Online retailers are often obsessed with driving up conversions. But having lots of sales doesn't necessarily mean your business is profitable. When you factor in operating costs you could be spending more money than you take in. That's why you should keep track of your return on sales.
Return on sales - or ROS - makes it easy to understand how healthy a business is. So what is ROS and how can you improve it?
Return on sales is a metric which defines a company's profits as a percentage of its sales revenue. In other words it indicates how much of your sales revenue becomes profit.
Return on sales has been around since before the rise of eCommerce and goes by many names including operating margin profit margin and operating profit margin. For years businesses across all industries have used it as a measure of their success.
Today eCommerce retailers use this standardized metric to understand how sales impact profits. Ideally your return on sales should be high as this means a lot of the revenue you generate is profit. If your return on sales is low it means you only make a small amount of profit and most of your sales revenue goes towards covering costs.
However it's worth noting that a low return on sales isn't always bad. For example an eCommerce startup may have a low return on sales because it is investing in new markets products and talent - all of which should lead to growth further down the line.
You can calculate return on sales by dividing your store's net profit by your total sales revenue.
ROS = Net Profit ÷ Sales Revenue x 100
If you're wondering how to get your net profit you simply add up all your product sales and subtract all your operational costs. So another way to write the return on sales formula is:
ROS = (Sales Revenue - Operating Costs) ÷ Sales Revenue x 100
When calculating return on sales your operational expenses should include all outgoings from website costs and staff wages through to rent and inventory costs.
However the likes of taxes interest and exchange rate costs are generally excluded. These expenses can vary from year to year and are outside of a retailer's control. By excluding them you'll get a more reliable reading of your online store's standalone performance.
Just be aware that by excluding these expenses your real profits will be slightly lower than your return on sales metric suggests.
So if an online retailer generates �200000 in sales in the first quarter of the year but spends �140000 running the store its Q1 ROS would be 30%.
ROS = (200000 - 140000) ÷ 200000 x 100 = 30
With a return on sales of 30% your online store would keep 30p in profit for every pound spent. It's a good idea for online retailers to monitor their return on sales regularly and map the results over time.
To improve ROS for your store you either have to increase your sales revenue or reduce your operational expenses. You may even opt to do both.
However when it comes to cutting costs it's important not to decrease investment in activities that help with long-term growth. Here we run through four low-risk methods to improve ROS.
Average order value is a key eCommerce KPI. It indicates the average amount a customer spends when they check out in your eCommerce store.
By increasing your average order value you'll benefit from higher sales revenue. It should slightly reduce the shipping and packaging costs associated with each order too.
To drive up average order value you can encourage customers to add more to their basket or convince them to choose pricier products. Here are some strategies you can use:
If you're wondering how to choose complementary products delve into your store's data to see what items are commonly purchased together. Or if you're active on third-party marketplaces use Where to Buy technology to view basket level data on the likes of Amazon and Walmart. This will provide a broader view of the products people purchase alongside yours.
Raising prices is one of the simplest ways to increase your ROS. Getting it right requires a lot of research but it can be extremely effective.
If you sell 10000 units of a product each month and increase the price by just 15p you'll enjoy an extra $1500 in sales revenue each month. That's an extra $18000 each year! If you do this with multiple products your profit margin will skyrocket.
Raising prices has been a common ROS strategy for decades. Harvard Business Review refers to examples of ROS operating margins increasing by 30-35% thanks to average price increases of 2-3%. More recently research by McKinsey showed that effective pricing strategies usually deliver a 2-7% increase in Return on Sales.
On the other hand if you raise prices too much you could lose revenue. That's why McKinsey recommends introducing price changes incrementally.
To avoid overpricing products you should also perform thorough competitor research. Online price monitoring tools can help with this. However if you offer superior customer service return policies customer warranties free shipping or other in-demand perks don't be afraid to charge a little bit more than a competitor.
Renegotiating with your vendors is a great way to reduce expenditure without compromising on service or business investment. Even a slight reduction in inventory costs can significantly increase your profit margin.
Proactively ask for reductions on your products and operational materials - especially if order volumes are on the rise. You should also try to convince your suppliers to take back any deadstock that are costly to store and difficult to sell. If your vendor isn't flexible contact other suppliers in search of a better deal.
During your back-and-forth communications ask about marketing partnerships too. Cooperative advertising campaigns can reduce marketing costs without compromising sales.
Another great way to bolster your brand's relationship with retailer sites is with the use of a Where to Buy solution. By offering consumers the option to purchase your products from their site you're providing an enhanced customer experience but also helping increase the sales of your retailer partners.
Nurturing leads from the awareness phase through to conversion is time-consuming. This kind of acquisition marketing can be costly too. So focusing on customer retention is a great way to nurture sales without needing to invest in expensive campaigns.
An academic study dating back to 2001 even suggests that increasing customer retention by just 5% can boost profits by 25%. With this in mind here are some cost-effective ways to increase retention:
Once you've built up a loyal customer base you may even be able to reduce acquisition costs by implementing a referral programme.
Many benefits come with improving your return on sales. Your store is more likely to survive economic downturns and internal crises. You should find it easier to secure investments and loans too. So it makes sense to start tracking and optimising your operating margin without delay.
