In these hyper-competitive and volatile times, businesses may be facing certain challenges in terms of increasing profit, tackling cash flow management, and sustaining customer satisfaction.
Increasing profitability is an essential small business accounting strategy for those wanting to run a successful business enterprise. To sustain and thrive in the long term, managing and increasing profit margins are crucial for improving profitability and your company’s financial success, both online and in-store.
The only problem? Profit margins are a challenging world. It’s easy to get lost when faced with seemingly technical concepts like profit margin ratios, operating profit margins, net versus gross profits, and more. It can be tricky to overcome the information overload and learn how to increase profit for your business.
In this guide, you’ll learn how to find the ideal profit margin formula for your business, plus create a profitability strategy that can keep you thriving and successful during uncertain times.
What is profit margin?
Profit margin is the revenue percentage that denotes your business profitability. You can calculate three key types of profit margins for your company: gross profit, net profit and operating profit.
It’s safe to say that your company’s profit margin can vary depending on your location, industry, and personal circumstances. The rise in online shopping has played a significant role in keeping retail margins low. As a general rule, a 10% net profit margin is deemed average, while a 20% margin is deemed high and 5% is considered low.
What is gross margin?
Gross margin is the difference between a company’s revenue and cost of goods sold (COGS) divided by revenue.
Through gross margin, a company can figure out how much money it keeps after incurring the costs related to making the product it sells and/or the service it provides.
You can calculate gross margin by deducting the cost of product sales from the total revenue and dividing the difference amount by the total revenue.
The formula for gross margin is:
(Total Revenue – Cost of Goods Sold) / Total Revenue
The higher your gross margin, the more money a company keeps on each rupee of sale. Higher margins can indicate whether your company is running a profitable operation and if sales are good.
What is a good profit margin?
If you’re asking yourself, “What is a good net profit margin?” then you’re on the right track. It’s safe to say that a good profit margin for your company can vary depending on your location, industry, and personal circumstances.
The rise in shopping online has played a significant role in keeping retail margins low. As a general rule of thumb, a 10% net profit margin is deemed average, while a 20% margin is deemed high and 5% low. If you want to compare your company’s performance based on profit and merchandise margins, check out the global average profit margin for your industry.
What is a good gross profit margin?
As per a 2020 report by NYU Stern School of Business, a good gross profit margin for global online retail business is 42.51%. To reach a higher gross profit margin, you’ll need to develop a custom pricing strategy for your business.
Shopify’s profit margin calculator can help you find a profitable selling price for your product. It is easy-to-use and leverages a simple profit margin formula to calculate what price you should charge customers for your product for an optimal merchandise margin ratio (Merchandise margin ratio refers to the profit you earn after covering the cost of production).
Determining the best profit margin formula for a single product can help you figure out how to find the net profit margin and improve the overall profitability of your business.
Now that we’re clear on the essential metrics and their definitions, you might be curious to know how you can increase your company’s profit margin. Read on to know more about it!
How to increase profit margin
1. Reduce operating costs
Reducing costs on your operational activities is a quick way to increase profit margin.
The tricky part in reducing operating costs is figuring out what to cut because these expenses—like utilities, payroll, and rent—vary from business to business.
Here’s what you can do. Start by auditing everything that’s running your business, particularly the most important expenses, such as those listed below:
- Labour costs
- Office space and utilities
- Employee benefits
- Equipment and maintenance fees
- Licences and tax deposits
Expenses like these are crucial to maintaining a steady and profitable business. However, you may always look for ways to optimise these costs by searching for efficient alternative solutions, like outsourcing these activities or purchasing a premium software package to keep your operations on track.
While searching for alternatives to reduce costs, ask yourself the following questions:
- What can I already do well? (For example, if you’re great at business financing, consider opting for a productivity or marketing software.)
- What do my employees spend too much time on each week?
- If I could take one time-consuming task off my mind, which one would it be?
Small business owners should always look for new ways to reduce operating costs without jeopardising the quality of their store or making operations more difficult. Try to measure the impact that removing an operating cost, such as a phone number on your site, has on margin improvement and customer satisfaction.
Also try to think about it this way, would you be willing to reduce your workload by 50% if it meant giving up only 15% of your business? For example, say you advertise a toll-free customer service number on your site, but it puts extra work on your plate without helping improve margins. You could cut out the cost and invest those savings—both in terms of time and money—into, say, better serving multiple customers at once with a chatbot or automated emails. On the other hand, while phone support may be a rarity among many online businesses, a number of ecommerce merchants still find it beneficial. In the end, you need to pick the option that works for you.
2. Don’t obsess over per order profits
Many businesses are unwilling to lose money on an order, even if that means ending the relationship with an unhappy or dissatisfied customer. You may have had a similar experience, which often goes something like this:
“I’m sorry, sir. We only made INR X on your purchase, so if we [fill in your reasonable request here], we’d lose money on your business. I hope you understand.”
This is a penny-wise approach and not necessarily the best way to do business in today’s highly social world. You may lose some money on orders when you’re proactively resolving a customer concern. But this can lead to an improved profit margin for your business. How exactly?
Customers are so accustomed to mediocre service that when a business goes out of its way to proactively resolve a problem—without charging them—they’re blown away. Apart from the life-long value of the customers, you’ll gain customer testimonials that are impossible to purchase and work like referral marketing for you.
If you’re running an ecommerce store, here are four ways you can invest in the future of your business and, ultimately, your long-term bottom line:
- Did something inexpensive break? Shipping customers a free replacement would be a small gesture that might earn you life-long customers. You can also update your store’s policies to accommodate some common return or replacement scenarios.
- If an expensive item needs to be returned, ship a replacement as soon as your customer submits the return tracking confirmation instead of waiting until it hits your warehouse.
- If a long-time customer needs something ASAP, ship it within hours at no charge.
- If a customer wasn’t happy with a purchase, proactively issue a suitable refund to help compensate them for the disappointment.
Serving customers like this may cost a bit more in the short term, but it will pay incredible dividends as you build a loyal and engaged fan base, resulting in a healthy bottom line.
3. Increase your store’s trustworthiness to generate sales
When looking for a product, shoppers today have endless options to choose from, most of which are tracked by marketers and store owners. But customer trust is a concept that’s hard to measure. Reports show that approximately 85% of Indian shoppers affirm that brand trust is essential when making a purchase.
Knowing what makes an online store trustworthy is important to establishing a successful online store, and Shopify is committed to helping business owners succeed in their online journey. In 2019, our US Shopify team ran a series of interviews with shoppers, having them review a recent purchase involving a store they were unfamiliar with or a product they’ve never bought before. The shoppers were also asked to make a purchase from a Shopify store they’d never bought from before.
The goal was to find out what makes a new shopper comfortable with buying a new item or buying from a store they were unfamiliar with. There were two patterns that influenced shoppers’ decisions on whether or not to buy a product:
- Trust builders: Content or design elements that make first-time shoppers feel more relaxed and confident in their purchase.
- Trust breakers: Elements that make first-time shoppers question the quality of a business and create feelings of distrust about their purchase being a safe choice.
These findings also revealed five key ways your online store can build trust with new shoppers and increase online sales:
- Design a welcoming homepage that makes a good first impression for new shoppers.
- Make product information easy to find with thorough product descriptions, easy navigation and precise search results.
- Share your brand story to help humanise your brand and make shoppers feel like you’re an authentic business.
- Show customer satisfaction by providing shoppers with social proof, like user-generated content or customer testimonials.
- Make transaction costs and pricing transparent before or at the check-out.
Building trust encourages a first-time shopper to make a purchase through your online store, and, in turn, increase your sales and profit margins.
4. Increase your average order value
If you want to increase profit margin, focus on increasing your average order value (AOV). Average order value is the average dollar amount a customer spends per transaction in your store.
You can calculate average order value by using a simple formula:
Total revenue / Number of orders = Average order value.
Shopify customers reports can calculate AOV for you, or you can use a number of helpful apps in the Shopify App Store to help you with the same.
There are a number of ways you can increase the AOV in your ecommerce store:
There are a number of ways you can increase the AOV in your ecommerce store:
- Add product recommendations to product and checkout pages: By adding popular products, or products that other shoppers purchased, in addition to what’s currently in a person’s cart, you can not only increase average order value but also make a shift from low-margin to high-margin sales.
- Upsell or cross-sell complementary products: Rather than suggesting popular items in your store, you can surface products that go well with items in a shopper’s cart—for example, coffee filters for a brewing station or shaving cream with razors.
- Provide order minimum incentives: You can also increase AOV and get higher margins by encouraging customers to spend a minimum amount. This could be a discount on orders over a certain amount or free shipping on a minimum order amount, which is easy to set up in Shopify.
💡Tip: Learn more about setting up shipping rates for your Shopify store.
- Create product bundles or packages: To get shoppers to purchase more, create bundles of products that cost less when bought together versus individually. When you bundle products, you increase the perceived value of a customer’s purchase and can help create a better shopping experience overall.
- Run deals and discounts: A great way to generate more revenue for your store is to offer price-off coupons or a discount on higher-margin products. Since these products make a higher profit per unit sold, you can afford to temporarily lower the price through enticing promotions for shoppers to take advantage of.
One of the most effective ways to improve your profit margin ratio is to increase the average order value. For additional information on how to increase profit using this tactic, take a look at these 5 Highly Effective Ways to Increase the Average Order Value of Your Online Store.
5. Create a customer loyalty program
Customer loyalty programs are a surefire way to increase profit margins and improve retail and service profitability. Statistics show that brands spend almost 11 times more on gaining new customers when compared to retaining existing customers.
You can create a customer loyalty program to sell to existing customers rather than spend more money to acquire new ones. High customer acquisition costs and inadequate focus on retention can quickly make a business unprofitable.
Nykaa offers exclusive discounts, perks and priority service to its loyal members through Nykaa Privé. The loyalty program has accumulated approximately 2.1 million members in 2021.
Nykaa shoppers who spend INR 7500 within a calendar year become eligible to sign up for Privé. In addition to free shipping and discounts, Privé members earn redeemable points through shopping, leaving product reviews and sending referrals.
Successful loyalty programs focus on the customer and provide value by appreciating the customers. While offering heavy discounts may not be reasonable from a small business finance standpoint, you can still find reasonable ways to reward customers to encourage frequent purchases.
6. Raise your prices
Indian customers place a lot of value on a product’s price, with almost 40% of shoppers claiming the product price as very important. Raising prices may seem like an intimidating idea when it comes to a retailer’s profit margin. Retailers assume that if they raise product prices, their customers will abandon them and their sales will dry up.
If you’re reselling an existing product in your ecommerce store, a slight increase in price can do miracles for your bottom line, especially if there’s significant market demand.
Imagine the following scenario for a popular item in your online store:
- Item retail cost: INR 1000
- Wholesale cost: INR 900
- Profit: INR 100
- Profit margin: 11.11% (INR 100 profit / INR 900 cost)
Let’s assume that after being inspired by an article on the Shopify blog, you re-priced this item at INR 1100:
- Item retail cost: INR 1100
- Wholesale cost: INR 900
- Profit: INR 200
- Profit margin: 22.22% (INR 200 profit / INR 900 cost)
Our minor 10% increase in prices resulted in a massive 50% increase in the profit margin!
If you’re still unsure about raising product prices, you will be glad to know that 94% of Indian customers are willing to pay premium costs for ethically produced or sourced goods. If you have a high-quality product with unique features or benefits for the customers, they’re more likely to pay no mind to higher costs.
When implementing this strategy, keep the following in mind: make sure you test different pricing levels for a product. While raising prices is often very effective, you might have to experiment and figure out which pricing structure works for your business.
If you have a large catalogue, testing pricing on thousands of products can be a tall task. Start out by performing an ABC analysis to find best-selling products in your inventory, then test their pricing.
This strategy relies on having a unique selling proposition and offering value to your customers. The more price-sensitive your customers, the less effective this will be. If you don’t have a unique selling proposition, it’s time to get one.
Finding the ideal profit margin for your business
There’s no doubt improving profit margins is a valuable strategy for small businesses. As you go about improving profitability for your business, consider checking out these tips on how to perform a break-even analysis. You’re bound to quickly figure out if a new product or service will be profitable and can make smarter business decisions for the future.
With these tips on increasing retailers’ profit margins in mind, you can create a strong foundation for your business and weather any economic uncertainty for the long run.
Profit margin FAQ
How do you calculate profit margin?
To find profit margin, divide your gross profit by revenue. To make the margin a percentage, multiply your result by 100. For instance, the profit margin on a product at a retail price of INR 1000 and a wholesale price of INR 800 would be 25%.
What does the profit margin tell you?
Since profit margin is the ratio of your company’s profit (sales minus expenses) divided by revenue, it tells you how your company handles finances and how efficient are its operations.
Is a high profit margin good for business?
Yes, a high profit margin is good, as it indicates that your company can make a reasonable profit on sales. Compared to the industry average, a lower margin can mean your company is underpricing. Investors typically pay more for a business with higher gross profit.
What is gross profit percentage?
Gross profit percentage, also known as gross margin, is the percentage margin you earn on a product or service after deducting production costs from the revenue. Costs can include labour, materials, overhead, and more.
What is a good profit margin for ecommerce?
Profit margins may vary from industry to industry. A good gross percentage for ecommerce businesses could be 15-20% and above.
What does operating profit margin mean?
Operating profit margin shows how much profit a business makes after paying for the costs of production, including wages, materials, and other operating expenses. It’s expressed as a percentage and indicates how efficiently a company controls the cost and expenses associated with operations.
How do I calculate operating profit margin?
To calculate operating profit margin, subtract your total operating expenses from your gross profit to calculate operating profit. Divide your operating profit by gross revenue to calculate your operating profit margin.