Margin, margin, margin—retailers talk about it a lot.
Yes, margin is extremely important. Without it, we wouldn’t be here. The difference between cost and sales price—that part we call the gross profit margin (margin, for short)— is what pays for the lights, and keeps the doors open and feeds us yummy Ramen noodles.
So I have a big surprise for some people: there’s more to life than margins.
Let’s be clear on what we’re talking about. Your margin is your profit (in dollars) divided by price, and usually expressed as a percentage. An item that costs you $6 and sells for $10 has a 40% profit margin. Price is inextricably linked to sales velocity, and vice versa. In general, a lower price creates more unit sales, and a higher price reduces the number of units sold.
The way we normally see this relationship expressed is when somebody, usually a nearby competitor, opens up a store with the thought that he can sell the same stuff for lower prices than you do and will therefore make more money. He thinks that he’ll make more money because he’ll sell more copies of his cheap stuff. He’s wrong, and it’s because he hasn’t done the math. Selling for 20% less than you do (assuming he pays the same cost) means that he has to sell about 50% more stuff than you to make the same amount of cash because his profit margin drops to almost nothing. That’s not feasible without additional advertising or some other way of letting customers know about that outstanding discount.
We’ve all heard that speech by now. We know that across-the-board discounting doesn’t work for the traditional game store business model. I’m not suggesting that you deliberately give up margins on items you’re already carrying in an attempt to increase sales.
Neither will I suggest that you don’t seek additional margin when it makes sense. If a new distributor offers you a better price than your old distributor on a product or a product line and it doesn’t come at a cost of service, ship time, or any other hidden cost, you should buy from that distributor.
What I am suggesting is that you look at the total package when deciding to carry a product, and that—under certain circumstances—carrying an item with a shorter margin isn’t a bad thing.
High Margins
When you test a theory, there’s no point testing it on close comparisons. I’m not going to discuss margin differences of 1-2%. Let’s test it at the extreme. If you listened to a publisher pitch a product that you think you’d sell once a year at a 95% margin, would you buy it? Hey, it’s a 95% margin. Of course you’d buy it.
Would you buy two?
Buying two would be stupid. If you’re only selling one a year, you’d never need two. You place a restock order at least once a week. The odds of missing out on a sale because you didn’t have one are low indeed. You’ll be happy spending your $10 to gain $90 at some point during the year. There’s no point in spending $20 when you can spend $10.
What if you could increase that sales rate by lowering that price? What if you could purchase it at $10, sell it for $60, and sell two per year instead of only one? Well, that’s “only” an 80% margin, but you’re netting $100/year in profit instead of $90. Clearly, the lesser margin is the better choice here.
What if you sold it for $50, spent $50 advertising it, and doubled your sales to 4 per year? You’d make $200 for a total investment of $90. That’s an annual gain of $110. Even better! More importantly, I think it makes a point. That “mere” 55% profit margin put more money in your pocket.
Low Margins
Now let’s look in the opposite direction.
Would you carry an item with a 5% margin? I’m sure you wouldn’t. Low margin is the antithesis of retailer wisdom. Nobody in his right mind would carry a product that offered a 5% margin.
What if you could sell 10,000 of them in a year at $4 each? Interested yet?
That’s about 30 whatevers a day. If you are on a two-day ship, you could order by the 100 and spend an initial outlay of $380. That’s right. Your total cash-flow goes down by only $380, and you put $500 in your pocket at the end of the year. Are you still saying “no” to carrying this item?
You might be saying “yes, but not at 5%.” Good for you. What if you raised the price by 10%? Sell them for $4.40 instead of the MSRP of $4. Your initial debt to your distributor is still only $380, but each 100 you sell earns you $440, or nearly a 14% profit margin. Sure, sales might drop. How much, you ask? How much you got, I ask?
How much would sales drop if you raised the price by 10%? 10%? Probably more. 20%? Maybe more. 30%? Maybe that. It depends on how well-informed your buyers are and how competitive the market was.
But sales would have to drop by 2/3—over 65%–before you lost money on your price hike. Lose 30% of those sales and double your profit—all at the exact same $380 initial investment. How does an extra $1,000 per year sound? Better? I like it better than $90/year on that 95% margin item.
Now, I’m willing to bet that most of you understand this concept intuitively, even better than you think you do. Do you carry or plan to carry Games Workshop in your store? Why? At “only” a 45% margin, it’s a weak product. For that matter, why do you carry new games at all? You can make 70-90% margins on used games.
Why stop there? You could buy only Magic commons that you can get in bulk for a price equivalent to $.005/card, sell them for a dime each and make that coveted 95% margin on every sale! Your store would be the best store ever! You’d make millions.
Or not.
A Bigger Picture
You don’t use this crazy business model because you understand two things. One, individual item margin doesn’t make or break your store. It’s your average margin you have to protect. A traditional game store doesn’t work on 5% margin because it doesn’t have the sales velocity for it. You’re not likely to sell 10,000 copies of every single item in your store.
The second thing you obviously understand is that it’s okay to sacrifice margin for sales volume under certain circumstances. You know you won’t pay your bills off of a 95% margin and $1,000 in sales. You can’t generate enough total dollars with the cheap stuff if you’re operating under a traditional game store model. You might sell some 75% margin used games, some 80% margin Magic singles, and some 70% margin hobby knives, but if you want to break $25,000 in sales, you need to add those middle-margin new card games, RPGs, and miniatures. You stock Warmachine at normal margins because it sells pretty well. You stock Games Workshop because you’re pretty sure their massive sales engine will bring customers to your door to the tune of $50,000 to $200,000 per year.
Which brings us to some further points about margins, like the ones you find in the real world, outside of spreadsheets.
The 10,000 widgets you sell at $4 could have a beneficial effect, even with the 5% margin. What if you sold each of those customers a $2.00 bumper sticker at 70% margin? You’d bank an additional $7,000. Using a more realistic upsell rate of 12.5%, or 1 in 8, you’d still make an additional $875 in profit. That almost doubles your total profit for the experiment.
How to Use that Low Margin
Here’s another option. What if you used that short-margin widget to bring people into your store? You pay premium rent to bring people into your store. You might have paid $5,000 for a fancy channel letter sign to bring people into your store. You might run TV commercials to bring people into your store. Where’s the sin in accepting a lower discount to bring people into your store if the result is new long-term customers? If you use your 10,000-widget sale to gain even 10 Warhammer 40k players, you might add $15,000 in downstream revenue to your bank account.
This is exactly the thinking behind a loss leader, or a popular item that you sell at less than cost in order to gain traffic count.
Of course, looking at the big picture brings problems. Nobody tells you in advance how many copies of something you’re going to sell. If you spend your $380 on your widgets, sell 6,000 and then the gravy train ends, you make less than you planned in total profit, add-on sales and in new customers. Part of predicting your price-setting (and consequently your margin goal) is being able to accurately project sales.
Cost
All of this discussion relies on manipulating one element of margin: your selling price. The other element of your margin is your cost. What happens when you mess with that?
Briefly, I mentioned buying goods from a distributor who offers them cheaper. In reality, that decision isn’t so easy. The cheaper distributor might have a higher minimum order, longer ship time, or make more mistakes. Or, you might not sell many copies of the item in question and find that switching your order over for the $.42 you’d save isn’t worthwhile.
There are other alternatives. You could buy directly from the manufacturer. You might save 10% or more that way, giving more weight to the value of price. A slower ship time might be acceptable for a $50 savings. However, will your discount go down as your volume goes down with that distributor? You don’t want to save $50 on one product line and pay an extra $400 across the board. That’s counterproductive.
How about quantity orders? We could be onto something here. While this is more common outside of the gaming industry, you might buy certain items which are cheaper in quantity. You might find your hobby supplies for example, are up to half as expensive if you buy in case quantities. How do you judge whether to buy a single box of hobby knives with a 40% discount or 20 boxes with a 70% discount? The difference is a cost of $20 vs. $288.
Let’s see what you can do with that higher discount.
You could buy the bulk deal at 70% off, keep what you intend to sell over the next 1-2 years, and trade the rest with another game retailer or a hobby supply store. That would give you the benefit of high margin without the liability of too much cash investment. However, it’s risky unless you arrange it first. Maybe nobody else wants any, or they all saw the same ad you did and made the same deal. Then you’re stuck with a closet full of product you won’t sell except at conventions.
What if you didn’t sell the hobby knives? I know it’s crazy talk. We’re retailers. We exist to sell things. But what if your main purpose isn’t to sell them but to drive sales of something else? Look at the rest of your miniatures supplies. What’s not selling? What if you offered a free $1.99 hobby knife with each purchase of any Hot Wire Foam Factory cutting tool? Well, that’s probably too much of a price difference. A free $2 item isn’t much incentive for a $40 item.
How about a tube of putty? Compared to that price, the $2 addition is a fairly significant bonus. Add the free knife to a $17.99 tube of putty, and your profit margin on the total purchase becomes 41.9%. That’s not bad. But what else did this do?
Well, for one, it increased your total profit by a factor of 5.4! Instead of the $1.40 profit you would have earned by selling the knife, you earned $7.50 profit on the combined sale. You might also have encouraged customers who never used putty before to start using it for the sake of the free knife, which means they’ll keep buying it after the promotion is gone.
Conclusion
So, any discussion on margin that just stops at “There’s no way I’m selling anything less than 45% margin in my store” is missing the point. You can’t have a discussion on margin without considering all the attendant factors. Neither a high margin nor a low margin is enough information on which to base a decision. It’s like saying there’s no way you’ll sell a game with a blue cover or a miniature with the weapon in its left hand. No way!
Margin is, after all, just a meter. It’s like a dollar-per-square-foot analysis or a turn rate. You don’t put a margin or a turn rate or a percentage in your bank. You put sales in your bank account, and you put profit in your pocket. Those are the numbers that matter. If you’re going to focus on a mathematically derived formula, focus on those.
