How To Calculate Ecommerce Profit Margins & 7 Ways To Increase Yours

How To Calculate Ecommerce Profit Margins & 7 Ways To Increase Yours

Ecommerce profit margins are a quick way to gauge your brand’s financial health. But what profit margins should you aim for? And how do you get there?

All ecommerce stores share the same goal: make money selling products. But unless you’re measuring your ecommerce profit margins, whether you’re turning a profit might not be so straightforward.

Sure, you can look at your top-line revenue or total sales. But that number looking good doesn’t mean you’re brand’s bottom line is where you need it.

After all, Casper went public in 2019 with a $1.1B valuation and revenue estimated around $440m that year. But they were losing $349 on every mattress sold. Meaning, despite that revenue, they were nowhere near profitable.

That’s where your profit margins come in.

What are ecommerce profit margins?

Ecommerce profit margins represent how much money your brand keeps after expenses. Calculated as a percentage, your margins determine the difference between your sales revenue and what you spend on operating costs.

For example, a 30% profit margin means a business keeps $0.30 of every dollar earned. The remaining $0.70 goes toward operating expenses.

By knowing this number, ecommerce stores like yours can track their profitability while also identifying ways to trim costs and increase revenue. And as a result, they can improve their profit margins. 

Generally, the most successful brands have the highest profit margins.

However, most stores are so focused on generating more revenue that they forget to track their margins. And unfortunately, your operating costs grow exponentially alongside your brand. So, more revenue means more expenses.

Unchecked, these scaling costs can wreak havoc on your cash flow, margins, and ability to turn a profit (despite technically raking in more money).

All that’s to say: If you’re not paying attention to your profit margins, you’ll miss out on opportunities to make more money. And you might even find your brand at financial risk.

How should you calculate your ecommerce profit margins?

There are 2 types of profit margins you can track: gross profit margins and net profit margins. Let’s go over the big differences and how to calculate each type.

Gross profit margin

Gross profit is how much money you make after subtracting your cost of goods sold (COGS) but before deducting other operating expenses (like warehousing, marketing, or software).

This type of profit margin shows your revenue performance at a high level, so you can quickly see if you’re incurring a profit or operating at a loss.

Now, let’s dig into exactly how you can find this magic number.

Gross profit margin formula

To calculate your gross profit margin, use the following formula:

gross profit margin = (revenue – cost of goods sold) / revenue x 100

To plug the right numbers into this formula, take a look at your: 

  • Revenue or total sales. To find this, open your Shopify, Amazon, or Cogsy account, and add up the sales you’ve made over a specific period.
  • COGS. Next, using the same dashboard, pull in your cost of goods sold or how much you spent purchasing inventory during that same time period.

For example, let’s say an ecommerce business earned $200,000 in revenue for the quarter. And its COGS for that same period was $100,000.

According to the gross profit margin formula, the ecommerce store has an incredibly high gross profit margin of 50%. Meaning, they keep $0.50 from every dollar of revenue.

gross profit margin = ($200,000 revenue – $100,000 cost of goods sold) / $200,000 revenue x 100 = 50% gross profit margin 

Net profit margin

Net profit is how much money you make after subtracting your COGS and all other operating expenses. This type of profit margin provides a more accurate portrait of profitability than gross profit because it includes fixed and variable operating costs.

Fixed expenses are independent of how many units you sell or carry. They also don’t typically change, either (unless you rack up additional expenses). Examples of fixed expenses include employee salaries, ecommerce platform fees, and loan payments.

Meanwhile, variable expenses change depending on how many units you sell or carry. Variable expenses include your inventory holding costs, fulfillment costs, and payment processing fees.

Now that you have an overview of what’s included in your net profit, let’s start plugging in some numbers.

Net profit margin formula

To calculate net profit margin, use the following formula:

net profit margin = (revenue – COGS – total expenses) / revenue x 100

In this formula:

  • You will find your revenue and COGS the same way you did when calculating your gross profit margins.
  • Total expenses. Look back over your financial reports for whatever period you’re calculating (the last quarter or year, for example), and add up all your fixed and variable operating costs.

For example, if a direct-to-consumer (DTC) brand has $200,000 in total revenue for the year, $100,000 in COGS, and $50,0000 in total expenses, their formula would look like this:

net profit margin = ($200,000 revenue – $100,000 COGS – $50,000 total expenses) / $200,000 revenue x 100 = 25% net profit margin

In other words, the brand keeps 25% or $0.25 of every dollar they make.

Average ecommerce profit margins

On average, ecommerce profit margins fall between 10-50%, depending on how you measure (gross versus net) and what you sell.

New York University’s Stern School of Business found that online retail has an average 41.54% gross profit margin.

Meanwhile, Shopify reports that the average net profit margin is 10% for online stores, with a 20% margin deemed high and 5% low.

Every ecommerce brand is different, so it’s impossible to say any number is definitively a good profit margin for store owners. That’s why it’s critical to track margins, figure out your own benchmark, and work to improve your profitability.

7 ways to increase ecommerce profit margins

Higher profit margins mean more profitability — and who would say no to that?

But while raising your prices might seem like the obvious answer, it’s probably the worst way to increase your profit margins. Why? Sure, you might take home more money, but you’ll tick off your customers (which could lead to lost sales) in the process.

Luckily, there are a few smarter ways to improve profit margins and keep more of every dollar (all while retaining your customers):

1. Increase prices

Let’s get this strategy out of the way first. We warned you about leaning on price hikes to widen ecommerce margins. But there are ways you can successfully increase prices without alienating customers.

As we mentioned above, increasing the price of your products is an obvious way to increase retail profit margins. But it’s often the worst way to do it unless you sell high-margin products (like luxury goods) or an essential good.

Take the recent markups due to inflation, for example. Almost overnight, consumers reacted to these price spikes by seeking cheaper alternatives and eating out less. Should you significantly increase your prices, you could expect the same response — and fewer sales would be your best-case scenario.

That said, customers tend to respond angrier when retailers raise prices without pointing to a cause they can understand (like to pay your employees a livable wage). So, if you’re going to raise prices, make sure you have a good reason.

For example, luxury brands like Chanel are raising prices to increase margins and maintain their luxury status. And while you might think that this would be a bad move amid rising recession fears, the customers who can afford the higher price tags are totally okay with it. That is, as long as it means they have an “exclusive product.”

So, if you decide to increase prices, first confirm you have a product that customers are willing to spend more on. (You can do this through customer surveys and competitor analysis.)

Then, focus on creating a well-researched pricing strategy (and be transparent about it by communicating to customers the new pricing, when it goes into effect, and the “why” behind the increase). The fewer surprises around these price spikes, the more understanding your customers will be.

You might even want to include social proof alongside the announcement (think: reviews, testimonials, and user-generated content). This’ll remind people your product is worth the new price tag and (hopefully) prevent these price increases from hurting sales.

2. Set minimum order quantities

Historically, only bulk suppliers and manufacturers required minimum order quantities (MOQs) to keep their profits high. But recently, more ecommerce stores saw how they could benefit from this strategy, too.

After all, MOQs mean larger orders and higher average order value (AOV). All while lowering how much you spend on fulfillment when you ship more units in the same order. Your profit margins widen naturally, as a result.

But how can ecommerce brands successfully set minimum order quantities? One of the most popular approaches is using optional MOQs, which incentivize customers to buy more rather than requiring a strict minimum.

Source: Huron

These offers not only increase the brand’s AOV but also improve inventory velocity. This higher velocity eliminates the risk of accruing holding costs from aged inventory (which further lowers operational costs).

If you’re hesitant to set up MOQs, try offering “unlockable” free shipping at first. Why? Because 58% of US shoppers will ditch their carts when faced with shipping fees. And 60% of ecommerce brands found that “free shipping with conditions” was a great marketing tool for cutting down on cart abandonment.

3. Bundle your products

In addition to MOQs, you can use product bundling to increase your AOV and widen margins simultaneously.

That’s because customers will generally opt for the bundle when you sell 2+ products together over buying those same items separately. Why? Because of the perceived value.

For example, lingerie leader Victoria’s Secret offers “value packs,” where the brand bundles 5 pairs of underwear for less than their individual retail value. With the bundle, your total is $32 (compared to buying the same products separately for $62.50).

Needless to say, most people go for the bundle. So, similar to MOQs, AOV increases while fulfillment costs decrease.

To do bundles well, you need full visibility into how much stock you have on hand. That way, you avoid a stockout situation.

Or, you can have Cogsy take care of this for you. The ops optimization tool forecasts demand for bundled SKUs when sold as part of the bundle and when separately.

Then, the tool factors those forecasts into its restock recommendations, so you know when to replenish and how much to order. That way, you can optimize purchase orders to consider manufacturer requirements (like minimum order quantity) and lead time, which might differ for each bundled SKU.

🤿 Dive deeper: Hear how Caraway manages bundles with Cogsy.

4. Optimize your inventory

The most straightforward way to improve your profit margins? Optimize your inventory.

That way, you carry only enough stock to meet customer demand – while avoiding common inventory issues like dead stock. And as a result, you don’t get stuck paying extra holding costs.

This is huge since excess inventory comes with some of the most expensive (and avoidable) expenses ecommerce brands accrue. (Walmart, for instance, missed Q2 2022 Wall Street expectations because it was so overstocked.)

With Cogsy, you can optimize your inventory by:

🔥Tip: Stockouts happen (whether it’s due to supply-chain disruptions or unexpected spikes in demand). When they do, you can sell on backorder to continue growing your revenue, even when items aren’t immediately available to ship.

5. Recommerce (sell used products)

Brands can also boost profit margins by diving head-first into recommerce (AKA, selling secondhand products). To do this, you can either sell returned products or collect customers’ unwanted items to “refurbish” and sell again.

Top brands like LululemonLevi’s, and Allbirds have all built and launched their own online recommerce programs to increase their profit margins and lower their environmental footprint.

If you choose to recommerce, you’ll spend little in upfront costs to regain and resell inventory.

But, since you only invest in manufacturing this product once, your COGS typically drop each time you resell the product (since buying back to resell is typically wildly cheaper than manufacturing a new product). That way, you can improve your margins without skyrocketing production costs.

However, many DTC retailers fear they’ll cannibalize new sales if they embrace resale. But according to Jake Disraeli, co-founder and CEO of Treet, a resale tool on a mission “to make secondhand feel firsthand,” recommerce doesn’t impact new sales.

That’s because those who seek out secondhand options tend to be new customers from an entirely different audience.

🤿 Dive deeper: Learn how to make resale a sustainable retail strategy.

6. Reduce your operational costs

Alternatively, you can trim operating expenses to grow your profit margins. But you have to know where cutting back makes the most sense. Otherwise, you could end up degrading your product quality and customer satisfaction.

Start by taking a look at the following expenses (and find any fat that needs cutting):

  • Office space and utilities
  • Labor costs and employee benefits
  • Equipment and maintenance fees
  • Licenses and insurance
  • Marketing campaigns
  • Software and website fees

In addition to slashing any unnecessary overhead, you can also consider software that automates some of your operational tasks.

For instance, say you have a customer support specialist responding to easy inquiries all day. You could consider a chatbot to handle common customer questions (that you likely have a templated response to, anyway).

That way, your support pro can focus on more complicated customer issues that need a human touch.

7. Reduce your cost of goods sold

Perhaps the best way to increase your profit margins is to lower your COGS.

Sure, you can do this by manufacturing your products for cheaper by using less expensive raw materials. Or (even better), you can negotiate lower vendor prices. The latter cuts costs without cutting corners.

To do this, use a tool like Cogsy to plan your production orders for the next 12 months and share those upcoming inventory needs with your supplier (this is your leverage).

Then, promise to do a specific volume of this forecast with your supplier. Tell them you want a lower per-unit price in exchange; otherwise, you’ll find another supplier who can offer that. (Make sure to get the agreed-upon price in writing.)

Does this really work? Sure does!

Lalo used Cogsy’s planning feature to cut vendor down payments by 50%. And with that freed-up capital, the baby goods brand has experimented with new growth initiatives (like opening up a flagship store) that unlocked 400% year-over-year growth and subsequently increased its margins.

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Ecommerce profit margin FAQs

  • Why are profit margins important?

    Profit margins are important because they measure the profitability of your ecommerce store. These metrics help owners determine how much revenue goes into the bank and make necessary changes to increase profits.

  • What is the difference between gross margin and net margin?

    Gross margins only deduct the cost of goods sold (COGS) from total sales revenue. In contrast, net margins subtract COGS and operating expenses for a more conservative number. Retail brands typically use gross margins to quickly determine the company’s financial health, and they lean on net margins for a more detailed view of earnings after deducting all costs and expenses.

  • What are operating margins?

    Operating margins determine how much of each dollar is left as a profit after deducting all operating expenses. The expenses include the cost of goods sold (COGS) and operational costs but leave out interest and taxes. Large operating margins mean more company profit.