The retail sector is one of the most diverse industries in the U.S., encompassing everything from agriculture to automobiles to fashion accessories. Some retail sub-sectors, such as high-end clothing and personal-care retailers, can have famously high gross profit margins, but net margins for the industry tend to be low compared to other sectors.
This is especially true for web-only retailers, which often see net margins as low as 0.5% to 3.5%. For example, Amazon (AMZN) had a net margin of less than 2% for several years prior to 2019, but today commands a market capitalization of over $900 billion.
Given the low margins in the industry, a successful retailer generally has a high sales volume, such as Wal-Mart.
Retail Margins by Sub-Sector
The most profitable retail sub-sectors by net margin are usually the building supply and distribution retailers. Companies in these sectors often achieve average net margins around 5%, almost double the average for the online retail sub-sector.
Certain markets, such as retail electronics and retail clothing, have to adapt to constant changes in consumer tastes. A company might be very profitable in the first quarter of the year and struggle during the fourth quarter, due to cyclical consumer spending patterns. Best Buy, for example—one of the major electronics retailers in the US, posted a net margin of 2.4% during its fiscal first quarter of 2018 but managed to generate a net margin of 3.5% for the first quarter of the fiscal year 2019.
- Retailers tend to have profit margins that are lower than in other sectors, which can run between 0.5% and 3.5%.
- Web-only retailers generally have the lowest profit margins, while building supply and distribution retailers have the best margins—reaching as high as 5%.
- Clothing and electronics retailers usually experience the highest amount of volatility in their margins.
- The rise of Internet shopping and the fact that almost all retail shopping is discretionary has played a role in keeping retail margins low.
- Successful retailers tend to employ a high sales volume strategy, such as Wal-Mart.
Why Retail Margins Are Low
The Internet has made it easier than ever to compare prices and shop from around the world. Low-cost foreign competition has also made it tough for retailers. However, one of the major reasons retail margins are relatively low is most retail spending is purely discretionary. Consumers can afford to be frugal and picky when it comes to discretionary items, as they make decisions quickly, and can often change their minds and return purchases without consequence. This means there is a relatively high price elasticity of demand for retail goods, which makes it difficult to raise prices.
Significance of Low Retail Margins
Most major retailers that hope to successful need to have a high sales volume. A low-margin, high-volume sales strategy has proved successful for companies like Wal-Mart (WMT) and Target (TGT). Wal-Mart has a net margin of just 1.6%, but it was able to almost $10 billion in net income for 2018. It did so by being one of the largest retailers in the world and generating revenue of over $500 billion last year.
At the same time, if a retailer can’t achieve some sort of scale and advantage that allows them to be profitable, they’ll ultimately go out of business, as so many companies have—including RadioShack, Nine West, Payless Shoes, and Toys R Us.