Diagnosing your eCommerce profit margin (plus tips to improve it)
Here’s a trap that many sellers fall into: you see your revenue rising, and figure all is well with your online store.
But just because you’re bringing in sales, doesn’t mean that your business is profitable. The reality is that many eCommerce sellers still struggle to understand and track their profit margins. And it doesn't help that eCommerce can be particularly volatile—sudden market changes, increased competition, and fluctuating costs can erode your profits.
The good news is that if your eCommerce profit margin starts ailing, there are ways to turn it around. Let’s take a deep dive into profit margin together and how you can overcome profitability challenges when running your eCommerce business.
What’s so tricky about eCommerce profit margins?
It’s easy to obsess over revenue, believing that if you increase the amount of money you bring in through your business, you’re in good shape. But it’s possible for your business to lose money on a sale if you haven’t considered all of your expenses, and miscalculated your product pricing or have become a bit too generous with your discounts.
Some expenses are obvious. For example, for every product you sell, you need to purchase or manufacture the item itself, plus cover the cost of shipping, storing, and marketing those products.
But some expenses are less obvious—and those hidden costs can add up fast. Think: the cost of returns, taxes, transaction fees, referral fees owed to third-party marketplaces, and many other factors. Understanding your true profits requires impeccable bookkeeping and business accounting both when first starting your business and when navigating it into profitability.
How do I calculate my eCommerce profit margins accurately?
There are two types of eCommerce margins to bear in mind: gross profit margin and net profit margin. Knowing how these margins are calculated—and the differences between them—can help you uncover the root cause of any profitability hiccups you may encounter.
Gross profit margin
Your gross profit margin shows you how much money your business keeps after factoring in product costs, but excluding expenses. The formula:
Gross Profit Margin Rate = [(Revenue - COGS)/Revenue] * 100
Cost of goods sold (COGS) includes costs related specifically to sourcing or creating your products, such as the cost of raw materials, inbound shipping fees, and storage costs. It does not include expenses like the cost of shipping products to your customers, marketing those products, website development, taxes, or rent.
Your gross margin gives you an immediate glimpse at whether your business is operating at a profit or loss. For example, if you have a gross margin of 25% and earn $100,000 in monthly revenue, you’re earning $25,000 each month before shelling out money to cover other expenses. Put another way, you’re retaining $0.25 per every dollar of revenue earned.
If your gross margins are shrinking, then you may look to find cheaper suppliers, increase product prices, cut back on marketing, and/or reduce labor costs. On the other hand, if your gross margins are healthy, you may expand your marketing campaigns or invest money into new inventory.
Net profit margin (aka “the bottom line”)
Your net profit margin is the ultimate measure of your profitability. The formula:
Net Profit Margin = [(Revenue - COGS - Operating and Other Expenses - Interest - Taxes) / Revenue] * 100
Net profit margin accounts for your COGS and all other operating expenses, from transportation costs and utility bills, to marketplace costs and wages.
The higher your net profit margin, the more money you have to invest back into your overall business. In addition to measuring profitability, net profit margin helps you understand how efficiently your business runs, giving you key insight into whether your overhead costs are too high or too low.
What’s a good profit margin in eCommerce?
Today, online retailers see on average 41.5% in gross margins and 7.3% in net margins, according to data compiled by a researcher at the NYU Stern School of Business.
However, there is no one-size-fits-all when it comes to eCommerce profit margins. Your product category, alongside the size and scope of your online store, are just a few (of many) factors that impact margins.
The pandemic’s effect on margins
The COVID-19 pandemic created a tremendous surge in online shopping. It may have even inspired you to open a new online store or grow your existing retail business. But how has this affected eCommerce profit margins?
To find out, researchers at Alvarez & Marsal and Retail Economics analyzed profit margins of more than 250 retailers in the United Kingdom, Spain, Switzerland, France, Italy, and Germany. Their analysis included both eCommerce and brick-and-mortar retailers.
The results showed that pre-tax retail profit margins have fallen as eCommerce penetration rates have risen in Europe. More specifically, profits fell from around 5% between 2018 to 2019 (pre-pandemic) to around 4.5% between 2019 and 2020 (during the pandemic). For pure-play online retailers, pre-tax profit margin averaged 1.4%—a significantly lower average than the total industry average (5.4%), which accounts for multichannel and brick-and-mortar businesses.
The study also notes continued challenges on the horizon. Researchers predict that pre-tax margins will fall to 3.2% overall by 2025. Reasons include higher rates (and high associated costs) of returns, escalating costs of raw materials and logistics, and increased competition from both brick-and-mortar and online retailers.
How do I improve my eCommerce profit margin?
With all that said, many online sellers who hit a profitability pothole find that a few pivotal tweaks can improve margins. Consider these seven steps for diagnosing and remedying and profitability problems:
01. Perform a break-even analysis
The more you know about the factors that impact your eCommerce profit margins, the better.
To that end, a break-even analysis allows you to compare your fixed and variable costs against your profit. It can help you understand how factors like lost shipments, damaged inventory, or increasing returns affect your bottom line.
You’ll also have an easier time understanding which margins and price points you need to hit in order to make a profit. Learn how to conduct a break-even analysis.
02. Determine your most (and least) profitable products
If you’re not able to separate your high-margin products from your low-margin products, then it’s time to do your homework. Dig into your books and get the most accurate information you can about your COGS and operating expenses.
Then, calculate the gross profit and net profit for each item or product type you sell. Once you have this information, you’ll have more accurate data to guide your replenishment schedules and pricing strategies.
03. Diversify your shopping channels
Additional sales channels may add to your expenses. However, a strong multichannel selling strategy can draw more traffic (and sales) to your online store. It can also help get your products in front of new audiences—you may find that buyers on Amazon may be more receptive to your high-margin items than buyers on eBay.
Among the various channels you may want to test: online marketplaces like Amazon, mobile marketplaces like Wish, social media platforms like Instagram, or comparison shopping options like Google Shopping. You could even try a physical pop-up store in a high-traffic locale to see whether a brick-and-mortar presence might make sense for your business.
04. Raise prices
This is a feasible strategy if you already have a base of satisfied customers who buy from your store regularly. It’s also perfect for brands that have built a strong reputation as a premium brand that offers something that many other sellers can’t.
However, raising prices may not be a good idea if your customers regularly expect low-cost or discounted pricing.
If you’re worried about scaring off shoppers by increasing your prices, reduce your risk by testing prices on select items and playing around with the messaging. Consider how messaging can influence how customers view your product and evaluate its worth. For example, by clearly pointing out how your product uses “premium materials” or is “handcrafted in the U.S.,” you could convince people to pay more for your items.
05. Lower your operating costs
Excess operating costs could be weighing down your margins. Make sure this isn’t this case by conducting an expense audit and use the results to identify areas where costs can be reduced safely.
Another smart idea: ask your employees which tasks consume the greatest amount of time. Seek to automate tasks that are causing inefficiencies. For example, if your team is spending an ungodly amount of hours updating inventory data by hand, implement a software like Wix eCommerce that automatically syncs inventory across all of your sales channels.
Likewise, you’ll want to eliminate unneeded or redundant SaaS subscriptions and services. Above all, try not to cut anything that will impact your customer experience negatively.
06. Increase average order value (AOV)
A higher AOV can translate to a higher margin per order. After all, even if an order contains two times more products than normal, your shipping and overhead costs for fulfilling that order don’t necessarily double. In this sense, a higher AOV can mean better margins.
Increase AOV by experimenting with these tactics:
Add product recommendations to your website’s product and checkout pages. This will create more upselling and cross-selling opportunities for high-margin products.
Bundle high-margin and low-margin products together, and offer them at a lower per-unit price. This will increase the perceived value of your products while raising AOV.
Give shoppers incentives for spending more on your site. This could include 10% discounts on any orders over $50, or free shipping for orders over $75.
Tailor your marketing efforts toward high-margin products, putting them front-and-center on your website, in your social media ads, and in your promotional email campaigns.
07. Start a loyalty or rewards program
Brand perception is an important factor, with 81% of customers saying they’ll only buy from a brand they trust.
Implementing a loyalty or rewards program is one smart way to build that trust and increase customer retention. By offering incentives for repeat purchases or referrals, you can generate revenue without spending as much money on marketing and acquiring brand new customers.
Remember that beyond offering rewards, you’ll want to make sure that you provide a great customer experience. This often starts with having an easy-to-navigate website, and ends with having great customer services throughout the entire buying and fulfillment process.
Make profitability your superpower
Whether you’re an experienced online store owner or just starting out, diagnosing the cause of your eCommerce profit margin woes is a necessary step. Once you know where your inefficiencies and weaknesses lie, you can start improving the customer experience and your internal processes to make sure that you actually retain the money coming in through your business.
Allison Lee
Editor, Wix eCommerce
Allison is the editor for the Wix eCommerce blog, with several years of experience reporting on eCommerce news, strategies, and founder stories.
