What does GMROI measure?You may already be familiar with the term Return on Investment or ROI. Traditionally, return on investment measures how much profit you get when you invest a dollar. GMROI stands for Gross Margin Return on Investment and is usually used in the retail industry for analyzing and calculating the profitability of inventory purchases. In other words, the GMROI formula lets you know how much profit you get from each dollar you invest into inventory. It is a measurement of the cost of purchasing, transporting, and holding inventory, plus the cost associated with fulfilling customer orders for that inventory — compared to the gross margin you receive from selling that same inventory. Want to see how you stack up in your industry? Download our GMROI Benchmarks Report Today! GMROI is also sometimes called the Gross Margin Return on Inventory Investment.
How is GMROI calculated?There are several different approaches that companies take to measuring GMROI, each based on the nuances of their unique internal accounting systems. Even amongst retailers, GMROI can be calculated slightly differently. This is because retailers incur many different types of costs, month-to-month:
- Real estate
GMROI = Gross Margin / Average Inventory CostBut for internal accounting purposes, retailers may use variations of this formula to get slightly different numbers. For example, retailers may want to calculate gross margin as a percentage, and will use a formula like:
Gross Margin % = ([Revenue – CoGS] / Revenue) * 100Ultimately, the exact formula will depend on many variables, the chief of which is the internal accounting system of your organization. Regardless of how this number is presented (as a dollar value, a ratio, a percentage, etc.), its purpose should still be the same. GMROI should measure the profitability of your inventory investment.
GMROI Calculation ExampleUsing the formula above, we can calculate the inventory GMROI of a fictional company, ACME Corp. Let’s assume that ACME has a revenue of $1,000,000, a CoGS (cost of goods sold) of $500,000, and an inventory cost of $200,000. First, we have to calculate the Gross Margin of ACME. Revenue ($1,000,000) – CoGS ($500,000) = Gross Margin ($500,000) Next, we divide the Gross Margin ($500,000) by the Average Inventory Cost ($200,000). This gives us a GMROI of $2.50. In other words, ACME Corp makes an average of $2.50 in profit for every dollar they spend on inventory.
Why is GMROI useful?Knowing how to calculate GMROI is useful in several ways. Perhaps most importantly, GMROI helps you gauge whether you are making a profit on the inventory you have. While many retailers are happy enough with a strong gross margin, knowing your GMROI can unveil issues with your inventory that are holding you back from higher profits. Unfortunately, many retailers have inventory that is costing them money rather than earning them profits. When you have inventory in your store that costs you money it cuts into any profits you do earn from your sales. Once you know what a good GMROI is, you’ll be able to make better decisions with regard to your inventory. No more wasting money on products that don’t sell or won’t earn you a healthy profit.
Problems with GMROIWhile inventory GMROI is a very useful metric to have, there are a few problems with using a high-level formula to “measure your temperature”:
- This formula won’t tell you how effectively you’re spending on real estate, workforce, transportation, or marketing — giving you only a portion of the picture for your company’s profitability. You can have a very healthy GMROII, but still, be losing money due to malinvestments in other areas.
- Using this formula for yearly CoGS and revenue will give you no insight into the performance of individual products, lumping money sink product lines and runaway hits into one metric. To use this metric effectively, you have to get more granular (measuring GMROI for categories, for example)
- However, attempting to distill cost down to an individual SKU or store / SKU combination is almost impossible to do manually — making granular analysis using this metric very difficult without specialized tools
What is a Good GMROI in Retail?While having a GMROI over $1 shows that you are making a profit on your inventory, it may not be enough to cover your total business costs. In other words, a positive, but low GMROI can still cause poor business performance. So, just what is a good GMROI for retail? Determining a good GMROI for retailers is difficult because every retail business is unique and the average GMROI can vary quite a bit depending on the retail vertical (car dealerships vs. grocery stores) and market segment (EDLP vs. luxury).
- Retailers that have very high sales numbers typically work with a smaller margin (because they require excess inventory to operate)
- SKUs with a large stock turn will typically have lower margins
- High-profit single items will usually sit on shelves longer, producing a lower overall GMROI