Step-by-step Guide to Calculate E-commerce Profit Margins
What Constitutes a Good Profit Margin?
Strategies for Improving Profit Margins
Profit margin is the percentage of profit made in relation to revenue. It is a representation of the efficiency of your business. It is very commonly used by business owners, investors, and others, to understand the business' health and potential growth.
Another way to define profit margin is how much of the money you made before subtracting costs (ie. revenue) that you get to keep after subtracting costs (ie. profit). There are many categories of costs that result in different types of profit margins. These include gross profit margin, operating margin, and net profit margin. These are explained in detail below.
Considering that revenue, cost, and profit are such broad, fundamental metrics that almost fully encompass your entire business, it is hard to point out a more crucial metric than this one for your e-commerce business. Generally it indicates how well your business is performing and if you have sustainable growth, and it useful in a variety of circumstances.
Before we start defining different types of profit margins, it is important to clarify revenue. There are two commonly used revenues, and depending on the business they may be defined differently. Broadly speaking, the two revenues are generally defined as follows:
Gross revenue = quantity sold * unit price
Net revenue = (quantity sold * unit price) - discounts - allowances - returns
Discounts, allowances, and returns are not accounted for in the costs defined in the sections below, and should be accounted into your revenue before calculating your profit margins. Therefor when we talk about revenue, we will be referring to net revenue.
Gross profit margin (or simply gross margin) is the percentage of gross profit relative to revenue. In other words it is the percentage of revenue left over after you subtract cost of goods sold (COGS). This ratio helps you understand how efficiently you are producing your products. The gross profit margin formula is as follows:
Gross Proft Margin = 100 * (revenue - COGS) / revenue
COGS are the costs that are strictly needed for the production of your goods or services. This includes the cost of materials and labor directly needed to create your products. It does not include costs to sell it, such as shipping, sales, and marketing. Let's take a store selling shoes for example. Costs such as for the leather and for the salaries of workers working in the factory to produce the shoe would be included in COGS. Costs for shipping the shoes to retailers or direct to customers, and for any marketing would not be included.
A notable common point of confusion is the difference between gross profit margin and product markup. Product markup is the retail price you charge your customers minus how much it cost you to produce a given product, meaning COGS. Gross profit margin and product markup use the same inputs - revenue and COGS. They simply express the result in different forms. Gross profit margin expresses the difference between revenue and COGS as a ratio or percentage. Product markup expresses the difference as a dollar amount difference. Gross profit margin refers to the amount of revenue you keep after removing COGS. Product markup refers to how much you are charging your customers on top of COGS. These two concepts overlap significantly, however, they have different nuances in what they are trying to convey.
Operating profit margin (or simply operating margin) is the percentage of operating earnings relative to revenue. In other words it is the percentage of revenue left over after you subtract operating costs (a.k.a. operational costs). This ratio helps you understand how good you are at turning sales into profits. The operating profit margin formula is as follows:
Operating Profit Margin = 100 * (revenue - operating costs) / revenue
The money left over after removing operating costs is known as operating earnings, or by another name of the same meaning, earnings before interest and taxes (EBIT). Operating costs are the sum of your COGS and operating expenses. That's right, operating costs and operating expenses are two different things. To remember easily, operating costs include COGS, but operating expenses do not. Your operating expenses include the indirect costs to running your business operations, whereas COGS as stated earlier are the direct costs for running your business. Operating expenses include costs such as sales costs, marketing spend, and administrative costs. Continuing the example of a store selling shoes, you would include things such as the rent you pay for your offices and shoe factories, logistics for getting your shoes into the hands of your customers, and the salaries of your sales people, marketers, customer service, HR, and R&D members. Operating profit margin represents the money left over before paying for interest on loans and taxes, and therefore it is common for investors and money lenders to check this metric.
Net profit margin (frequently referred to simply as profit margin) is the percentage of net profit relative to revenue. In other words it is the percentage of revenue left over after you subtract all of your costs. This ratio helps you understand how efficiently you are making money, all things considered. The net profit margin formula is as follows:
Net Profit Margin = 100 * (revenue - costs) / revenue
The money left over after removing all costs is your net profit. It is important to understand if you are making money or losing money! It is common for early-stage businesses to be unprofitable, and you will be using up whatever cash you have available while in this state. Understanding your net profit margin will help you know if and how much money you would need to borrow or be invested in in order to keep your business going. Undoubtably, you would want to increase efficiency in your business by increasing your revenue while keeping your costs down in order to eventually reach profitability.
Let's gather these metrics from your Shopify console in Analytics > Reports.
Let's gather your net revenue by gathering all the money you receive from your sales.
Different stores will have their costs scattered through out different tools and documents. It is up to you how accurate you want to be in tracking your costs, however we prepared a table to help you categorize them quickly. Keep in mind these lists are not exhaustive, and are only intended to serve as a guide. After you categorize them, please fill them into the calculator at the top of this page.
Reference:
https://help.shopify.com/en/manual/reports-and-analytics/shopify-reports/overview-dashboard
To understand how you are doing and whether you have an excellent profit margin or are on the weaker side, it is best to compare to industry standards and industry benchmarks. We've done the homework for you and gathered benchmark data for gross profit margin across different categories within retail as of 2018, and benchmark data for all profit margins across different industries as of 2024.
For those looking for an easy to remember general rule of thumb for net profit margins - 5% is considered low, 10% is average, and 20% is considered high.
As you can see in the chart below, beverages (65.74%), jewelry (62.53%), and cosmetics and beauty (58.14%) took the top 3 spots. Alcoholic beverages (35.64%), sporting goods (41.46%), and electronics (43.29%) took the bottom 3 spots. The overall average is 56.23%, however, as you can see it can vary quite a bit depending on the segment you are in.
Retail's net profit margin ranges between 1% ~ 9% depending on the sub-category you are within retail. Banks ranked amongst having the highest profit margin percentage at about 30%, and software as well was quite strong at about 20%. Retail proves to be one of the more challenging sectors regarding profit margins, however there are worse. Real estate development has a profit margin of -16%!
Reference:
https://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/margin.html
We've established the importance of tracking profit margins and how to calculate them, and benchmarks to understand how your profit margins compare to industry averages. Now if it turns out your profit margins can use some improvements, what practical and actionable tactics can we pursue to do so? Let's look at some great places to start.
You can perform an audit of your product lines to see how each of your products are individually contributing to revenue as well as costs. This change can improve your situation in many ways. It can improve your inventory management and overhead. Also, specializing in fewer things may allow you to improve on that product leading to a competitive edge and increased sales on the revenue side, and the ability to increase bulk purchase discounts on the costs side.
There are several ways to increase AOV. Common ones include upselling, cross-selling, and bundling products. Shopify has many great apps to help you do so easily.
Another strategy is to simply increase sale prices. This may depend on the circumstances of what you are selling, however, if price competition or price sensitivity is low then your customers may still be willing to buy despite the increased price, leading to an increase in profits.
The cost of acquiring new customers is five times greater than retaining existing customers. Therefor investing in strategies such as customer loyalty programs can be a great way to increase customer lifetime value (CLV), and your bottom line.
Your online store's conversion rate (CVR) is one of the most important metrics for e-commerce businesses. Helping your customers find the products they are searching for through personalization and recommendations is a great way to improve your CVR. Tools such as product quizzes do just that, with case studies showing significant improvements to CVR.
Vendors where you get your parts and raw materials typically are a big expense for many retailers. Business owners tend to shy away from negotiating, however, there are several win-win ways you can negotiate down prices while keeping your vendors happy. Some examples include asking for longer contracts for cheaper, or buying more in bulk. Offering early payments is also another option to suggest.
Otherwise, shopping for new vendors may be worthwhile as well. Vendors located closer to you can save you on shipping. Setting your sights on cheaper materials for packaging or places that don't significantly affect the quality of your product are also places to consider.
As already touched on in the sections above, however reducing product lines or other inventory management improvements are a good place to look for increasing efficiencies. When your inventory is too large with products not selling well, you may end up marking down those products to get rid of them, hurting your profit margins. Not to mention, you will save on rent and storage!
Gojiberry surveys are great for conducting product research. Understanding your customers’ needs and what factors most encouraged them to purchase your products will help you know what product lines match these needs. It will prevent you from investing into adding product lines that don’t perform well, and instead into product lines that do!
Take a look at the places where you are spending the most of your time and money, but are making the smallest contributions to your revenue. Don't forget to ask your employees as well, they are a gold mine for feedback on this. Not only will you be finding chances to save money, but definitely stress as well!
With new AI and automation tools being developed daily it feels, there are many opportunities to reduce waste. Chat bots can lower labor costs dedicated to customer service. You can automate your marketing with automated email flows and cart abandonment campaigns, as well as your order fulfillment flows to reduce time spent and errors made.
Marketing is a huge cost generator for lots of businesses, but nevertheless important to your success. The trick is to put those costs in the right places. To know what those right places are, you need reliable data in two places. You need to understand who your best customers are, and where they are coming from.
Gojiberry pre-purchase and post-purchase surveys are the most reliable ways to get actionable insights to make informed decisions directly from the source - your customers. Google Analytics and other web analytics tools cannot capture what YouTube video or TikTok influencer caught them onto your brand. With 3rd party cookies being increasingly blocked, it is now difficult for Meta Pixel to track the demographics of users on your site. With Gojiberry's surveys, you can simply ask your customers through marketing attribution surveys and demographic surveys. Our high response rates are great for quickly getting the data you need to allocate your marketing budget effectively and to set better targeting for your online ads.
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