattern persist year after year?
Use those patterns when planning your seasonal inventory purchasing. If you notice that you sell a higher volume of certain product types in a given season, consider purchasing more units of that item to capitalize on its seasonality and maximize sales.
A secondary benefit to planning your seasonal inventory ahead is that suppliers may offer discounts for advanced or bulk orders. You may be able to lower that item’s COGS, maintain it’s retail price and maximize that item’s gross profit.
4. Find ways to reduce operational expenses
Krista Fabregas, a retail analyst at FitSmallBusiness, suggests that retailers find ways to streamline their operations as a way to increase profit margins.
There are several key areas where a retailer can reduce operational costs. For starters, look at labor costs and avoid overstaffing. Next, look at other costs like your product packaging, shopping bags and even your store lighting. Are there any costs that can be reduced? In the case of lighting, it may be worthwhile to invest in energy-efficient commercial lighting.
Another way to reduce operational costs is by streamlining productivity. Are there certain repetitive tasks that are taking up chunks of you and your staff’s time? A usual culprit is anything to do with data entry.
The good news? Most time-consuming data entry tasks can be automated. For example, rather than manually transferring sales data from your point of sale system to your accounting software, consider using a two-way integration like Lightspeed Accounting, which automatically pushes information from one system to the other. Spend less time punching in numbers (or avoid paying someone to do that task for you) and benefit from accurate bookkeeping.
5. Increase your average transaction value (ATV)
Increasing your store’s average transaction value (ATV) is both an excellent and achievable way to increase profits. Retail is an inherently social activity and, although technology helps merchants serve customers, nothing can replace the connection between an empathic and informative (but not pushy) sales associate and their customer.
But how can you use social interactions to boost ATV?
Teach your sales associates the art of suggestive selling. Once a customer is in your store, it’s on your sales associates to build a rapport, listen intently to their needs and find products that fulfill those needs. In our 2020 Retail Trends Report, we found that 82% of consumers want more human interaction when they shop and those interactions between sales associates result in higher in-store sales. At the NBA Store in New York, for instance, conversions increased by 182% when customers engaged with a sales associate.
Your store layout has an impact on in-store sales, too.
How you promote and display your products in-store, known as visual merchandising, can help customers find what they’re looking for, discover related products and make a purchase. Point of sale marketing (placing low-investment products near the checkout) is another tactic retailers use to increase impulse purchases and a customer’s transaction value.
6. Elevate your brand and increase the perceived value of your merchandise
It’s interesting to see that cosmetics retailers have some of the best margins in retail. According to experts, one reason behind this is the fact that beauty and cosmetics brands excel at creating personal and emotional connections with customers.
“Beauty is a category on fire… The price value equation is quite good, cosmetics make people feel better about themselves and foster strong customer loyalty, and the merchandising creates a sense of exploration,” says Laura Heller, Editor at Retail Dive.
She continues, “The product category creates a kind of personal connection with shoppers, unlike many other consumer goods. The price value equation is quite good; cosmetics make people feel better about themselves and foster strong customer loyalty, and the merchandising creates a sense of exploration—something the off-price retailers have also done quite well. Depending on the brand, packaging, and marketing attached, the profit on each small item can be really high.”
Chris Guillot, Instructional Designer of Merchant Math and Founder of Merchant Method, offers a similar view, saying that “cosmetics brands do a great job with brand management, playing to their customer base at an emotional level—status and lifestyle.”
According to Guillot, “Retailers of all sizes and stages of growth can focus on their unique brand positioning as a way to differentiate from their competitors and increase perceived value.”
7. Increase your prices
Raising your prices will enable you to make more money on each sale, thus widening your margins and improving your bottom line. Many retailers, however, balk at the prospect of increasing their prices out of fear that they’ll lose customers.
We wish we could give you hard and fast rules when it comes to pricing, but the fact is, this decision depends on each company’s products, margins, and customers. The best thing to do is to look into your own business, run the numbers, and figure out your pricing sweet spot.
On top of considering basic pricing components like your costs and margins, look at external factors such as competitor pricing, the state of the economy, and the price sensitivity of your customers.
And consider what types of customers you want to attract. Do you want to sell to shoppers who would take their business elsewhere just because they could get an item for less, or would you rather attract customers who don’t base their purchase decisions solely on price?
You’d be surprised to find that the majority of consumers (though this may vary from one industry to the next) may actually belong to the latter group. A study by Defaqto has found that “55% of consumers would pay more for a better customer experience.”
Take all these things into consideration; do the math, and once you come up with a price increase, test it on a few select products then gauge customer reaction and sales from there. If the results are positive, roll out the increase across all your products.
Be creative with your price increases
You may also want to consider implementing creative or psychological tactics when coming up with your prices, to make them more appealing. You can, for instance, incorporate tiered pricing into your strategy.
Check out what shoe retailer Footzyfolds did. To combat cheaper knock-offs of its merchandise (they were selling them for $25, while Target had them for $10) the store decided to revamp its prices—but not in the way you might think.
Instead of lowering prices across the board, Footzyfolds introduced a high-end category for their products. With the new pricing format, they lowered the price of their everyday products to $20 a pair, but introduced a new “Lux” category for $30 a pair.
Owner Sarah Caplan told the New York Times that this move helped them increase profits. “We actually have had the most interest in our higher-priced shoes,” she said to the publication and reported that after launching the high-end line in the summer of 2010, they saw revenues increase by 100%.
8. Optimize vendor relationships
Earlier in this post, we discussed the importance of implementing smarter inventory management and purchasing practices. If you want to take things a step further, consider building stronger relationships by working more closely with them.
Engage in joint business planning
Daniel Duty, co-founder and CEO of Conlego, says that retailers should engage in joint business planning with vendors. “This is a collaborative tool whereby profit goals are agreed to, and initiatives are developed to help reach those goals. In other words, both sides help each other become more profitable,” he shares.
Reduce supply chain costs and inefficiencies
“The supply chain—or the process of getting a product from the factory to the store floor — is always full of inefficiencies and huge costs,” adds Daniel.
“Retailers should study their supply chain to figure out where there are unnecessary costs. For instance, shipping product in less than a full truckload is more costly than when it is full. Making many deliveries each week to a store is more expensive than just one. Retailers should ask their suppliers if they are doing anything that is adding to costs to the supply chain that could be stopped.”
It also helps to have a discussion with your vendors to see if there’s anything you can do to make things easier or more cost-effective.
That’s what photo digitization service ScanMyPhotos.com did. President and CEO Mitch Goldstone says that collaborating closely with their vendors enabled them to enhance their business processes. “We invite our vendors to think of us as a partner. The better we do, the better they do. The process is simple, just ask vendors to help improve your workflow.”
Mitch shares that they even invited one of their vendors, the United States Postal Service, to visit their headquarters. “We asked them to study our entire shipping operation and the technology that drives our fulfillment services. Many, many elements we thought helped streamline the business were all wrong and the USPS marketing team became our best partner to reinvent everything.”
See if you can do the same thing in your business. Strengthen your relationships with vendors and determine how you can work better together. Doing so could help you identify ways to reduce product costs and operating expenses. Or, at the very least, it could improve your workflow and productivity.
9. If you must discount your products, be smart about it
While discounting typically goes against traditional advice on profitability, it could work to your advantage if you do it right.
For instance, you could provide tailored and personalized offers. Remember that not all customers are wired the same way. Some people may need a 20% off incentive to convert, while others don’t really require a lot of convincing.
Instead of killing your profits with large, one-size-fits-all offers, identify how big of a discount is necessary to convert each customer.
Timing is also critical. As M. Pope Anthony, president and buyer at Anthony’s Ladies Apparel, notes, “there is a fine line between too soon and too late. If you hold on to items too long, you will eventually have to sell them at a much deeper discount.”
Good historical information and experience are crucial. Being overstocked on old, undesirable inventory will tie up your dollars and prevent you from buying new products. Eventually, your volume will decline, rendering you with fewer margin dollars.
10. Inspire your staff to do more
One way to boost your profits is to increase the output of your existing staff. No matter what type of store you’re running, there’s a good chance that your employees aren’t being as productive as they could be—and that’s not necessarily their fault.
According to the Harvard Business Review, companies lose over 20% of their productive capacity to organizational drag — “the structures and processes that consume valuable time and prevent people from getting things done.”
As such, it’s important that you evaluate your store processes to ensure that they’re not slowing people down. The key is to come up with procedures that can easily be replicated and implemented by your staff even when you’re not around. (Hint: if you have the right POS and retail management system, you’re off to a great start!)
Once you’ve tightened up your processes, you can work on empowering and training your team to level up their game. There’s no one right way to do this, as each retailer is different. But here are a few ideas:
- Set the right sales targets and motivate your team to meet (and beat) those goals.
- Identify the key traits of successful retail associates and develop those skills in your staff.
- Implement retail hiring and training best practices to boost performance, sales, and customer service.
- Educate your staff on suggestive selling.
11. Get more sales from your existing customers
Multiple studies have shown that selling to existing customers is more profitable than acquiring new ones. That’s why it’s incredibly important that you don’t neglect your current customers.
Make it a point to nurture your relationships with them and continuously find ways to drive sales.
Our Bralette Club (OBC) does an excellent job here. OBC implements automated email campaigns to drive sales from customers who haven’t bought anything in a while.
OBC uses Marsello to automatically segment shoppers based on their behaviors. When a customer is considered “at risk” of not returning, OBC will automatically send a “We miss you” email containing a 15% discount.
Take action to increase your profit margins
Although the tactics you use to increase your store’s net profit margin will vary depending on your sector and what type of product or service you sell, several things are constant across all types of retail businesses:
- Selling online is an excellent way to generate more sales and costs less than opening a second retail location.
- Avoiding markdowns and discounts by improving your inventory purchasing will help maximize each item’s gross profit.
- Purchasing seasonal inventory in advance may reduce its COGS and increase your gross profit.
- Reducing operational expenses will result in you having more liquid capital to invest elsewhere. Just make sure you aren’t sacrificing the customer experience as a result.
- Look for ways to increase in-store sales and your customers’ ATV.
Ultimately, each of these tactics has a similar objective: spending less and selling more. As you prep your retail store for long-term growth, consider applying them in your day-to-day operations and monitor their impact on your bottom line.
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