Running a dropshipping store can be a very profitable venture without holding inventory - but you must be aware of the profit margin stats and what they mean for your business.
If you’ve ever worked in retail, you know that the profit margin is one of the most critical numbers for a business.
Everything you sell needs to be priced appropriately, which means understanding how much profit you will make on each item.
In this article, we will break down all the information you need to know about dropshipping profit margins, including how to calculate them and what values you should be aiming for.
We will also provide some tips at the end to help increase your profit margin!
Why should you analyze your dropshipping profit margin?
Isn't all this effort into finding your dropshipping profit margin a bit overkill?
No!
Analyzing your profit margins is essential - especially if you want to be successful in the long term.
There are a number of reasons for this:
- It allows you to find more profitable products and dropship them instead of less profitable ones.
- It helps you understand your business better and make informed decisions about where to invest your money.
- It allows you to price your products correctly and avoid leaving money on the table.
- It helps you track your progress and see if you are improving over time.
In short, if you don’t know your dropshipping profit margin, you won’t be able to tell which products are making you money and which are costing you money.
As a result, you could end up dropshipping a lot of products that don’t make you any profit at all!
So, now that we have established how important it is to calculate your profit margin, let’s move on to how you can do it.
How do you calculate the profit margin of your dropshipping store?
Calculating your dropshipping profit margin is pretty simple.
You can calculate two types of profit margins: the gross profit margin and the net profit margin. Both measure how efficient a dropshipping store is at generating profits.
Let's go over both of them below:
Calculating the gross profit margin
The gross profit margin indicates how profitable your dropshipping store is for each sale, given the costs involved with each sale.
It is the easiest to calculate and simply indicates how much profit you are making on a sold product.
To calculate your gross profit margin, you must take your total revenue from sales and subtract the cost of goods sold (COGS). This will give you your gross profit.
Gross profit = Total revenue - COGS
Once you have your gross profit, you can divide it by your total revenue to get your gross profit margin. Here's the formula:
Gross profit margin = Gross profit / Total revenue
For example, let’s say you have a dropshipping store that made $100,000 in sales last month. If the cost of goods sold were $60,000, your gross profit would be $40,000.
You would divide $40,000 by $100,000 to get your gross profit margin to get 0.40.
To conclude, your gross profit margin would be 40%!
Calculating the net profit margin
The net profit margin is the ultimate measure of profitability for a company.
It is a bit more complicated to calculate than the gross profit margin because it considers all your other expenses when running your dropshipping business.
For your ecommerce store, you can have expenses for things like:
- Marketing campaigns
- Ecommerce platforms
- Dropshipping suppliers
- A domain
- Apps
- Transaction fees
- Taxes
- And more!
To calculate your net profit margin, you will need to take your total revenue from sales and subtract the cost of goods sold and all other expenses. This will give you your net profit.
Net profit = Total revenue - COGS - All other expenses
Once you have your net profit, you can divide it by your total revenue to get your net profit margin.
Net profit margin = Net profit / Total revenue
For example, let’s say you have a dropshipping store that made $100,000 in sales last month.
If the cost of goods sold was $60,000 and your other expenses were $20,000, then your net profit would be $20,000.
To get your net profit margin, you would divide $20,000 by $100,000 to get 0.20.
In other words, your net profit margin would be 20%.
However, if you want to make finding your net profit margin a bit simpler, we have something awesome for you.
Did you know that we have developed a profit margin tool calculator tool?
That's right!
You can use it to find your profit margin in just a few simple steps. Check it out here!
Now that we’ve gone over how to calculate your dropshipping profit margins, let’s talk about what values you should be aiming for.
What is a good profit margin for dropshipping stores?
Once you’ve calculated your gross and net profit margin, you might be wondering: “Are these good profit margins?”.
Unfortunately, there is no definitive answer to this question, as the 'right' dropshipping profit margin will vary depending on a number of factors.
These factors can include things like the type of products you are dropshipping, your target market, your advertising budget, and more.
That being said, there are a few general guidelines you can follow when it comes to dropshipping profit margins.
For most dropshippers, a 30-40% gross profit margin is considered good.
This means that for every $100 in sales, you should be left with around $30 to $40 after buying the products from your supplier.
Meanwhile, you should aim for a net profit margin of around 20%.
In other words, after taking into account all of your expenses, you should be left with $20 in profit for every $100 in sales.
All in all, the most important thing is that you are making enough revenue to cover all of your expenses and then some. In other words, running a profitable dropshipping store.
If you can do that, then you are on the right track!
The 7 most important profit margin stats for your dropshipping store
Here are some of the most critical profit margin stats for your dropshipping store:
- Cost of Goods Sold (COGS)
- Shipping costs
- Average order value (AOV)
- Conversion rate
- Customer lifetime value (CLV)
- Customer acquisition cost (CAC)
- Refund rate
Now, let’s take a closer look at each of these:
Cost of Goods Sold (COGS)
The cost of goods sold (COGS) is often the most significant expense for dropshipping stores. It is based on how much it costs to manufacture the products sold.
The COGS may differ for those buying wholesale and manufacturing their own products.
For a dropshipping store, the COGS is equal to the price you pay at your dropshipping supplier.
For example, let’s say you sold 100 products in the last month and paid your supplier $5 per product. In that case, your COGS would be $500.
As mentioned earlier, the COGS is a key ingredient in calculating your gross profit margin. Therefore, it is a crucial statistic!
If you are using Shopify, you can set up your COGS for each product by going through the following steps:
- Select ‘Products’ in the Shopify admin.
- Pick the product you want to edit.
- Add the ‘Cost per Item’ in dollars to the ‘Pricing section.’
- Save the changes.
Related article: How Do You Track Your Profit in Shopify? (7 Apps & Tips)
Shipping costs
Like COGS, shipping costs are a significant expense for dropshipping businesses. They include expenses needed for shipping labels, packaging, and postage.
You can find your store's shipping costs by checking what you paid your supplier for shipping for all orders you shipped in a given period of time.
For example, let’s say you shipped 100 orders in the last month, and you paid your supplier an average of $3 for shipping per order. In that case, your shipping costs would be $300.
Average Order Value (AOV)
The average order value (AOV) is the average amount of money each customer spends on your store.
To calculate your AOV, divide the total revenue from sales by the number of orders.
AOV = Total revenue / Number of orders
For example, let’s say you had 100 orders in the last month and the total revenue from these orders was $5,000. Your AOV would be $5,000 divided by 100, or $50.
Generally, your dropshipping profit margin will increase if you manage to increase your AOV.
However, it also strongly depends on the items you sell. For instance, a store selling phone cases will have a lower AOV compared to a store selling treadmills.
Conversion Rate
The conversion rate is the percentage of your store's visitors that make a purchase.
To calculate your conversion rate, divide the number of orders by the number of unique visitors.
Conversion rate = Number of orders / Number of unique visitors
For example, let’s say you had 50 orders in the last month and 1,000 unique visitors. By dividing 50 by 1,000, you get 0.05. In other words, 5% of your store's visitors made a purchase.
The average conversion rate for Shopify stores is between 0.6% and 3.1%. Meanwhile, having a 4.2% conversion rate would put you in the top 10%. (Source)
Also, keep in mind that not all niches and products have the same conversion rates:
Tip: A higher conversion rate will result in a higher net profit margin. If you would like to increase your conversion rate, take a look at our 12 tips here!
Customer Lifetime Value (CLV)
The customer lifetime value (CLV) is the average amount of money each customer spends on your store throughout their lifetime. Therefore, it is a tool to help you estimate your store's future revenue.
When calculating your CLV, you will often have to make certain predictions, as you never know for sure if a customer will purchase from your store again in the future.
If you are running a dropshipping store, you can estimate your CLV by multiplying your AOV with an estimated number of transactions per month (per customer) and an estimated retention period (the number of months you expect a customer to keep returning to your store).
CLV = AOV * Number of transactions per month * Retention period
The more often a customer comes back and purchases from you, the higher the customer's lifetime value will be. This will help you to increase your net profit margins!
Various profit analytics apps are also available to help you estimate your CLV. For example, the Lifetimely app on Shopify can be a great tool:
Customer Acquisition Cost (CAC)
The customer acquisition cost (CAC) is the average amount of money you spend to acquire a new customer.
To calculate your CAC, you should take your total marketing and advertising expenses for a given period and divide it by the number of new customers you acquired in that same period.
CAC = Total marketing expenses / Number of new customers
For example, let’s say you spent $1,000 on marketing and advertising in the last month and acquired 50 new customers.
Your CAC would be $1,000 divided by 50, resulting in $20.
If your CAC is lower than your CLV, you are headed in the right direction! This means that a customer will pay you more money during their lifetime than what it costs you to make them a customer.
However, this doesn't mean you will be profitable because you also need to pay your other expenses from that revenue!
Refund Rate
The refund rate is the percentage of orders that are returned.
To calculate your refund rate, simply divide the number of refunds by the total number of orders.
Refund rate = Number of refunds / Total number of orders
For example, let’s say you had 100 orders in the last month, and five of those orders were returned. Then your refund rate would be 5%.
A high refund rate is disastrous for your dropshipping store's profit margin. First of all, your revenue decreases as you are forced to return the money to the customers. And secondly, your expenses rise as you are generally the one who has to pay for all shipping expenses and transaction fees.
How do you increase your dropshipping profit margin? (5 Tips)
Now that we’ve gone over everything you need to know about dropshipping profit margins, let’s talk about a few tips that can help you to increase your margins.
1. Use a dropshipping pricing strategy
When adding new products to your dropshipping store, you might ask yourself:
“How do I price my products?”
That’s precisely what a pricing strategy covers!
A pricing strategy takes into account various characteristics of your business and calculates an optimal selling price as an output.
By using a pricing strategy, you can avoid:
- Setting your product's price too high. This can lead to you missing out on sales.
Or: - Setting your price too low. This can cause lower profit margins as you will miss out on potential profit and revenue, which you might have had with a proper pricing strategy.
It may sound unnatural, but a pricing strategy may give you a reason to lower your product prices to increase your dropshipping profit margin.
For example, let's say you lower your product's price by 20%. In return, your conversion rate rises by 50%. In that case, your profit margins may actually increase!
There are a lot of different pricing strategies that you need to know. For example, you can have a fixed dollar markup or a fixed percentage markup.
To learn more about the best pricing strategies for your dropshipping store, check out our article here!
Plus, check out this article here if you're dealing with multiple product variants.
2. Lower your product costs
Another way to increase your dropshipping profit margin is by lowering product costs (COGS).
Just remember, when dropshipping, your COGS is one of the most essential factors in determining your profit margin.
You can lower your COGS by using a number of strategies.
First of all, you can negotiate lower product prices from your supplier. That way, you can sell the product for the same price but make a higher profit.
You can also look for cheaper shipping methods, which allow you to lower your expenses.
Finally, you can source your products from other suppliers to compare prices and find the cheapest option.
3. Avoid unnecessary expenses
Next up, try to avoid any unnecessary expenses.
Do you have any paid apps installed that you don't really use? Have you been running a marketing campaign for quite some time already that doesn't reap its fruits? Can you save on any subscription costs?
If so, get rid of those apps, end that marketing campaign, and cancel that subscription. By doing so, you will free up some funds that can be put towards other more important areas of your business.
Reinvesting in your dropshipping business is always a good idea to make sure it keeps running smoothly and efficiently.
But even if you don't see an opportunity to reinvest the money you saved, your profit margin will still increase as your expenses have been lowered!
A dropshipping business is like any other business - it requires time, energy, and money to keep it running.
4. Attract free traffic to your dropshipping store
A surefire way of increasing your profit margins is by attracting free traffic to your store. That is, if you can manage to attract free traffic and if those visitors will convert to paying customers.
Our tip here is to focus on creating high-quality content.
By writing blog posts, making videos, or posting on social media, you can attract free traffic from people who are interested in what you have to say.
And if those people like what they see, there's a good chance they will visit your store and make a purchase.
5. Start upselling or cross-selling
Last but not least, start upselling or cross-selling!
Upselling and cross-selling are sales tactics that aim to get customers to spend more money by buying additional or related products. These strategies can be effortlessly implemented with the help of powerful tools like MonsterUpsells or ReConvert.
For example, let’s say you’re selling a phone case in your dropshipping store.
An upsell could be offering a higher-end phone case with a tempered glass screen protector.
On the other hand, a cross-sell could be to offer a related product, like a phone stand or a phone charger.
Here, MonsterUpsells' 'Frequently bought together' feature can suggest these related products to customers within the cart, enabling them to add the suggested item with a single click.
By offering these additional products, you can increase the average order value and, as a result, your dropshipping profit margin.
So, start utilizing these powerful upselling and cross-selling tactics to optimize your store's revenue potential.
Conclusion
Dropshipping profit margins are important to understand if you want to succeed with dropshipping.
Be sure to calculate your gross profit margin, net profit margin, and the other profit margin stats so you can track your progress and see how well your business is doing.
If you are looking for the easiest way to calculate your dropshipping profit margin, check out our profit margin calculator here!
And last but not least, use our tips to increase your dropshipping profit margins even further.
For example, don't forget to set up a proper dropshipping pricing strategy and ensure you know what to do with your competition.
That's it for this article. We hope you found it helpful and informative. If you did, please share it with your friends and followers!
And if you have any questions about dropshipping profit margins, you can let us know in the comments below!
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