03 Sep What is GMROI in Retail? (Formulas, Benchmarks, Examples)
As a retailer, inventory is one of your biggest investments.
Afterall, retailers invest in merchandise hoping to sell it at a profit. That’s the crux of the entire retail business model. As such, the GMROI formula is used to evaluate how successful retailers are in getting a return on their inventory.
In fact, GMROI is one of the top key performance indicators (KPIs) used in retail.
Calculating GMROI is like taking your business’s temperature. It can let you know how financially healthy your business truly is, or even how profitable a category or a single product is. A low GMROI is often the cause of poor business performance for retailers.
The good news is once you know what your GMROI is, you can take clear steps to improve it.
What is GMROI?
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 calculating 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.
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
While the formula for GMROI will be similar in most situations, the costs taken into account will be very different depending on your goal.
As mentioned above, GMROI is most commonly used to calculate the profitability of inventory purchases. As such, this is the formula we will be focusing on.
According to Quickbooks, the standard formula for inventory GMROI is:
GMROI = Gross Margin / Average Inventory Cost
But 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) * 100
Ultimately, the exact formula will depend on many variables, chief of which is the internal accounting system of your organization.
Regardless 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 Example
Using 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 regards to your inventory. No more wasting money on products that don’t sell or won’t earn you a healthy profit.
Problems with GMROI
While 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 then 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
While some say that a GMROI of $2 reflects a healthy retail business, others say that this is too low.
For example, statistics published by The Retail Owners Institute show that the average GMROI for shoe stores was $1.86, while electronic stores had a GMROI of $4.07.
Ultimately, a “good GMROI” will depend on how much control a retailer has over costs and prices.
Retailers that deal with vendors that dictate costs, or those in highly competitive markets will experience lower GMROI. Conversely, specialty retailers that are more vertically integrated and manufacture their own product will see a higher GMROI.
And as mentioned above, GMROI will also heavily depend on your market position in terms of branding. High-end brands will have a higher GMROI than a discount brand.
So, to determine a “good GMROI,” you need to conduct market research and compare your organization to similar retailers in your space.
How to Improve GMROI in Retail
Not happy with your GMROI and want to do better?
Here are some good ways that you can turn things around:
1. Improve Your Forecast Accuracy
Low GMROI is, by definition, a bad investment into inventory. That is, buying too much inventory and not selling it through.
Thus, retailers that can accurately forecast future demand can make better purchasing decisions and get more return on their inventory investment. Basically, If you knew exactly how many units of each SKU to allocate to each location and channel to maximize sales and minimize costs, you’d command a very high inventory ROI.
But that’s not the only benefit.
Being able to predict demand will also help you improve the distribution of your existing inventory. Without purchasing new inventory, incorporating an accurate demand forecast would allow you to rebalance inventory optimally across your stores — shifting slow moving inventory from one store into the fast-lane at another store.
Keep in mind, however, there is a big difference between retailers that simply use past sales to create a forecast and those that use advanced analytics (taking into account dozens of influencing factors) to calculate demand.
2. Optimize Your Pricing
At first glance, this seems simple.
Increase the ticket price of an item, and this will increase your GMROI. Right?
But hold on.
If all things are equal, when prices increase, total sales decrease. That’s the law of supply and demand at work. That means that if the price was set too high and people stopped buying your product, your GMROI would decrease.
That’s why just increasing prices has no guarantee of increasing your GMROI. And if done irresponsibly, can actually hurt your bottom line quite a bit.
But decreasing prices can also improve your GMROI.
Let’s say you have a large quantity of deadstock taking up shelf-space. This inventory brings no revenue, and is thus pure cost.
If you knew the exact price that would allow you to move all of this inventory at maximal revenue, you could increase your GMROI while dropping prices.
So instead of increasing or decreasing your prices, you should be thinking of setting your prices to the point of maximal GMROI per SKU / store.
Using price as a lever to optimize GMROI is so successful, in fact, that there is a multi-billion dollar industry of analytics companies providing pricing optimization software to retailers.
Regardless of whether or not you’ll be using such software, it would benefit you to approach pricing more scientifically — as initial prices, seasonal prices, promotions, and markdowns are all heavily related — and should be part of a strategic price management strategy as a product moves through the product life cycle.
3. Cut Your Inventory Costs
Use smart strategies for your online order fulfillment and returns management.
This can help you reduce your business costs that can cut into your GMROI. As customers are becoming more tech-savvy and expect flexible fulfillment options, retailers need to be careful about which strategies they employ to satisfy these consumer trends in a cost-efficient manner.