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 low net margins. For example, Amazon (AMZN) had a net margin of less than 2% for several years prior to 2018, but today commands a market capitalization of $1.7 trillion and a net margin of around 7%. But what really is a good profit margin for retailers? Below covers the points to take into consideration when valuing a company's margins.
- Retailers tend to have profit margins that are lower than in other sectors.
- Grocery and food retailers generally have the lowest profit margins, while building supply retailers have the best margins.
- Clothing, home improvement, and electronics retailers usually experience the highest amount of volatility.
- 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.
Retail Margins by Sub-Sector
The most profitable retail sub-sector by net margin is usually the building supply retailers. Companies in these sectors often achieve average net margins of 9.63%, more than the average for the online retail sub-sector, which on average is 7.26%, which is still higher than many other retail sectors.
Walmart, Amazon, and Costco are the top three retailers in the world by revenue.
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 5.05% at the end of its quarter ending Oct. 31, 2021, right before the holiday season, and 3.80% for its quarter ending Jan. 31, 2021, after the holiday season from the prior year.
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 be successful need to have a high sales volume. A low-margin, high-volume sales strategy has proved successful for companies like Walmart (WMT) and Target (TGT).
Walmart has a net margin of just 2.39% as of Jan. 31, 2022. It generated an income of $13.6 billion on extremely high revenues of $573 billion by being one of the largest retailers in the world.
At the same time, if a retailer can’t achieve some sort of scale and advantage that allows them to be profitable, like Walmart, they’ll ultimately go out of business, as so many companies have, including RadioShack, Nine West, Payless Shoes, and Toys R Us.
What Is the Average Markup Percentage?
The average markup percentage for small businesses is generally 50%. This means that a business will charge 50% more for a product than the cost of making that product. Companies do this to ensure they are covering their costs and earning a profit.
How Can I Increase My Profit Margins?
Ways to increase your profit margins are by improving your inventory methods in order to avoid markdowns to sell-off extra inventory; improving your brand image to be one of more quality and worth; reducing operating expenses; increasing the order value of customers in the store; negotiating better terms with suppliers, and increasing your prices if it makes sense.
Why Is Buying Wholesale Cheaper Than Retail?
Buying wholesale is cheaper than retail because wholesale products are purchased directly from the manufacturer, cutting out middlemen costs, and in bulk so that discounts are offered.
The Bottom Line
Retailers generally have low profit margins due to the nature of their businesses. Online retailers tend to have higher profit margins than brick-and-mortar retailers. In order to generate respectable profit margins, companies need to generate high sales, known as a low-margin/high-volume sales strategy.