Product profit margin… one of the most critical yet widely misunderstood components of running a successful online business. Master the skill of generating a healthy profit margin and you'll build a thriving, profitable e-commerce business. Get it wrong and you can end up under water or, even worse, out of business.
Unfortunately, independent online sellers often oversimplify the profit margin equation—a mistake which leads directly to decreased profits. Add to that the many variables to take into consideration when calculating profit margins for your business. It's not a "one size fits all" calculation.
The following four must-know facts will help demystify the murky waters of calculating product profit margin. And they apply to your business no matter what you sell or where you sell it!
1. Not every product will carry the same margin
In the quest for high margin inventory, some sellers go on a never-ending search for products that produce a 100-percent (or better) profit margin across the board.
Others, tired of the search, toil away for long hours each week, selling low-margin products, barely able to eek out enough profit to even pay themselves the minimum wage.
Build a product line made up of products that carry a variety of profit margins, from high to low
Sellers will frequently tell me, "I only want to sell products with a $20 profit margin." Or "I want to be margin seller (selling products with a high profit margin), not a volume seller (a seller who sells a high volume of low-margin products)."
However, none of these approaches will achieve the desired result. The key to profit margin success is in building a product line. More specifically, a product line made up of products that carry a variety of profit margins, from high to low. The skill comes in keeping an eye on both the customer shopping experience and sourcing products that are favorable to your bottom line.
Let's look at an example:
If you sell sewing machines, cutting boards, dress forms, fabric, sewing scissors and thread online, each of these products will carry a different profit margin.
The dress forms and fabric may have the highest markup. The cutting boards and sewing scissors represent lower ticket, mid-range margin items. The sewing machine may be a high ticket item with a relatively low profit margin. And the thread? You may just break even or even lose money on thread.
But that doesn't mean you shouldn't sell thread. You wouldn't expect your customer to spend $350 for a sewing machine, $75 on fabric, $40 on a scissors and so forth and then go to a completely different store to buy a spool of thread, simply because your profit margin on that particular item is too low!
Like instruments in an orchestra, each item is required to make your customers happy and boost your margins.
Keep in mind that the size of your operation determines your ability to absorb the cost of selling lower margin items. If you have a larger business, and you've done a good job of sourcing products that carry a variety of profit margins, you can afford to sell a certain percentage of lower margin items in an effort to attract new customers. Your higher margin items will offset the cost of these "loss leaders" (low margin products used to get customers in the door).
But if you're a small seller trying to generate a startup profit, you don't have a lot of room for margin elasticity. So you'll need to be very careful on any markdowns you take or low-margin merchandise you decide to bring in.
2. Every product has a purpose. This influences profit margin.
Whether it's a product line staple (the core of your product line), a cross-sell, an up-sell, a seasonal product or a loss leader, the purpose of your product determines its profit margin requirements.
Many new online sellers want to sell name brand electronics—a category of product that carries with it a 3-percent to 8-percent margin at best. What they don't realize is that the money is not made on the electronic gadgets themselves. The money is made on the accessories that are sold with the gadgets. Cross-sells and up-sells, such as games, cases, controllers, etc.—these are the higher profit margin items.
You'd be surprised how many experienced sellers calculate profit based solely on item cost
NOTE: If you pick a low-margin product line staple, be prepared to move a lot of product!
In our brand new Power of 10 Product Sourcing home study course, we teach merchants how to use our exclusive Product Line Wheel™ to identify a product's purpose and set requirements for estimated profit margin. There are 12 different product types on the wheel that you need to know about!
3. You must look at the entire Cost of Goods Sold
This is an area where sellers (especially new sellers) can really get dinged when calculating profit margin. Yet you'd be surprised how many experienced sellers still calculate profit margin based solely on the cost of the item!
When estimating profit margin potential on a particular product, you need to factor in not only the base cost of the item, but also all the costs associated with selling that item. This is what's known as Cost of Goods Sold (COGS).
COGS includes:
- Base cost of goods — What is the base cost of this inventory (including shipping to your place of business)? The base cost is just the starting point for determining how much you stand to make on this inventory.
- Fees — If you sell in a marketplace that charges listing or final value fees on specific items, you must factor these into your profit margin equation. (Web site maintenance, hosting, etc., all factor into your bottom line profits as well.)
- Cost to deliver — This is often a hidden cost, but it can dramatically impact your profit margin. What does it cost you to deliver the goods? Wrapping materials, shipping and staffing resources? It costs a lot less to sell a pre-packaged product you can pick off the shelf, pop in a box and hand to the waiting arms of the FedEx delivery person, than it does to prepare an oversized, heavy, fragile or odd-sized item for shipment. And don't forget shipping costs! With the popularity of free shipping, you may just break even or even lose money on the sale due to shipping costs alone.
And just to keep things lively, keep in mind the supply and demand factor. An in-demand, low-supply product can double or triple in price quickly during a busy selling season. But prices can fall just as fast when the market becomes saturated.
Now you can see from the factors above that paying $19 for an item wholesale and selling it for $29 does not equate to a full $10 profit margin!
Continually adjust your product line and your expenses to achieve optimum profit margin
4. Profit margins diminish on stale inventory
Hanging onto slow-moving inventory for too long significantly diminishes an item's profit margin. This was a popular strategy for several years among eBay Store owners who could list an item relatively inexpensively in the Store Inventory Format (SIF), over and over again—sometimes for years at a time. With the end of the SIF listing format, that option is no longer attractive or profitable.
There is always a cost associated with holding on to stale inventory. Listing fees and storage space notwithstanding, every piece of stale inventory you hold onto represents cash that could be reinvested in higher profit margin products.
Finally, you must continually adjust your product line and your expenses to achieve optimum profit margin.
When all is said and done each month, and you're reviewing your profit-and-loss statement, the bottom line is this: What is your profit margin after expenses?
If you don't like the numbers you see, go back to the drawing board and look at your next options. Can you cut expenses? Sell more? Round out your product line and product profit margins? Is a certain product causing you to lose more money than your business can withstand?
Where can you adjust? That's the question you must answer on a continuing basis in order to ensure maximum profit margin each month!