Gross Profit Margins; How to Think About Them for Brands with a Big Retail Presence

A friend of mine who wants to remain anonymous (I get quite a few of those) sent me an email the other day and had an interesting point to make about gross margin for brands who owned retail stores.

When a brand opens retail stores they do it at least in part because they expect to capture the margin that previously went to the retailers they sold product to. We all understand that. Just to pick some numbers, let’s say that brand earns a 35% gross margin when they sell their product to retailers they don’t own. And let’s say it’s 65% when they are selling the product in their own retail stores.

Of course, they incur all sorts of additional expenses by virtue of having to run and staff stores and some of those may be accounted for as part of the cost of goods sold, reducing gross margin. But let’s just go with my “accounting light” numbers for purposes of my example. The point is just that they get a much better product cost margin at retail then they do at wholesale.
 
Here’s what my friend said. I’ve paraphrased it a bit.
 
“When you see a sales decline with the margin rising, it could be that most of that decline is taking place in the wholesale rather than the owned retail sales. So the increase you see in gross margin would be, to a greater or lesser extent, just the mathematical result of selling a higher percentage of the higher margin retail product. It wouldn’t represent better inventory management, reduced product cost, or price increases or any kind of positive management action.”
 
Let’s say a brand is selling $1,000 of product (it’s a really small company). 30% of those sales are through their retail stores and 70% to other retailers. On the 30% they sell through their owned retail, they earn a gross profit of $195 (using the gross margin percentages I chose above). On the 70% they sell through other retailers, gross profit is $245. That’s a total gross profit of $440 on that $1,000 of sales, or 44%.
 
Let’s assume their total sales fall by $100. Let us further assume that the entire decline is in their wholesale sales. Now they are selling $600 at a gross profit margin of 35%, earning $210 in gross margin dollars. On the sales in their owned retail, they continue to earn $195 in gross margin. That means they earn a gross profit of $405 on sales of $900. Their gross margin percentage has risen from 44% to 45%, but not, as far as I can see, for any reason we should feel good about.
 
An independent retailer can reduce or eliminate the presence of a brand that isn’t selling pretty quickly. If you’re brand X, you’re probably going to be pretty reluctant to stop carrying brand X at your owned stores. This begins to get us into all sorts of interesting discussions about merchandising when you’re both a brand and a retailer. Will weakness in your wholesale accounts eventually translate to weakness in your owned stores? Or can your ability to merchandise your entire line the way you think it should be make a difference?     
Declining sales would typically go hand in hand with declining inventory levels. There are reasons you might not see that- like building inventory for a new brand launch- but overall if you see declining sales, higher margins and no fall in inventory from a brand with significant owned retail, it’s worth exploring.

 

 

1 reply
  1. john bernards
    john bernards says:

    have a good time at surf expo–i did not get a chanch to talk to you last week—your margin understanding is correct–it is going to be hard for small stores to compeate alnd stay inbusiness.

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