Operating margin is a percentage that shows how much profit an eCommerce business keeps from its sales after covering operating costs like marketing, shipping, and administrative expenses. It's calculated as:
Operating Margin = (Operating Income ÷ Net Sales) × 100
For example, if your sales are $20M, your product costs (COGS) are $12M, and operating expenses are $4M, your operating margin is 20%. This metric helps businesses:
- Track profitability: See how efficiently sales turn into profit.
- Spot inefficiencies: Identify areas to cut costs or improve.
- Attract investors: A strong margin signals financial health.
Improving your margin involves reducing product and operating costs (e.g., negotiating supplier terms, automating tasks) and increasing sales (e.g., bundling products, offering strategic free shipping). With eCommerce profit margins averaging 10%, managing this metric is crucial for long-term success.
Operating Profit Margin: A Quick Guide
Operating Margin Components
Understanding the parts that make up operating margin is essential for eCommerce businesses aiming to monitor and improve profitability. Here's a breakdown of the main elements that influence this metric.
Sales Revenue
Sales revenue represents the total income from sales after deducting returns and discounts. For eCommerce businesses, this is the starting point when calculating operating margin.
Factors that affect sales revenue include:
- Total product sales
- Customer returns and refunds
- Discounts from promotions
- Fees charged by specific platforms
Cost of Goods Sold
Cost of Goods Sold (COGS) refers to all direct expenses tied to producing or acquiring products for sale. For eCommerce companies, this typically includes:
"Managing inventory costs and controlling the cost of goods sold are critical elements of managing gross margin."
Data from NYU Stern shows that retail businesses generally achieve gross margins of 21.88% to 34.17%, depending on various factors . These margins are shaped by:
- Manufacturing or wholesale costs
- Shipping and handling charges
- Storage fees for inventory
- Packaging expenses
- Import duties and taxes
Operating Expenses
Operating expenses, often called Selling, General & Administrative (SG&A) costs, cover the indirect expenses of running an eCommerce business .
| Expense Category | Examples in eCommerce |
|---|---|
| Marketing | Ad campaigns, influencer collaborations, email outreach |
| Platform Fees | Marketplace commissions, payment processing costs |
| Administrative | Customer support, accounting tools, office supplies |
| Technology | Hosting services, inventory software |
| Personnel | Employee wages, contractor fees, staff training |
Now, let’s look at how to calculate operating margin using these components.
Operating Margin Calculation
Operating margin measures how efficiently a business operates and how profitable it is. Here's how to calculate it:
Basic Formula
Step 1: Find Operating Income
Operating Income = Net Sales - Cost of Goods Sold (COGS) - Operating Expenses
Step 2: Convert to Percentage
Operating Margin = (Operating Income ÷ Net Sales) × 100
Sample Calculation
Let’s break it down with an example. An online patio furniture retailer provides the following financial data:
| Financial Component | Amount |
|---|---|
| Net Sales | $20,000,000 |
| Cost of Goods Sold | $12,000,000 |
| Operating Expenses | $4,000,000 |
Step 1: Calculate Operating Income
- Operating Income = $20,000,000 - $12,000,000 - $4,000,000
- Operating Income = $4,000,000
Step 2: Calculate Operating Margin
- Operating Margin = ($4,000,000 ÷ $20,000,000) × 100
- Operating Margin = 20%
"Operating profit margin is the ratio, expressed as a percentage, of your company's sales to the company's operating expenses." - Shopify Staff
This 20% margin means the company earns 20 cents in operating profit for every dollar of sales . Now, imagine the COGS drops to $10,000,000, while sales and operating expenses stay the same. In that case, the operating margin increases to 30%.
Up next: strategies to improve your operating margin.
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Ways to Increase Operating Margin
Boosting your operating margin isn’t rocket science - it comes down to smart cost management and revenue growth. Let’s break it into three actionable strategies.
Lower Product Costs
Cutting product costs starts with building strong supplier relationships. Here’s how to make it work:
- Negotiate Better Terms: Offer long-term contracts in exchange for volume discounts. Begin negotiations with higher purchase volumes to test supplier flexibility .
- Streamline Shipping Costs: Small changes can lead to big savings. For example:
| Strategy | Benefit |
|---|---|
| Reducing Box Sizes | Lowers dimensional weight charges |
| Using Shipping Bags | Cuts down overall shipping weight |
| Negotiating Carrier Rates | Locks in better pricing for bulk |
| Regional Fulfillment | Shrinks shipping zones and expenses |
Once product costs are under control, it’s time to tackle operating expenses.
Cut Operating Costs
Reducing day-to-day costs frees up resources for growth. Here are two impactful steps:
- Automate Routine Tasks: Automation can save time and money. Richard Voyce, digital director at The Conran Shop, highlighted this:
"Our greatest frustration was seeing our budgets tied up in maintaining the platform, rather than channeling those resources into creating exceptional experiences for our customers" .
- Speed Up Your Website: Faster websites mean more conversions. A site with a one-second load time converts 2.5 times more visitors than one that takes five seconds .
After trimming costs, shift focus to boosting revenue.
Increase Sales
Growing sales is a direct way to improve your margins. Try these tactics:
- Smart Product Bundling: Dr. Squatch saw a 54% revenue jump per soap buyer by setting a two-pack as the default .
- Offer Free Shipping Strategically: With 76% of shoppers more likely to buy when free shipping is available , set your free shipping threshold just above your average order value. For instance, if the average order is $45, set free shipping at $50 to encourage larger purchases.
Funding Impact on Operating Margin
Strategic funding plays a crucial role in boosting operating margins, complementing internal cost management efforts. By providing the necessary capital for growth, smart funding can help businesses scale effectively. Research shows that 82% of business failures stem from cash flow issues , highlighting the importance of securing proper funding to maintain healthy margins.
How Funding Helps Businesses
Take CROSSNET, for example - a sports brand that secured funding to fulfill its largest wholesale order, enabling expansion into Sam's Club stores nationwide . Similarly, Cath Kidston leveraged funding to shift to a digital-first model, achieving 85% of their global sales through online channels .
Funding allows eCommerce businesses to fine-tune their operations and improve margins in several ways:
| Funding Purpose | Impact on Margins |
|---|---|
| Bulk Inventory | Access to supplier discounts |
| Marketing Investment | Drives faster sales growth |
| Supply Chain Optimization | Cuts operational costs |
| Market Expansion | Boosts overall revenue |
The secret to maximizing funding lies in strategic planning. Businesses with clear financial strategies are 16% more likely to succeed than those without . Multi-territory sellers, for instance, grow 35.7% faster than single-market operators, proving the advantages of well-deployed funding .
Onramp Funds: A Flexible Solution
Revenue-based financing (RBF) is an excellent option for maintaining margins while fueling growth. Unlike traditional loans, RBF aligns with your revenue cycles, easing cash flow pressures during slower periods .
Jeremy, founder of Kindfolk Yoga, shared his experience with Onramp:
"Onramp offered the perfect solution with revenue-based financing to secure the capital we needed to invest in inventory and pay it back at a reasonable time frame once we made sales. The process was quick, easy, and the support was great" .
This funding model is particularly useful for eCommerce businesses because:
- Inventory Management: Produce more inventory without depleting cash reserves .
- Growth Investment: Expand into new markets without disrupting current operations .
- Risk Management: Repayments adjust based on sales, protecting margins during slower periods .
With the average eCommerce profit margin sitting at 10% , access to flexible funding can be the difference between struggling to stay afloat and thriving in a competitive market. Exploring funding options could be the key to strengthening your business’s operating margins.
Conclusion
Summary
Benchmarks indicate that a 5% net margin is on the lower end, while hitting 20% suggests strong performance . Alarmingly, 90% of eCommerce businesses fail within their first four months, highlighting the importance of keeping margins healthy .
Dan Little, Co-Founder and CEO of LinkMyBooks, puts it well:
"Revenue growth doesn't always mean profitability. Tracking e-commerce profit margins is key to assessing business health"
This underscores the importance of prioritizing margin improvements over just chasing revenue growth. Smart funding strategies can play a big part in supporting these efforts.
Next Steps
Here’s how you can turn these insights into action:
| Time Frame | Action Items | Expected Impact |
|---|---|---|
| Immediate | Optimize packaging costs | Save up to 91% on shipping |
| Short-term | Implement smart discounting | Minimize margin erosion |
| Medium-term | Develop loyalty programs | Drive 12–18% revenue growth |
| Long-term | Automate operations | Cut labor costs significantly |
Key areas to focus on include:
- Cost Management: Invest in inventory optimization tools to prevent overstocking or running out of stock. Automating tasks like label printing and bookkeeping can also save time and money .
- Revenue Growth: Fine-tune your pricing strategy with gradual increases and product bundles to maximize order value. For instance, 76% of shoppers are more likely to buy when free shipping is included - use this incentive wisely for higher-value purchases .
- Strategic Growth: Expand into international markets and streamline your supply chain. Tobias Buxhoidt from parcelLab offers a key insight:
"It's essential to note that reducing ecommerce business expenses doesn't mean slashing costs indiscriminately. Instead, it's about making intelligent, strategic decisions that reduce expenses while maintaining or improving business competitiveness"
Reaching the ideal gross margin of 45.25% requires ongoing monitoring and adjustments. Consider exploring funding options to help you improve margins without compromising operational flexibility. For instance, platforms like Onramp Funds (https://onrampfunds.com) provide equity-free financing tailored for eCommerce businesses. This can help you scale operations, manage cash flow, and invest in growth.
