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E-commerce success depends on many factors, including margin management. Margins affect product prices, sales volumes and the potential to generate future profit. How high should gross and net margins be in an online store?
Margin, gross margin and net margin: definitions and differences
In its broad sense, a margin is the difference between a product’s selling price and its production or purchase cost. It can be expressed as an amount or a percentage. Percentage margins are more useful for comparing products and conducting analysis.
Formula: (Selling price − Production or purchase cost) / Selling price × 100%.
This is the gross margin, which takes account only of direct production or purchase costs. The final profit depends on many more items, including:
- Basic operating costs.
- Marketing.
- Website maintenance.
- Product storage.
- Shipping.
- Customer service, including after-sales support.
- Taxes and charges.
- Interest on loans and other borrowing.
- Rent and utilities.
Net margin is a broader indicator that includes these additional components and shows how much profit remains after all costs. It relates to the overall business, while the product’s gross margin indicates its contribution before indirect costs.
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How high should an online shop’s margin be?
There is no single correct level for either gross or net margin. It can range from a few percent to several tens of percent and should be carefully matched to the shop’s strategy, vision, reputation, sales scale and products.
Very high sales volumes can produce substantial profits at a minimal margin. Conversely, a small but focused operation selling niche products at a high margin can also be profitable. The appropriate model depends on the business and what it sells.
A common e-commerce approach is to begin with relatively low margins and gradually increase them as the shop develops and attracts customers. It is one possible strategy, rather than the only option.
Basic principles for setting margins
- The margin should cover all business and online-store costs and allow an appropriate profit.
- A margin set too low can damage profitability.
- An excessively high margin, particularly one well above direct competitors, can drive customers away in a competitive market.
- Match margins to the target audience, product type, vision, reputation, competition, sales scale, economic conditions, costs and final price.
- Product margins can be changed over time, including seasonally.
- A large sales scale can generate high profits even at a low margin.
- Little or no competition can create conditions for higher margins.
- Use cross-selling to offer higher-margin products alongside lower-markup products.
- Allow for promotions and discounts when setting margins.
- Remember that pricing is also a marketing tool: a high price can contribute to a premium-brand image.
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Summary
A useful margin supports the shop’s business model, covers its costs and leaves the intended profit. Product-level gross margins and company-level net margin answer different questions. Review both while considering volume, competition, discounts and the customer’s perception of value.
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