5 most profitable retail business models

By now most are aware of the general retail business model, but did you know the most profitable are not necessarily as straight forward? Retail is a business of margins. It’s a business of margins because between competition, changing business landscapes, price rises and falls etc. there really is not a lot of room for error, and thus, living on margin. This post is all about those margins, and more specifically, the business models some retailers are using to keep more of their margin, while running a more profitable business.

To understand in more detail, let’s run through the classic (largely unprofitable) retail business model. You buy a pair of jeans for $50 at retail cost. That retailer got those jeans at roughly $30–$35 and takes the difference. At this point, the retailer uses that margin, let’s say it’s $15 or 30% margin on the jeans, to cover all the costs associated. This is rudimentary, but, what happens with the $15 is…a lot. That same retailer must now pay 1) employees 2) fixed costs (roof, utilities — may also be variable, software, debt) 3) variable costs (electricity, software, inventory purchases, sales commissions, cleaning supplies, office supplies etc.) 4) any shipping costs not covered by customer 5) packaging 6) unexpected breakage, lost goods, stolen goods, other. So, you can see, that $15 has to go a long way. Most retailers and even eCommerce companies have realized this, hence why we now have some variations and combinations of different retail business models to keep companies alive, even Amazon!

Luxury Always Wins

The luxury model is built much the same way as a classic retail business, the only difference is the margins are quite a bit larger. In this case a retailer may take up to 50% margin, or, even at a 30% margin, they are keeping more of the “net” (after paying all expenses). Luxury has always been a pretty profitable segment, and is why 6 out of the top 9 most successful retailers (based primarily on the ratio of sq. ft. of retail space to dollar value of sales from that space) are in the luxury segment.

Luxury has the clear advantage of clientele that have disposable money to spend. They also have the advantage of (usually) shorter supply chains, which help to cut out middlemen and increase profit margins. In addition, Luxury stores are placed in areas that do not feel the effects of market downturns as much. Large luxury retailers typically have less stores, in more profitable areas, whereas low-profit retailers have stores in unprofitable areas affected greatly by any sort of market downturn.

Beyond this, the luxury segment has another advantage of carrying less inventory. It’s not that they don’t stock everything the customer needs, but they typically have a smaller inventory stock which is much higher in value. This leads to less inventory carrying costs, less shrinkage, less loss, lower warehousing and transport costs and more.

Put all these things together, and it’s clear the winner for retail by profit per square foot, is the luxury segment. Especially brands which are vertically integrated (owning the manufacturing, distribution, and retail) keep higher margins, and more controls over the business than other retail businesses.

Digital Natives

For all intensive purposes I’m going to define this as a brand who has started online selling their product, and decided to branch out in to physical retail. Such companies as Bonobos, Casper, Harry’s, Dollar Shave Club and others define this model.

These digital native brands are popping up left and right (soon to be unprofitable??) and for good reason. With the rise of marketplaces to sell on, social sites to get the message across, and mobile devices to have access anywhere anytime it’s clear this business model is promising. The cool thing about these brands is that they typically start off with one very specific product niche, and expand from there.

While they didn’t start the trend, you could lump Amazon into the original digital native brand, though now they are everything and more to eCommerce and retail, which we will dive into soon. Beyond this though, these brand are doing three things really well: cutting out middlemen, controlling the supply chain or manufacturing and marketing straight to consumer. Most retailer are stuck with classic supply chains because they don’t make the product. New companies are realizing they can slash costs and go straight to the consumer now to increase their margins.

Subscription retail and eCommerce

Another one of the popular “millennial” inspired business model is the subscription model. This goes along with the razor/razor blade model in that usually the customer will buy something up front, say a razor, then each month they are automatically sent razors without having to repurchase. I personally have several things on subscriptions like my contacts, razors, and some foods even.

This model is great for retail and eCommerce because obviously you don’t have to do the work to acquire the sale again, and the sales are consistent each month. This model should be extended to more places. Retailers should be offering subscription plans at store checkout, on the shelf with signage, and on the website with links to subscribe. Any way to get someone on the subscription is a good thing.

Private Label

Private label has become all the rage of many retailers nowadays. With Amazon, Target, Walmart, Kroger and more of the largest, along with some smaller stores turning to private label to drive up the profit margins. Private label is simply controlling more of the production and distribution chain, while slapping your own label on it and charging slightly less. Target is one of the most famous examples of private label with their “Market Pantry” brand. Right next to them is Walmart, which, for a comparison did $49.3 billion worth of private label sales in 2013 out of $465.6 billion in gross sales.

Private label for some retailers doesn’t make sense as the number of products they carry is far smaller, and therefore doesn’t allow for it. However, for those retailers or departments stores trying to keep up, placing their own higher margin competitor right next the brand they carry makes all the sense. Private labels bring higher margin and better bargaining power. In supermarkets, average private labels have a margin of 12–15% compared to the average supermarket margin of 5–7%.

With that being said, if it’s in the cards for you to create a private label brand, it may be the savings grace you’ve been looking for, with the right partners of course.

Marketplaces

At the heart of many of the movers and shakers in the retail industry are the marketplaces which allow everyday people to begin selling on your platform. Marketplaces, from eBay to Amazon, Uber to Turo are growing in popularity. Their economics and startup costs can be daunting, but the fact is, this is one of the best ways to go. Niche marketplaces now make up one of the largest segments of retail in general. While some of the largest marketplaces own most of the real-estate and traffic, it’s still possible to have a niche marketplace succeed.

Typical marketplace margins are hard to estimate, and lack much evidence, however, they charge anywhere from 1.9% at Open Table (restaurant reservations) to 25% at Turo (car rental marketplace). With the right balance of marketing, the marketplace economics work very well.

As you can see, not all retail is made the same. While we have been inundated with stories of the “retail apocalypse” it’s not hard to see the retail environment is simply shifting to alternative sources and conveniences, which customers have come to prefer, and expect. If you have any comments, would love to see them. If you liked this piece go ahead and share.

If you’ve got a retail store or eCommerce site in need of rebuilding or enhancement, be sure to reach out to a specialist@orkiv.com.