Inventory is usually the biggest asset for retail or e-commerce businesses, and so it is important to be able to measure its ROI and take some steps to improve it over time. One of the inventory metrics used to evaluate inventory performance is GMROI.
What is GMROI?
GMROI stands for Gross Margin Return on Investment (aka. Gross Margin Return on Inventory Investment) and is used to measure the amount returned on every dollar invested in inventory. For example if GMROI= 3$ it means that for every dollar invested on inventory the return is 3$.
It can be used to improve inventory management or improve buying decisions by comparing different SKUs, departments or product categories and measure their respective ROI.
GMROI = Gross Profit ($) ÷ Average Inventory at cost ($)
You sell products for 100,000 $ in a year at a gross margin of 45% and the average inventory at cost value is 35,000 $
Gross Profit ($) = 100,000 x 0.45 = 45,000 $
GMROI = 45,000 $ ÷ 35,000 $ = 1.285 $
This means that for every 1 $ you invest in inventory you make 1.285 $
How to Use GMROI to Make Business Decisions?
Now you have seen that GMROI tells you how much you make from every dollar invested, but to really make the most out of the KPI, you need to start using it to compare between different products and categories and then make decisions based on that.
Let’s look at an example comparing different product categories. You can use the same approach to compare product departments, product SKUs or even different vendors.
You can see from the table above that Category 1 has the highest sales and also the highest gross profit because of the high top line. However it doesn’t have the highest gross profit margin, this goes to Category 3.
Now when we look deeper at GMROI level we will find that Category 3 & Category 4 have similar sales volume, and despite Category 3 having the highest gross margin of 56% it is Category 4 that is the most productive one with a GMROI of 2.13. That’s because Category 4 has a high inventory turnover, so during one year it sold over and over again, all with the same initial investment.
This means that if you invest 1$ in Category 3 you will get 1.12$ in return, while if you invest the same amount in Category 4 you will get 2.13$ (almost double!), all this while you will get the same sales volume from both. That’s why judging a product’s performance simply by sales or even gross margin is not enough to make the best out of your portfolio.
This is the beauty of retail math and knowing how to master your numbers !
When you look at your product portfolio down to this level you will start changing the way you buy.
You will start negotiating better with suppliers, by showing them how their products are not that productive and that you need to bring it up to the same productivity level as the other vendors or you will start shifting your buying budget towards more profitable vendors.
This will give you a higher bargaining power over your suppliers and you will start getting better prices or shifting your dollars to other, more profitable products.
You will also start making better pricing decisions by seeing how much you should price your products at to get the most out of them (hint: it is not by pricing them at the highest margin. In our pricing guide we explain why).
In 2015 I had a category that is highly seasonal and it contributed 5% to my sales. However; after analyzing this category I noticed that, because of seasonality, I have a very low timeframe to sell the goods at full price and also because of seasonality I have to carry the remaining products that didn’t sell at the end of the season to the same season next year. This meant: lower turnover + lower margins = horrible GMROI !
I started shifting my buying budget away from this category by giving it lower amount every year and giving other categories that were less seasonal and have good margins the shifted amount instead.
As a business this has improved my returns without necessarily improving my sales. This is one way to improve the performance of your retail or e-commerce business in a highly competitive market, where you are not able to get more sales every year.
You start looking at your returns from each and every product and optimizing them, and here is where GMROI, along with other KPIs can come in handy.
How to Increase Gross Margin Return on Investment
As we have seen from the GMROI formula, it comes down to two things: Gross Profit & Average Inventory
GMROI = Gross Profit ÷ Average Inventory
So improving GMROI can be done by:
1. Improving Gross Profit
- Optimizing your prices to make the most out of every product
- Optimizing your markdown levels
- Negotiating with your suppliers for better prices
2. Reducing Average Inventory
- Improving Inventory Turnover, again by pricing right or through tactical sales promotions
- Optimizing your buying, so that you don’t carry more inventory than necessary
- Analyzing your inventory reports to know what is performing and what isn’t and take action accordingly.
Now to put what we have discussed into perspective, let’s look at some industry benchmarks for GMROI. (Figures are quoted as an average of 5 years at median value for U.S publicly traded retailers).
GMORI by Retail Segment
|Retail Segment||GMROI ($)|
|Clothing & Accessories||3.3|
|Beauty & Cosmetics||2.8|
|Pharmacies & Drug Stores||5.2|
|Hobby, Toy & Games||2.3|
|Office Supplies & Stationary||6.6|
|Pet & Pet Supplies||4.2|
|Supermarkets & Grocery Stores||5.7|
|Food (Health) Supplements||4.8|
For more financial ratios benchmarks check out our annually updated list of Retail Benchmarks
As you can see from the above benchmarks for different kinds of retail businesses GMROI can vary widely. This is because it favors products with lower gross margins that result in high inventory turnovers. Therefore, you will find retailers with typically high turnovers, such as supermarkets have a high GMROI. This, however, doesn’t mean that they are more profitable. Actually supermarkets and grocery stores have very thin net profit margins.
This should be taken into consideration while comparing GMROI for different businesses, or even for different categories within your retail business. Make sure that you are comparing apples to apples, and that an artificially higher GMROI due to extremely low gross margin, and hence an extremely high turnover rate doesn’t cloud your judgement on how profitable this product really is.
Compare products that have margins and turnovers within a typical range for your retail business as we have shown above.
Gross Margin Return on Investment (GMROI) is one of several inventory metrics & KPIs that can help a retail or e-commerce business owner improve the performance of their business, by simply making better decisions about where to put their money.
In this competitive retail world today we are all selling pretty much the same things, just like in investment world people are investing in the same stocks. Some will end up making money and others will lose, even while investing in exactly the same names.
That’s because those who know their numbers and have a strategy use this to improve their returns over time and will have a competitive advantage over all the others.
Read more articles on inventory management .
Retailer & Founder of Retail Dogma, Inc.
Rasha has 12 years of retail & ecommerce experience. She has started an ecommerce business in 2008, and later worked at H&M, Bath & Body Works, Victoria’s Secret and Landmark Group.
She has lived in 4 different countries, speaks 3 different languages and holds a master’s degree in Strategic Management & Marketing.