How do grocery stores make money with low profit margins?


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Auditor William from Buffalo, New York asks:

Grocery stores still complain that the company has “incredibly thin” margins. Sometimes they quote 2 or 3 percent. If that’s true, why would anyone be in the grocery business, when in the long run, stocks and bonds win out. And without the effort and potential liability? Something is wrong. Ideas ?

Overall, grocery store profit margins are around 1% to 3%, but those numbers don’t tell the whole story.

There are other financial parameters to consider, said Peter Zaleski, an economics professor at Villanova University.

He gave this example: Let’s say you buy a grocery store that costs $5 million and you buy it as if you were buying a house. You’ll put down 20% by investing $1 million and borrowing the rest.

Now suppose the store generates $15 million in sales in one year and you make a profit of 1%, or $150,000. But as a percentage of the value of the store, which cost $5 million, the profit rate is 3%.

“It sounds a little better. But that still doesn’t make us excited,” he said. “Except remember: we didn’t invest $5 million, we only invested $1 million. So on our million dollar investment, that’s a 15% rate of return.

So, he added, there are three rates of return to pay attention to: There is a percentage of profit that is a return on those sales — 1% in the example above. Then there is return on assets (3%) and return on equity (15%).

And don’t forget, grocery stores sell a ton articles, in particular products.

“Of course, we’re only making 1% profit, but it’s worth being in this business because we’re making it in volume,” Zaleski said.

As another example, take one of the largest fast food franchises in the world: McDonald’s.

“McDonald’s doesn’t make that much money on every burger, but it sells billions,” said Shivaram Rajgopal, an accounting and auditing professor at Columbia Business School.

Meanwhile, he explained, a fancy French restaurant has a higher margin because it “sells you a lot of expensive wines and fancy dishes”, but turnover is low because customers can go there. to spend hours.

One of the benefits of being in the grocery store is that you sell necessities and have returning customers, Zaleski explained.

Some wholesale stores, like Costco, have an army of enthusiasts who have created Instagram and TikTok accounts touting the deals you can get there.

Noor Abdel-Samed, managing director of LEK Consulting, pointed out that Costco reported a profit of $1.3 billion last quarter on $52 billion in revenue. This equates to a 2.5% net profit margin, or return on sales.

“It’s perfectly fine, it’s healthy. If you try to raise that too much by raising prices, people stop shopping. If it gets too low, you don’t have money to spend investing in new locations,” Abdel-Samed said. “So everything is carefully calibrated to stay competitive with others, but also to be able to maintain operations and generate enough profitability to continue and grow.”

Abdel-Samed said the initial margin for a grocery store might be 20%, but then you have to pay the company’s executives, as well as labor and shipping costs.

A successful grocery store starts with having the right products and adapting them to the type of place you are in, he explained. For example, if you’re in rural Georgia, he said it makes sense to stock larger products. Since people have to drive to get to the store, they can load these larger items into their vehicles.

Abdel-Samed said large grocery chains used to treat all of their stores the same, but now they customize each store to cater to the region they are in.

You also need to strategically price different items and provide competitive bids for staples such as bananas or bread, he added. Some grocery items have such low markups for certain items that they are loss leaders — like rotisserie chicken, which has become a staple in stores across the country.

But Abdel-Samed said you compensate for those products with items that may not sell as much, but have higher profit margins.

Grocery stores have launched their own private labels over the past 10 to 15 years, which generate higher profit margins since they don’t have to buy them from a big brand like Procter & Gamble, according to Abdel-Samed. .

Although grocery stores make up for low profit margins in other ways, Zaleski and Abdel-Samed said it’s still a tough business. Small stores especially face certain disadvantages.

“Large national chains have the scale to make deals with manufacturers on massive quantities of goods that can be sold at a lower unit price because the chain sells more of it in more places,” said Jim Dudlicek, a spokesperson. for the National Grocers Association, in an emailed statement. “To compete, some small independent retailers may become members of wholesale organizations or buying cooperatives that guarantee volume discounts that small grocers could not obtain on their own.”

We are also in the midst of the greatest period of inflation in 40 years. Supply chain issues, rising costs and labor shortages are also straining grocery stores, prompting some stores to close.

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