Profit Margin Analysis: Retail Apparel
Retail stores provide simple but practical examples of profit margin analysis. Stores buy their products from manufacturers (or distributors) and then mark up each product’s unit cost to arrive at its retail price. The relationship between the unit cost of the products sold and their retail price determines the store’s gross profit margin. Operating profit is computed by subtracting from gross profit all expenses such as rent, utilities, advertising and the compensation of the sales staff.
The range of profit margins can be fairly wide, particularly at the gross profit level. The average supermarket chain has a gross profit margin of around 25 percent. A jewelry store enjoys a gross profit margin that is twice as much or more. The differences between types of “low margin” and “high margin” stores can be largely explained by the very nature of the products that these two types of stores sell (i.e., staples and essentials vs. luxury items).
Profit margin analysis of the retail business becomes more interesting when a comparison is made between two competing retail companies with similar product offerings. Take for example two global giants in the retail apparel business: H&M and Zara. Both sell trendy, fashionable apparel at prices that can be considered moderate to mid-level (depending on the average incomes of the countries in which the stores are located). The relative attraction to shoppers of these leading global giants will of course depend on consumer tastes and demographics. But how do their profit margins compare? A useful way to think about this question is by looking at their operations.
In reading about the operations of these two store chains, I noticed an important difference in their business models. In its annual report, H&M states:
H&M does not own any factories but instead outsources product manufacturing to around 700 independent suppliers through H&M’s 16 local production offices in Asia and Europe.
Zara is actually the major entity of a Spanish global company called Inditex. Inditex owns and operates other retail apparel chains such as Massimo Dutti but its flagship chain is Zara. As explained in Inditex’s Annual Report, Zara (as well as its other store chains) has its own manufacturing facilities and some independent suppliers. But besides owning most of its own manufacturing, the key difference of Zara’s business model when compared to H&M is logistics and distribution.
….an important part of the [design] activity, including manufacturing in our own centres or by external suppliers, takes place in close proximity. [This] enables fast responses to the market.
As a result of this arrangement, Inditex likes to boast that throughout the world, Zara stores receive new clothing shipments an average of twice a week.
In any case, here are a few questions to entertain regarding the profit margin analysis of H&M and Zara.
1. What are their gross profit margins? (“High” would be around 50% or more, and “low” would be around 25% or so.)
2. Who has the higher gross profit margin, H&M or Inditex (includes Zara)? What about their operating and net margins?
We will discuss the answers to these questions in our next blog. A complete explanation of the different types of profit margin and the factors that help to explain their differences are explained in detail in our Learning Burst Academy course entitled Business Acumen: Your Key to Success.” We also provide many different examples in many different industries besides the retail consumer business. You can also download a handy summary of the different types of profit margin as well as other key financial ratios.