While revenue growth is crucial, it does not necessarily equate to profitable growth. Successful ecommerce brands, such as Warby Parker and Allbirds, have demonstrated that substantial revenue growth does not guarantee profitability.
In 2021, both companies went public, revealing in their IPO documents that despite significant sales, they were operating at increasing losses. More than a year later, the situation remains unchanged, with no clear path to profitability despite rising revenue.
This conundrum arises because revenue, often considered a vanity metric, does not account for all business expenses, from marketing and customer acquisition to operations and fulfillment. Ultimately, it doesn't indicate whether your business is making money.
Therefore, savvy DTC brands closely monitor their profit margins to understand exactly how much profit they are making.
So, what constitutes healthy profit margins for an ecommerce business? And, crucially, how can you increase your margins if you haven’t yet reached your target?
The profit margin, representing the percentage of each dollar remaining after expenses, is a key indicator of your business' financial health. The greater the remaining amount after accounting for costs, the better your profit margin.
For instance, a 20% profit margin, where you retain $0.20 of every dollar, is more favorable than a 10% profit margin, where you retain $0.10 of every dollar. However, the standard for "good profit margins" in retail varies depending on whether you are measuring gross or net profits.
Note: The figures below serve as general benchmarks. Your brand's ideal profit margins may differ based on your industry and niche.
Typically, ecommerce businesses consider gross profit margins between 50-70% as "good." However, the NYU Stern School of Business reports an average gross profit margin of 41.54%.
Gross profit margins account for the profit remaining after subtracting the cost of goods sold (COGS) but before deducting other expenses, such as warehouse or shipping costs. Thus, this metric provides a preliminary overview of your company's financial health rather than a comprehensive picture of profitability.
Shopify has identified that a 10% net profit margin is average for ecommerce brands, making it the benchmark for good net profit margins. Meanwhile, high net profit margins hover around 20%, and low margins are approximately 5%.
It's essential to recognize that good net profit margins will always be lower than gross profit margins. This is because net profit margins account for operating expenses and COGS, whereas gross profit margins only consider COGS. Therefore, net profit margins offer a more precise reflection of your business' profitability.
Profit margins are a pivotal indicator of your company's financial well-being. By calculating your gross and net profits, you can quickly assess whether your business is generating profit, breaking even, or incurring losses.
For instance, if your profit margins are alarmingly low, you risk depleting your capital, making it impossible to operate and grow your business in a competitive market.
Conversely, if you maintain healthy profit margins and optimize your inventory, you can liberate working capital to expand your business. This capital can be invested in stock, product development, talent acquisition, new channel launch, or reinforcing existing successful strategies.
It goes without saying that a higher profit margin is beneficial for your business. Here are four proven strategies to boost your profit margins and maximize your profitability swiftly.
While not the optimal strategy, increasing selling prices is one way to boost profit margins. However, this approach requires a solid rationale to prevent customer distrust and attrition. With the ongoing pandemic-induced inflation and supply chain disruptions impacting customer loyalty, this approach carries risks.
A recent study revealed that 71% of global consumers switched brands, with approximately 66% doing so to secure a better deal. This indicates that many consumers are forgoing brand loyalty in favor of better value. Consequently, a sudden, significant price increase could result in reduced sales and profits.
If you choose this route, consider the following:
🔍 Deep Dive: Implement pricing experiments to increase your margins by 5-20%. Learn how here.
A more effective way to increase profit margins is by reducing the COGS. Since COGS and profit margins are inversely related, reducing your inventory purchasing costs will lead to higher profit margins.
Inventory optimization, ensuring you have the right stock levels to meet customer demand, can prevent costly retail mistakes, such as stockouts and dead stock, which can severely impact profit margins.
For example, stockouts cost brands $1 trillion annually, while dead stock costs brands an astonishing 30% more than the inventory's value on average.
Alternatively, you can negotiate lower vendor prices if your inventory is already optimized. For instance, baby brand Lalo shared its 12-month production plans with suppliers, leveraging this transparency to reduce down payments by 50% and secure more favorable terms. This strategy could also be employed to decrease per-unit costs, thereby increasing margins.
🔍 Deep Dive: Explore the 16 best practices of vendor contract negotiation.
Average order value (AOV) is a key inventory management KPI that represents the average amount spent by a customer per transaction. Increasing AOV has a dual impact: higher revenue and lower costs.
As AOV typically increases when customers purchase more items rather than more expensive items, higher AOV results in lower fulfillment costs per transaction. Additionally, it accelerates inventory velocity, reducing holding costs for SKUs.
To increase AOV, consider the following:
Remember, higher AOV translates to higher profit margins, enabling you to maximize your profitability effortlessly.
🔍 Deep Dive: Discover 11 ways to increase your average order value by 20%.
Operating expenses encompass all costs not included in the COGS, such as rent, payroll, utilities, and marketing. Reducing operating expenses increases profit margins and maximizes your profitability.
To achieve this, evaluate each expense to determine its necessity and whether it can be reduced or eliminated. Additionally, reconsider your advertising spend, as PPC ads are not the only way to reach your target audience.
Here are some suggestions to get started:
🔍 Deep Dive: Uncover 10 proven strategies for reducing your operating expenses.
Profit margins are fundamental to a successful ecommerce business. Higher profit margins indicate a healthier business, better positioned to grow and compete in the market.
Applying these tips to enhance your profit margins and manage your cash flow with Artoh can significantly impact your business's success.
Ultimately, revenue growth does not guarantee profitable growth. Your brand must prioritize increasing profit margins over revenue to thrive in a competitive market.
