Achieving a profit margin is essential for any business. If you fail to carefully track profit margins, the success of your e-commerce store will be short lived. So how do you calculate a healthy profit margin for your business? What are the different types of profit margins? How do you achieve your profit margin goals? Let’s dive in and find out.
An accounting lesson. Profit margins are arguably the simplest and widely used financial ratio in finance. A company’s profit is calculated at three different levels. The first being gross profit, the second being operating profit and the third and most important level net profit.
Gross Profit Margin
Gross Profit is calculated by subtracting your cost of goods sold or (COGS) from your total revenue and dividing that number by total revenue. The top number of this equation (Revenue-COGS) is known as gross profit or gross margin. Remember when calculating COGS do not include operating expenses, interest payments, taxes etc. Include only the direct cost of producing the product itself. Gross Profit reflects the percentage of each dollar of revenue retained after paying for the cost of production.
Operating Profit Margin
Operating profit is calculated by taking into account all overheads operating admin and sales expenses which are required to run a business. This figure does not include debts, taxes and other non-operational expenses. But it does include the amortisation and depreciation of business assets. Dividing the operational profit by revenue reflects the percentage of each dollar that remains after payment for all day to day expenditure.
Net Profit otherwise known as the “bottom line” is the most important profit margin metric you can measure for your business. This metric determines whether or not your business is making money. To calculate net profit subtract all expenses from revenue and divide this amount by 100 to receive your net profit margin as a percentage.
Different Profit Margins for Different Businesses
On one side of business, achieving a high-profit margin plays a key part in a business success. On the other side, achieving a large number of sales volume with low-profit margin is the key to achieving a successful and profitable business model.
The first step to achieving a healthy profit margin is to work out where your business sits on the pendulum. As this will dictate your profit margin goals. Most businesses will sit somewhere in the middle. A mixture between setting a price for your product which protects your margin whilst appearing to be an attractive option for potential buyers. It’s worth noting, every business is different so everyone’s target profit margins are going to be different, depending on their products and brand positioning,
If you are not tracking your margins its fair to say that your margins are not optimised. Optimising your profit margins is something which is achieved over a long period of time. It is something that you look to improve as your business grows and scales up. Setting profit margin goals give your profit margin optimisation strategies a purpose and reason.
Whatever your profit margin goals are, make sure they are SMART (Specific, Measurable, Attainable, Relevant, Timely) An example of a bad profit margin goal is “A profit of 35% “it’s just too vague. However, if your goal is “to achieve an average net profit margin of 10% from all products over the next 18 months then your goal is SMART.
Below we have listed some strategies to help you optimise your margin. Whether your products are low margin products or higher margin products.
Optimising Low-Profit Margins
Bundle Low Margin Products with High Margin Products
If you have items which are not profitable if shipped alone consider bundling them with higher margin products. A good way to achieve this is by offering low margin items as “Add on” products before customers check out on your E-commerce site. If you are looking at how to implement this on your site take inspiration from Amazon the masters of a good bundling/add on strategy.
Cut Production Costs
This is an obvious one but lowering your production costs increase the margin on your product. (obviously) As obvious as this sounds cutting production/product purchasing costs can be tricky. Before attempting to cut costs on low margin products it’s important to measure exactly where each dollar is going in the production of your goods. For example, if you are a clothing business you may find the cost of a particular type of cotton to be 50 cents more expensive per tee then a cheaper style of cotton which feels nearly identical to the average consumer. This is where you measure up the pros and cons of saving that 50c per shirt sold.
Raise the Price
Another obvious one. If a product isn’t making you any money raise the price. It’s a business you are running after all.
Discontinue the Product
Finally, if all other strategies are exhausted consider discontinuing your product. The exception to this would be if your product is an essential part of your brand. For example, if your product is the equivalent to what Coke Classic is to Coca-Cola Company perhaps discontinuing the product is not a great idea.
Maximising High Profit Margins
Increase Marketing Spend
It makes sense to put your high margin products front and center of your brand. So invest time in marketing them. Think about email marketing, ad campaigns and retargeting strategies to get new customers in and old customers coming back.
If your e-commerce store doesn’t have a cross-selling strategy you’re missing out. Cross-selling is a sales technique used to get customers to spend more by purchasing products that are related to what is being bought already. Two great cross-selling strategies that are easy to implement into your business are;
- Cross-sell high margin products when a buyer is checking out with a low margin item.
- Bundle together low margin and high margin products together. For example, a digital camera and a memory card.
By adding variations of high margin products such as different designs, colours and sizes to your website is a great way to maximise sales on a particular product. For example, if you sell a travel backpack in multiple colours your product will appeal to more people than if you sold the one colour.
To conclude optimising your profit margins is essential for your e-commerce business. By tracking the profit margins of all your products you can find out which products you should push and which products you should look to either phase out or optimise to get the most out profit out of your product. Remember to be SMART with your goals and remember that profit margin optimisation is a long term play it is not something that changes over night. It is something you work on as your business grows and scales.