Sales margins and sales volume are two sisters who work work hand-in-hand to determine the profitability and therefore the survival of your business.

Sales volume is the dollar value of the sales which your business makes during a given period while a sales margin is the percentage profit on each sale. A gross sales margin is the percentage of the sales price which remains after the cost of the item (or service) sold is subtracted. A net sales margin is percentage of the sales price which remains after the cost of the sold item (or service) sold and the cost associated with selling the item are both subtracted.

For example, let’s say that we are selling vintage ties online for $40 a tie and we normally pay $20 to buy them initially. The gross sales margin is 50% (($40 – $20) / $40). However, there are advertisement expenses (like Google Ads) equivalent to $3.50 a tie and credit card processing fees of a $1.50 a tie (3.75%). This means that the net sales margin is 37.5% (($40 – $20 – $3.50 – $1.50) / $40).

However, sales margins on their own are relatively meaningless. An 80% net sales margin doesn’t change much on a $5.00 item ($4.00 net profit per item sold) if you only sell 10 items per year. You need to have sufficient sales volume to cover your fixed business expenses such as rent, salaries and software subscriptions, and then for your net sales margin to still allow your business to turn a profit.

Primary Sales Structures

There are three main types of sale structures which lead to a business being profitable over the long term: (1) low volume, high margin; (2) high volume, low margin; and (3) medium volume, medium margin.

The first type of business (low volume, high margin) has highly differentiated (unique) products with relatively little competition. Luxury fashion brands are good example as they sell relatively few pieces at high prices, but the profit from each sale is substantial.

The second type of business (high volume, low margin) generally sells products which are quite indistinguishable from those sold by their competitors. This is normally a capital-intensive business where all the players compete on price as they all sell commodity-like products whereby the products sold by one are very similar by the products sold by a competitor. Large wholesalers such as Walmart and Costco are good examples as they have a massive number of sales which allows them to have extremely low margins. This is a particularly challenging business space to be in as you need to have huge sales volume to make money off of your business and, even then, a small change in cost can render your business no longer profitable.

The last type of business (medium volume, medium margin) is a space where most businesses are in. This means that there is a certain level of product (or service) differentiation, but not too much. Competition plays a role, but there is not a crazy race towards the bottom like in the preceding example. Your corner bakery is a good example of this type of business.

But what about a high-volume, high-margin businesses? That type of business is the true business dream and the golden goose, but it is next to impossible to sustain over a longer period. Intellectual property protection may allow such businesses to thrive over the short term (i.e. pharmaceutical companies when they come out with a new patent-protected drug.) However, since this business model is so attractive, its summons competitors who will drive down the business’ sales margin and sales volume by selling competing products at lower prices. To keep its sales, the initial player will have to also cut its prices and even improve its products. This drives down the initial business’ aggregate profit as: (1) sales volumes go down; (2) sales margins are reduced through lower sales prices; and (3) sales margins are reduced through increased costs (e.g. more production costs or more research and development costs).

Another way to look at this dream scenario is to view it as one in which the main player has a monopoly on a given product or service. As this monopoly is challenged, the main player loses its position of dominance which compels it to become more competitive and therefore to lower its prices and invest more in its product offerings.

Occasionally, start-ups find themselves in this dream scenario as they are the first to offer a certain product or service, meaning that they have no competitors. In such a situation, intellectual property protection is key, so try to patent your technology as soon as possible to prolong this exclusivity period. In addition, keep on focusing on research and development as each new innovation may open the door to additional patents and the associated protections from competitors. That being said, a parallel goal should be to increase your sales volume as much is possible to strongly position your business for the time when there is more competition in the marketplace, allowing it to increase its sales volume to offset a decrease in its sales margin.

Putting this all together, we see that the more unique the product (or service) offering or the more shielded it is from competition, the higher your sales margin can be. Conversely, the less unique the product or the more competitive the marketplace, the lower the sales margin.

This means that your first step is to determine how many other players are currently competing in the marketplace. Next, try to determine what type of demand there is in the market for your product at different price points. In addition, you need to see what price makes sense financially for you (see Pricing your Hourly Rate for more information on that point.) After having determined these price-demand points (a demand curve), your following step is to determine the supply which is currently on the market and the price points which your competitors are selling at (the supply curve).

With those data points in hand, you can now determine what type of business type you should target. A good rule of thumb is to aim for a 25% to 30% sales margin and even a little higher if your business is quite capital-intensive to account for the cost of that capital (i.e. interest charges). Obviously if you can get more, take advantage at least as long as your sales volume keeps on rising.

As a final note, try to avoid a long-term plan of undercutting your competitors with lower prices. Although this strategy might be successful at the start, another competitor will likely do the same to you a little bit further down the road. Rather, try to have some differentiating features to your products or services to better position your business should the market become more competitive. This should hopefully keep your business in the sweet spot of medium sales volume and medium sales margin. Best of luck!