Profit margin is one of the key measures for a strong e-commerce business that’s built for long-term success. It tells you whether your company is on unstable rooting or solid foundations. It’s crucial to calculate your profit margin accurately to ensure your eCommerce business remains profitable. This knowledge enables you to boost your overall profitability without solely relying on raising product prices.
What are e-commerce profit margins?
E-commerce profit margins show the percentage of your earnings that you keep after subtracting expenses. In other words, the more money you get out of each dollar once you’ve covered your costs, the better profit margins you have.
When evaluating your e-commerce store’s income, it’s crucial to understand three main metrics: net profit margin, gross profit margin, and operating profit margin. Each of these metrics offers different insights into how well your business is doing.
- Gross profit margin
The gross profit margin is essential for assessing a company’s profitability. It’s calculated by determining the percentage of remaining revenue after subtracting the cost of goods sold (COGS) from the total revenue.
This margin indicates a company’s profit from every dollar of revenue before accounting for operating expenses like salaries, rent, and utilities. A high gross profit margin shows that a company efficiently manages its production and sales, while a low margin may suggest that production costs are too high compared to revenue.
- Net profit margin
Net profit is the money a company has left after covering all its expenses with its total revenue. Total revenue encompasses income from sales, services, and other sources. The net profit margin gives you a sense of a company’s overall profitability and ability to make money through its operations. A higher net profit margin indicates a more profitable company.
- Operating profit margin
The operating profit margin is a percentage that reveals how much profit a company generates from its revenue after subtracting its operating expenses, before factoring in interest and taxes. This margin reflects the company’s effectiveness in handling costs and earning profits from its operations. A higher operating profit margin suggests efficient cost management and profit generation. Conversely, a lower margin may indicate that the company’s operating expenses are relatively high compared to its revenue.
Three profit margin formulas to consider
- Gross Profit Margin
The formula for calculating the gross profit margin is as follows:
- Net Sales represent the total revenue generated from all sales, accounting for refunds, discounts, and allowances.
- COGs stands for “cost of goods sold,” which refers to the cost of producing the goods, such as the cost of ingredients.
For example, if your total sales are $10,000 and your cost of goods sold (COGS) is $6,000, your gross profit equals $4,000, making your gross profit margin 40%. This data helps compare products, SKUs, and seasonal trends. However, to gauge your business’s overall financial health, it’s best to look at net profit margin.
- Net Profit Margin
The formula for calculating the net profit margin is as follows:
If your total sales amount to $10,000, and you have costs of goods sold (COGS) at $6,000, plus extra expenses of $2,500 that include taxes, labor, bank fees, and currency exchange for supplier payments, your net profit totals $1,500. This means your net profit margin is 15%.
This underscores the need to not solely rely on gross profit when assessing your business’s financial health. This is especially important in the world of e-commerce, where business owners often pay close attention to the cost of goods and sales revenue.
- Operating Profit Margin
The formula for calculating the operating profit margin is as follows:
For instance, if your total sales amount to $10,000, and you have costs of goods sold (COGS) at $6,000, plus extra expenses of $2,500 that include taxes, labor, bank fees.
First, calculate the Operating Profit:
Operating Profit = $10,000 – ($6,000 + $2,500)= $1,500
Now, you can calculate the Operating Profit Margin is 15%.
Why are profit margins important?
Profit margins are vital because they indicate your company’s financial well-being. By calculating your gross and net profits, your business can quickly determine whether it’s making money or burning cash.
For instance, if your profit margins are extremely low (in other words, terrible), you’re at risk of depleting your capital. When this happens, you won’t have the money needed to continue operating, making it exceptionally tough to survive in a competitive market, let alone expand your brand. (Insufficient capital was the leading cause of business closures in 2021.)
Conversely, maintaining healthy profit margins and optimizing your inventory naturally creates working capital to grow your business. With this capital, you can invest in more stock, develop new products, hire new talents, explore new markets, or reinforce what’s already successful.
Average profit margins by industry in 2023
The average profit margins by industry
Now that we comprehend the difference between gross and net profit margins, what is a good profit margin for your business?
Here are the average profit margins by industry for the year 2023:
|Industry||Gross Profit Margin||Net Profit Margin|
|Business & Consumer Services||31.80%||4.97%|
|Electronics (Consumer & Office)||32.41%||7.08%|
|Financial Svcs. (Non-bank & Insurance)||85.08%||32.33%|
|Green & Renewable Energy||62.92%||-19.78%|
|Healthcare Information and Technology||52.49%||16.64%|
|Office Equipment & Services||33.40%||2.55%|
|Publishing & Newspapers||42.65%||3.55%|
|Software (System & Application)||71.59%||19.66%|
Industries with the highest profit margins
In industries that don’t involve physical products, like Software as a Service (SaaS), the costs of goods sold (COGS) are typically lower, leading to higher profit margins. The sectors with the highest profit margins are:
Challenges in maintaining high-profit margins
While every business aims to maximize its profit margins, several challenges can affect these numbers:
- Rising operating costs: When the costs of raw materials, labor, or overhead increase, they can squeeze profit margins.
- Intense competition: In industries where competition is fierce, businesses might have to reduce prices, impacting profit margins.
- Regulatory changes: New regulations or taxes can increase operational costs.
- Supply chain disruptions: Events like natural disasters, pandemics, or geopolitical issues can disrupt supply chains, increasing costs and reducing profit margins.
- Consumer behavior: Shifts in consumer preferences or buying behavior can lead to increased product development or marketing costs.
Businesses need to stay flexible, continuously monitor industry trends, and adapt to challenges to maintain healthy profit margins.
What is a good profit margin for e-commerce?
- Good gross profit margins
In the e-commerce industry, aiming for gross profit margins in the range of 50-70% is generally recommended, which is considered good. However, according to data from the NYU Stern School of Business, the average gross profit margin is reported to be 41.54%. It’s important to understand that gross profit margins measure the profit left after subtracting the cost of goods sold (COGS) before factoring in other expenses, like warehousing and shipping costs. So, it offers a quick look at your company’s financial health rather than providing a complete picture of profitability.
- Good net profit margins
Shopify has found that an average net profit margin of 10% is typical for e-commerce brands, and this has now become the standard for good net profit margins. In comparison, high net profit margins are around 20%, while lower margins typically fall to about 5%.
It’s important to remember that good net profit margins will always be lower than good gross profit margins. Why is that? Net profit margins consider the deduction of operating expenses and the cost of goods sold (COGS) from your total revenue, while gross profit margins only subtract COGS. Therefore, this measurement provides a more accurate snapshot of your business’s profitability.
Four ways to optimize your profit margins
Increase your trustworthiness
Building trust is critical for driving sales and increasing net profit margins. While product price and features are straightforward for marketers and store owners to assess, trust is a more complex aspect that can be challenging to measure and comprehend.
According to Shopify, here are two key patterns that that impact shoppers’ decisions when it comes to buying a product:
- Trust builders: These are elements or design features that instill confidence in first-time shoppers, making them feel comfortable with their purchase.
- Trust breakers: These are elements that create doubts about a business’s quality, leading to mistrust and making shoppers question the safety of their choice.
Based on these findings, there are five fundamental ways to build trust with new online shoppers and boost your sales:
- Create a welcoming homepage that leaves a positive first impression on new shoppers.
- Ensure product information is easily accessible through detailed product descriptions and precise search results.
- Share your brand’s story to convey authenticity and establish a connection with shoppers.
- Demonstrate customer satisfaction by providing social proof.
- Maintain transparency in transaction costs and pricing.
Lower cost of goods sold
It would be best to consider lowering your cost of goods sold (COGS) to boost profit margins effectively rather than raising prices. COGS and profit margins have an inverse relationship, which means that reducing your expenses in purchasing inventory leads to higher profit margins. The key is optimizing your list, which means keeping the right amount of inventory to meet customer demand – not too much or too little.
Optimizing your inventory helps prevent common and expensive retail mistakes that can seriously impact your profit margins, such as running out of stock and having unsellable products (dead stock).
For example, stockouts alone result in a yearly loss of $1 trillion for brands. Deadstock typically costs brands a significant 30% more than the inventory’s actual value on average. Furthermore, if your inventory is already optimized, you might have the opportunity to negotiate lower prices with your vendors.
Increase average order value
Average order value (AOV) is a vital metric in managing your inventory, showing the average amount a customer spends per online store transaction. Boosting AOV has a dual benefit: increased revenue and lowered costs.
This is because AOV typically rises when customers buy more items than more expensive ones. As AOV increases, the costs of each transaction go down (as items can be bundled and shipped together). At the same time, your inventory turnover improves, ensuring quicker merchandise turnover and preventing additional holding costs for inventory items.
But how can you increase your average order value? There are some effective strategies:
- Implement minimum order quantities (MOQs), which don’t have to be mandatory but should encourage customers to reach a specific spending threshold. For instance, Huron uses softly enforced MOQs with unlockable perks like free shipping at $40 and a free product at $50.
- Use product bundling, offering multiple products at a lower price than if purchased individually. The perceived value of the bundle encourages customers to choose it over buying items separately. An example is Dr. Squatch, a men’s soap brand that bundled its limited edition holiday soaps as an exclusive holiday set, saving customers $4.
- Incorporate product recommendations across your site, suggesting other items that interest customers. These recommendations should cross-sell or upsell based on what customers have recently viewed or added to their cart. Despite its apparent simplicity, this approach can significantly impact AOV, with approximately 35% of Amazon’s sales attributed to product recommendations.
Raise your prices
Many business owners have concerns about raising prices, fearing that it might lead to customer abandonment, declining sales, and even business failure. However, when you’re reselling an existing product in your e-commerce store, a modest price increase can significantly boost your revenue and work wonders for your profitability, mainly when there’s a demand in the market.
Consider this example for a popular item in your online store:
- Original retail cost: $100
- Wholesale cost: $80
- Profit: $20
- Profit margin: 25% ($20 profit / $80 cost)
Now, imagine that, after gaining inspiration from an article on the Shopify blog, you decide to re-price this item at $110:
- New retail cost: $110
- Wholesale cost: $80
- Profit: $30
- Profit margin: 37.5% ($30 profit / $80 cost)
With this modest 10% price increase, you’ve achieved a remarkable 50% increase in profits and gross margin!
Enhancing profit margins is an invaluable strategy for small businesses. We hope this article has given you a comprehensive understanding of profit margins.
*References: Shopify, Sellers Fi, Cogsy, Polymer.