6 Ways To Increase Profit Margin for Businesses

6 Ways to Increase Profit Margin for Small Businesses

Your business is likely going through a few stressors right now, like tackling cash flow management, keeping customers happy, repaying loans, and finding ways to increase profit.

When it comes to improving overall profitability, managing and increasing profit margins are key to your company's financial success. It's an essential small business accounting strategy for those wanting to run a successful business both online and in-store.

Nevertheless, it's easy to get lost trying to figure out your profitability ratio, operating profit margins, net versus growth, and more. It can be tricky to overcome the information overload and actually learn how to boost profit for your business.

In this guide, you'll learn how to find the ideal profit margin formula for your business, and create a profitability strategy that can keep you thriving during uncertain times.

What is profit margin?

Profit margin is defined as the difference between the sales revenue your business generates and the costs your business incurs. It is the measure of your business's profitability. Successful businesses tend to have higher profit margins.

There are three types of profit margin: gross profit margin, operating profit margin, and net profit margin. Let's take a look at each one.

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What is gross profit margin?

Gross profit margin (or gross margin) is the difference between a company's total revenue and cost of goods sold (COGS), divided by revenue. It's shown as a percentage. 

A company's gross profit margin helps it figure out how much money is left over after incurring the costs related to making and delivering its product or service. 

The formula for gross profit margin is:

[(Total Revenue – Cost of Goods Sold) / Total Revenue] x 100

The higher your gross margin, the more money your company keeps on each dollar of sales. Higher margins can indicate whether your company is running a profitable operation and if sales are good.

What is operating profit margin?

Operating profit margin (or operating margin) is similar to gross profit margin, with one key difference: whereas gross margins only factor in the cost of goods sold, operating margins consider a range of other operating expenses associated with running your business, including rent, payroll and labor costs, utilities, insurance, and advertising, to name a few.

The operating profit margin formula is:

{[Total Revenue – (Cost of Goods Sold + Operating Costs)] / Total Revenue} x 100

Operating margins can give you a more accurate picture of your actual pretax profit margin, and show how operating expenses are affecting your bottom line.

What is net profit margin?

Finally, net profit margin (or net margin) deducts all of your business expenses, including cost of goods sold, operating expenses, and interest payments and taxes, from total revenue generated to calculate your overall net income.

The formula for net profit margin is:

[(Total Revenue – Total Costs) / Total Revenue)] x 100

Your net margin can shed light on the impact of taxes and debts on your company's profitability.

What is a good profit margin?

If you're asking yourself, “What is a good profit margin?” then you're on the right track. It's safe to say that a good profit margin for your company depends on your location, industry, and personal circumstances. 

For example, in 2019, industrial banks had the highest average net profit margins with 51.8%. Typical profit margins in manufacturing hovered around 8.5%, according to the same research. 

Retailers usually have a low profit margin compared to other sectors: 

  • Brick-and-mortar retailers tend to have an average profit margin between .5 and 4.5%

  • Web-based retailers generally have higher net profit margins, while building supply and distribution retailers have the best margins⁠—reaching as high as 6.5%.

The rise in shopping online has played a big role in keeping retail margins low. As a general rule of thumb, a 10% net profit margin is deemed average, while a 20% margin is deemed high and 5% low. If you want to compare your company's performance based on profit and merchandise margins, check out the average profit margin for your industry

What is a good gross profit margin?

In some cases, gross profit margin is a better metric for assessing your profitability at a glance. A good gross margin figure for online retail is around 45.25%, according to NYU Stern School of Business. To reach a higher gross profit margin, you'll need to develop a pricing strategy for your business. 

Shopify's profit margin calculator can help you find a profitable selling price for your product. It's easy-to-use and leverages a simple profit margin formula to calculate what price you should charge customers for your product for an optimal merchandise margin ratio.

Shopify's free Profit Margin Calculator

Determining the best profit margin formula for a single product can help you figure out how to find net profit margin and improve profitability for your business. 

How to increase profit margin

  1. Reduce operating costs
  2. Don’t obsess over per order profits
  3. Increase your trustworthiness
  4. Increase your average order value
  5. Create a customer loyalty program
  6. Raise your prices

1. Reduce operating costs

Reducing operating costs and expenses is a quick way to increase profit margin and improve profitability. 

The tricky part to reducing operating costs is knowing what to cut, because these expenses—like utilities, payroll, and rent—vary from business to business.

Photo courtesy of: Unsplash

Start by auditing everything that's running your business, including:

  • Labor costs
  • Office space and utilities
  • Employee benefits
  • Equipment and maintenance fees
  • Licenses
  • Insurance

Then look at where you can cut back on operating expenses and how a premium software package can help. To choose the right technology for your business, ask yourself the following questions: 

  • What can I already do well? (For example, if you're great at business financing, consider productivity or marketing software.)
  • What do my employees spend too much time on each week?
  • If I could take one time-consuming task off my mind, which one would it be?

For example, say you advertise a toll-free sales number on one of your sites, but it puts extra work on your plate without helping improve margins. Would you be willing to reduce your workload by 50% if it meant giving up only 15% of your business? 

If yes, you could take that savings—both in terms of time and money—and put it into, say, better serving multiple customers at once with a chatbot or improving your site. Phone support may be a rarity among many online businesses, but a number of ecommerce merchants still feel it's necessary. 

💡Tip: Browse the Shopify App Store for a live chat or Chatbot app.

Try to measure the impact removing an operating cost, such as a phone number on your site, has on margin improvement and customer satisfaction. A small business owner should always look for new ways to reduce operating expenses without jeopardizing product quality making operations more difficult.

2. Don’t obsess over per order profits

Many businesses are unwilling to lose money on an order, even if that means ending the relationship with an unhappy or dissatisfied customer. You may have had a similar experience, which often goes something like this:

“I’m sorry, sir. We only made $X on your purchase, so if we [fill in your reasonable request here], we’d lose money on your business. I hope you understand.”

This is a penny-wise approach and a bad way to do business in today's highly social and connected world. If you're not losing money on orders to quickly and proactively resolve customer problems, you're missing out on the chance to improve net profit margin.

Photo courtesy of: Unsplash

Customers are so accustomed to mediocre service that when a business goes out of its way to proactively resolve a problem—without charging them—they’re blown away. Apart from the life-long value of that customer, you’ll receive referral marketing and recommendations that are impossible to purchase.

If you’re running an ecommerce store, here are four ways you can invest in the future of your business and, ultimately, your long-term bottom line:

  1. Did something inexpensive break? Ship customers a free replacement immediately without requiring them to hassle with the return.
  2. If an expensive item needs to be returned, ship them a replacement as soon as they submit tracking confirmation of the return instead of waiting until it hits your warehouse.
  3. If a long-time customer needs something ASAP, overnight it to them at no charge.
  4. If a customer wasn’t happy with a purchase, proactively issue a partial refund to help compensate him for the disappointment.

Serving customers like this will cost a bit more in the short term, but will pay incredible dividends as you build a loyal and highly vocal fan base that improves the financial health of your business.

3. Increase your trustworthiness

Trust is essential for generating sales and increasing net profit margins. While product price and features are easy for marketers and store owners to evaluate, trust is harder to measure and truly understand.

At Shopify, we want to know what makes an online store trustworthy. In 2019, we ran a series of interviews with North American shoppers, having them review a recent purchase involving a store they were unfamiliar with or a product they've never bought before. We also asked them to make a purchase from a Shopify store they've never bought from before. 

Photo courtesy of: Unsplash

The goal was to find out what makes a new shopper comfortable with buying a new item or buying from a store they were unfamiliar with. There were two patterns that influenced shoppers’ decisions on whether or not to buy a product:

  • Trust builders. Elements or design details that make first-time shoppers feel more relaxed and confident in their purchase.
  • Trust breakers. Elements that make first-time shoppers question the quality of a business and create feelings of distrust that their purchase is a safe choice. 

These findings also revealed five key ways your online store can build trust with new shoppers and sell more online:

  1. Create a welcoming homepage that makes a good first impression for new shoppers.
  2. Make product information easy to find with thorough product descriptions and precise search results.
  3. Share your brand story to help shoppers feel like you’re an authentic business.
  4. Show customer satisfaction by providing shoppers with social proof.
  5. Make transaction costs and pricing transparent.

Building trust between you and a first-time shopper encourages them to make a purchase in your online store and, in turn, increase profit margin. 

4. Increase your average order value

If you want to increase profit margin, focus on increasing your average order value (AOV). Average order value is the average dollar amount a customer spends per transaction in your store. 

You can calculate AOV by using a simple formula: total revenue / number of orders = average order value.

Shopify customers reports can calculate AOV for you, or you can use a number of helpful apps in the Shopify App Store.

Photo courtesy of: Unsplash

There are a number of ways you can increase AOV in your ecommerce store: 

  • Add product recommendations to product and checkout pages. By recommending popular or related products during checkout, you can not only increase average order value but also make a shift from low-margin sales to high-margin sales. 
  • Upsell or cross sell complementary products. Rather than suggesting popular items in your store, you can surface products that go well with items in a shopper’s cart. For example, coffee filters for a brewing station or shaving cream with razors. 
  • Provide order minimum incentives. You can also increase AOV and get higher margins by encouraging customers to spend a minimum amount. This could be a 15% discount on orders over $75 or a minimum order amount for free shipping, which is easy to set up in Shopify.
  • Create product bundles or packages. To get shoppers to purchase more, create bundles of products that cost less when bought together versus individually. When you bundle products, you increase the perceived value of a customer’s purchase and can help create a better shopping experience overall.
  • Run deals and specials. A great way to generate more net income for your store is to offer coupons or a special on higher margin products. Since these products make a higher profit per unit sold, you can afford to temporarily lower the price through enticing promotions for shoppers to take advantage of. 

One of the most effective ways to improve your profit margin ratio is to increase average order value. For more on how to increase profit using this tactic, look to 5 Highly Effective Ways to Increase the Average Order Value of Your Online Store.

5. Create a customer loyalty program

Customer loyalty programs are a surefire way to increase profit margins and improve profitability in retail and the service industry.

High customer acquisition costs and not enough of a focus on retention can quickly make a business unprofitable. Rather than spending money to find and close new customers, you can create a customer loyalty program to sell to existing ones.

Sephora is known for having a strong customer loyalty program. The program has over 17 million members who make up nearly 80% of the company's sales. 

Increase profit margins with customer loyalty programs like Sephora

Members earn rewards for each purchase based on a point system. Once a member accrues enough points, they can choose how to use them—whether through gift cards or discounts to help offset the high prices without cheapening the product. 

The best loyalty programs focus on the customer. They provide real value that shows loyal customers you appreciate their business and want to do what's best for them. While heavy discounts aren't reasonable from a small business finance standpoint, you can still find ways to reward customers so they buy more frequently and make a shift from low-margin sales to high-margin sales. 

6. Raise your prices

Many business owners fear that if they raise prices, customers will abandon them, sales will dry up, and the business will collapse. But if you're reselling an existing product in your ecommerce store, a small increase in price can boost revenue and do miracles for your bottom line, especially if there's market demand.

Imagine the following scenario for a popular item in your online store:

  • Item retail cost: $100
  • Wholesale cost: $80
  • Profit: $20
  • Profit margin: 25% ($20 profit / $80 cost)

Now image that, after being inspired by an article on the Shopify blog, you re-priced this item at $110:

  • Item retail cost: $110
  • Wholesale cost: $80
  • Profit: $30
  • Profit margin: 37.5% ($30 profit / $80 cost)

Our minor 10% increase in prices resulted in a massive 50% increase in profits and gross margin!

If you're not sure where to start on raising prices, consider that the average order value of US online shopping orders during the third quarter of 2021 was $177.38, while orders placed from tablet and mobile devices had an average value of $125.27 and $96.25, respectively.

Average value of US online shopping orders, Q3 2020 and Q3 2021

Under the best circumstances, your conversion rates won't dive and you'll have achieved an instant 50% increase in your overall profits. Even with a 30% drop in conversions, you'd still be making more money than under your old pricing strategy, but with fewer customer servicing costs to consider. 

When implementing this strategy, make sure you test different pricing levels. While raising prices is often very effective, you'll need to confirm it for your market/business.

If you have a large catalog, testing pricing on thousands of products can be a tall task. Start out by performing an ABC analysis to find best-selling products  in your inventory, then test their pricing.

This strategy relies on having a unique selling proposition and offering value to your customers. The more price-sensitive your customers, the less effective this will be. If you don't have a unique selling proposition, you need to get one.

Finding the ideal profit margin for your business

There's no doubt improving profit margins is a valuable strategy for small businesses. As you go about improving business profitability, be sure to check out these tips on how to perform a break-even analysis. You're bound to quickly figure out if a new product or service will be profitable and can make smarter business decisions for the future. 

With these tips on increasing retailers' profit margins in mind, you can create a strong foundation for your business and weather any economic uncertainty for the long run.

Profit margin FAQ

What does an increase in profit margin mean?

An increase in profit margin means that after costs are deducted, your business is earning more money from each product sold or client served.

Why is profit margin important?

Profit margin demonstrates the overall financial health of your business. The higher your profit margin is, the more efficiently your business is setting prices and managing costs.

Is an increase in profit margin good or bad?

Higher profit margins are a good thing, as profit is what gives you the resources to grow your business, hire additional employees, and improve your products or services. A high profit margin also makes your company more attractive to investors and lenders.

How can a company increase profits?

  1. Reduce operating costs
  2. Don't obsess over per order profits
  3. Increase your trustworthiness
  4. Increase your average order value
  5. Create a customer loyalty program
  6. Raise your prices