Deciding what your overall margin should be
One of the most frequent questions asked of this writer as he is speaking at a trade show is, "What should my margin be?" A simple question, and it does have a simple answer for many businesses. Unfortunately, a mistake occurs when the person asking the question begins to utilize the information. Let me give you an example.
If I tell the buyer the margin should be 45%, too often they take that as a goal to use throughout their buying. Watch this person as they are sitting with a sales representative, and you will often see them applying a multiplier factor of 1.81 to the cost of most everything they are buying. They will total the purchase order at cost and retail just to verify that the 45% margin will be had.
This idea would work if everything you stocked was sold at full price, and if you had no competition. As items become marked down for having sat too long on a shelf, and items are marked down as a customer tells you what you are selling is $5.00 higher than the chain store down the street, that 45% margins quickly becomes just a number you started with.
At the same time, by making a certain margin, be it 35%, 45%, or 55%, a goal, then too often this same retailer is selling too many items at a price far below what the market will bear. An example of this can be seen in any of the large warehouse stores.
Read their annual report to their stockholders and you will find they are achieving a margin, which is in the 22%-26% range. And when you walk in their stores with someone who has experience as a buyer for some of the same items, you will hear that person state, "They are selling these items for cost!"
Yes, the warehouse store is selling this item for cost. Sometimes they are selling items for less than cost. These items, which you see near the front door, and in massive displays, are their "come-ons", loss leaders, and commodity items. The point of this observation is that with the number of items, which have a minus, zero, or single digit margin, the warehouse store still has an overall margin of 22%-26%.
This is telling us there are hundreds of items throughout their store where they are getting margins well in excess of their store average. If your business is computerized, you can determine how you are going to obtain an overall margin by design, as compared to having your overall margin be an afterthought. Businesses that have excelled at margins are those whose inventory is tracked by the overall store, departments and categories.
In creating the combination of these factors, you will need to know how much of your sales come from each of your departments. Most small businesses will have ten to thirty departments. What is important is that you have a logical division so that you can see how much you are selling from this department and what margin you are obtaining. Many computerized stores have their departments subcategorized into categories.
For example, if you have a department that is women’s clothing, within that you would probably have a fineline which contains only blouses. As you would look at sales reports, you will quickly see if your blouses are contributing their fair share to the overall profitability of the department and of your store. If this fineline has a 55% margin, you would probably want to consider increasing the selection, as well as the amount of square footage dedicated to blouses. This can work as long as you can determine a reason for new blouses and not be just adding blouses that are essentially duplications of what you now sell.
When you find a fineline that is providing a less than average margin, you should first evaluate the items to see if you can increase the prices. Reviewing the items may necessitate changing the brand of items you stock if the low margin is due to a competitor who is stocking the identical item. If this is not the case, evaluate the fineline with consideration given to the number of sku's you are stocking, how prominent a position this merchandise has in your store, and perhaps even the necessity of the fineline. You may move these items to a less desirable location, discontinue half of the selection, or maybe discontinue all of them if you can find a more profitable group of items to take their place on the shelves or peg hooks.
"What should your margin be?" You can see that while this may be an easy question to ask, there are many items to consider in determining an answer. Not only from store to store, but from aisle to aisle within the same store.
When I was a kid, I remember my Dad telling the story about the retailer who was "playing games" with his margins. Dad said this retailer used to brag about how he maintained an overall margin, which was higher than any other store in the industry. The retailer said he used a technique in which he would increase the price of an item by an amount equal to that which he had decreased another item. If he had to mark an item down because of competition, or the item became soiled or dated, he simply found another item within the store on which he thought he could increase the price by a like amount.
The storeowner was pretty proud of his ability to maintain his high margin; until the day he looked on the shelf and saw the one item, originally priced at $17.99, which was now marked $1,000. "What should your margin be?" Let's talk about it.