Gross Margin: How reflective is it?


September 12, 2007

By Diwakar Kumar

It is being said that it might be easy to turn cash into inventory but the main challenge is to turn the inventory back into more cash. According to researchers and analysts, many retailers fail to make more money just because of inefficient utilisation of space, labour, or product assortment in their operations. Tracking Gross Margin, which indicates the additional amount that a customer pays to the company for its product over and above the costs that the company incurs to procure or make it, has thus become critical for modern day retailers.

Managing a sustainable gross margin poses many challenges to a retailer. For any retailer, with limited space in a store, it becomes difficult to attain margin goals because high-priced products may fetch the business immediate gains – and higher gross margin, but the retailer could lose out to more competitively-priced retailers in the long run. In fact, a higher gross margin is not always an accurate reflector of a retailer’s health.

Improving business efficiency

The efficiency of the business can be improved with careful steps in the line of operation like highly efficient supply chain management, inventory management, demand forecasting, leveraging on technology etc. In an effort to generate sales from higher gross margin products, retailers typically lean on private label development.

“Compared to the western retailers, the Indian retail industry has much thinner gross margins and comparatively higher operating costs (most importantly the rental costs), and there is definitely a need to locate higher gross margins through areas such as private labels (PL),” remarks Devangshu Dutta, chief executive, Third Eyesight. This is one of the reasons behind retail giants like Shoppers Stop, Trent, Pantaloon Retail, Reliance Retail, Spencer’s Retail and Vishal Retail moving towards PLs to address consumer needs and to increase profitability, he states.

The poll question and experts’ view

As a follow up on the subject, IndiaRetailing’s weekly poll question — Is a retailer’s Gross Margin always an accurate reflection of its health? — had 58.82 per cent of the respondents supporting the theory, whereas 37.25 per cent of them negated the same and the remaining 3.93 per cent preferred to stay neutral.

Commenting on the poll question, Dutta underscores that net margin should be the only true reflection of a retailer’s health. “Gross margin is only the starting point. The maximum potential gross margin, to me, is the difference between the cost of the product and the highest price the consumer is willing to pay. A retailer has to decide on balancing the two sides of the equation. The first one denotes the maximum price that the customer would be willing to pay, and the other is the lowest possible sourcing cost without affecting the quality of the product itself,” he analyses.

“Obviously, a higher gross margin allows the retailer much more scope in deciding the operating costs. However, there are businesses with a high gross margin on products but slow inventory turn and high markdowns as well,” underlines Dutta.