Let’s say your business idea is to be a retailer and resell products in your startup. Suppose you purchase a product at, say $30 each, and resells them at the recommended retail price of $100 each. The gross profit margin in this case is clearly 70% using the formula as follows:
Suppose that when you are evaluating the viability of your start up idea, you enter the 70% profit margin into the calculations. You project what sales would be like at the end of the third year of operations. Using an assessment tool like the StartBizUp App, you found the business idea to be not only viable but somewhat attractive. Before you proceed to launch your start up based on this result, you should take another look at the profit margins.
Take the case of apparels. When the product with a new design first hits the shelves, it is commonly sold at the recommended retail price. Within a short period, the retailer is able to know whether the product is a best seller or not. If it is, the retailer rejoices and places a reorder. If it isn’t, the retailer may markdown the price by 10% – 30%. At a 30% discount, the gross margin drops to 57%. If, after a certain period, the product is sold out at the reduced price, the retailer is satisfied.
However, in the event that the product fails to sell well even with a 30% discount, the retailer may make further markdowns. At this stage, with a 50% discount, the retailer is somewhat satisfied to be able to get rid of all the stock. At 50% discount, the gross margins drops further to 40%.
Unfortunately, there would be certain products which don’t move much even with a 50% discount. These products would then be sold at big annual or biannual sales event at the retailer at a 70% discount. At this discount rate, the retailer deems it lucky to not only not make a profit but get its money back on the product considered to be a dud. If it turns out that the entire stock gets sold at this heavily discounted price, then the retailer heaves a big sigh of relief.
There would be cases where even with a 70% discount, the retailer is left with some or even significant quantities of the unsaleable product. The last resort would be for the retailer to sell them to a discount reseller or worse, as scrap by weight. At this stage, the product goes for a 90% discount or more. This meant a loss for every product sold.
Now if you work out the average profit margin for the product, you would find that it has dropped significantly. The table below shows a typical breakdown for a product line comprising a number of designs. Although the exact quantity sold for the discounts given varies according to product lines and designs, the proportion shown gives you a good idea of what retailers can expect. At the end of the day, the retailer’s average gross profit margins comes to a down to earth figure of 37% in the example below.
Therefore when evaluating the viability of a start up idea, it is important to use the correct figure for gross profit margin to get a more realistic projection.
In many developed countries, government agencies regularly publishes useful data on manufacturing and services establishments. You can get information on the gross profit margins of different products from these publications. At times, the breakdown given in these publications are not detailed or specific enough for your use. In such cases, you can always approach the governments agency to obtain the more required information. Chances are that these data were collected anyway but not published.