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.
Asitava Sen, director, Business Consulting Services, The Nielsen Company clarifies, “Gross margin is an important performance indicator for retailers. It implies the net difference between the buying and selling prices for a product. However, it’s not the only parameter to consider. Gross margin depends on functionality of the product. For example, daily use commodities will have lower margins than luxury products. It’s a function of exclusivity and the premium that the retailer can charge on that product.”
He further underscores that the most relevant parameter therefore is Inventory Turns –how quickly the product could be sold and replenished in the shelf. Therefore, the composite parameter to consider is Gross Margin Return on Inventory (GMROI), which is gross margin multiplied by inventory turns. “Thus, for a lower gross margin product, say a daily use commodity, one can make reasonably high absolute profit by selling larger volumes and quicker replenishment. Besides margins, there are a number of key performance indicators both for front-end and back-end operations. Some of these are sales/square feet, conversion rates of footfalls into shoppers, net profit margin, ROI etc.”
Commenting on the debate, Seshu Kumar, business head, Rural Retail, ITC Limited – Agri Business Division, says, “Gross Margin would not take into consideration store-wise profits and losses. It is possible for a retailer to generate enough profits in some stores to cover losses of other stores. However, fall in sales of the profitable stores, due to increase in competition, changes in local environment etc., can result in the complete chain losing money. Hence store-wise Gross Margins are a better indication of a retailer’s’ health.”
“Every retail format has its own unique financial model, which is determined by a combination of revenues, margins and costs. Each of these independently and collectively determines the financial health of the format,” says Viney Singh, MD, Max Hypermarket India Private Limited.
So, to answer our question — if gross margin is the last word in profitability – it would appear that, by and large, yes. However, there are caveats – same-store statistics are a better indicator as are gross margins considered along with other key indicators as Sales Per Square Foot, and Inventory Turnover.