No word is more important to retailers than ‘margins’. It is crucial to building a profitable business. However, this most critical term is also the most misunderstood. To help bring clarity to understanding margins, we break margins down to key details every retailer needs to know.
What is Gross Margin?
Margin refers to the retail term Maintained Markup (MMU) which is the same as the general accounting term Gross Margin. It is the difference between sales and cost of goods sold and is always discussed as a percentage.
Gross Margin % = [(Net Sales – Cost of Goods Sold)/Net Sales)] x 100
Gross margin measures how much of every sales dollar a store keeps to pay for everything other than inventory. For example, If a store has a 48% gross margin, that means that out of every $100 of merchandise bought in that store, $52 goes to pay for the inventory and $48 goes to pay for everything else.
Quite simply, this equation is the math that makes retailers money. To build a more profitable business, a retailer must increase gross margin – plain and simple. But how?
What Increases Gross Margin?
The best strategy to increase gross margin is to increase initial markup when pricing items. Initial markup (IMU) measures the amount of potential profit in the retail price of inventory. It is the difference between what an item costs from the vendor and what the retail price is that consumers pay. It is always discussed as a percentage.
Initial MarkUp % = [(Retail Price – Cost)/Retail Price] x 100
Consider two stores that are doing the same sales volume of $400,000 and taking the same percentage of annual markdowns.
This store uses a 50% initial markup, which means that it takes an item with a $10 cost and then marks it up to $20. Not everything sells at full price, so the amount of gross margin that remains after considering markdowns – on average – is 37.5 percent. Another way to look at it is for every $100 that it brings in, $37.50 goes towards paying for everything else and $62.50 goes to pay for its inventory.
This store has set its initial markup at 55 percent. It prices that same $10 item as Store #1 at $22 retail. After markdowns, the gross margin is 43 percent. For every $100 that it brings in, $43 goes towards paying for everything else and $57 goes to pay for inventory.
- Both stores make $400,000 sales in a year.
- Both have the same markdown percentage for the year.
- Store #1’s gross margin is 37.5%.
- Store #2’s gross margin is 43%
- For every $100 that Store 1 sells, after paying for inventory it puts $37.50 in the bank.
- For every $100 that Store 2 sells, after paying for inventory it puts $43 in the bank.
The real takeaway is this: for every $100 that Store 1 sells, after paying for inventory they put $5.50 more in the bank than Store 2 does. Store 1’s gross margin is 5.5% higher because their initial markup is higher. The dollar impact of a higher gross margin is determined by multiplying the sales by the gross margin percentage difference ($400,000 x 5.5% = $22,000). At the end of the year, Store 1 will have an extra $22,000 in its bank account.
The best strategy to increase gross margin is to increase initial markup when pricing items.
Store 1 banked that additional $22,000 because they followed the strategy of increasing their initial markup so that the average markup of their entire store is 55 percent. The key here is that is the average initial markup...some items have their retail price determined by manufacturers. Other items, however, are marked up higher because the retailer has the discretion to do this. Store 1, for example, has set a goal that every month it reviews the cost and retail of the inventory it brought in so that the total of all reaches a 55 percent initial mark up.
This strategy can work for any retailer – including you. An easy way to increase your profitability is to increase your gross margin by increasing your initial mark up. The shortcut to increasing initial markup is to look for items where the cost can be multiplied 3 or 4 times – or even more. This action creates an IMU of 66 to 75 percent. The risk is minimal because, even when marked down, there is still so much gross margin available. To help you discover products like this for your store, attend ASD Market Week and get high margin products you can mark up to 300%. You can register here for the next show, March 17-20.
By Cathy Wagner, founder of RetailMavens.com. Select image from Adobe.