Profit Margin vs. Return on Investment (ROI)

When it comes to selling products, there are two main ways to determine how much money you make on each sale: Profit Margin and Return on Investment (ROI).

It’s important to understand what Profit Margin and ROI mean and how you can use them to measure the success of each sale and of your business overall. Understanding how to calculate each one and when to use each measurement is key to knowing what products to source and what prices to sell them at.

In this article, we’ll break down what Profit Margin and ROI are, what the differences between them are, and how you can determine which one is best to use for your business. We’ll also go over how you can use each one to determine price thresholds for your products.

What is Profit Margin?

In simple terms, Profit Margin focuses on the total price that you sold your product for, and is calculated as Profit / Revenue.

This means that to determine what your profit margin is, you simply take your profit (how much money you made after any expenses, such as costs and fees) and divide it by your revenue (the total amount of money you made on a sale).

When determining your profit, your expenses include things like your item's purchase costs and any fees that are assessed by the marketplace that the item is sold on. For example, if you are selling items on Amazon and using their Fulfilled by Amazon (FBA) shipping method, the fee that you pay Amazon to ship your product would be considered an expense and would need to be taken into account when determining the profit that you made after fees.

Here’s an example:

If you bought an item for $40, sold it for $200, and Amazon Marketplace took a cut of 15% ($30), you would have a profit of $130 and a profit margin of 65%.

Profit is your Revenue ($200) - Cost ($40) - Fees ($30) = $130

Profit Margin is your Profit ($130) / Revenue ($200) = 65%

What is ROI?

ROI, which stands for Return on Investment, focuses on how much money you made in relation to how much money you invested and is calculated as Profit / Cost.

Your profit is simply how much money you made on a sale after any expenses, and your cost is simply how much it cost you to source the product. For example, if you bought an item at a retail store for $20 to then resell on Amazon Marketplace, your item’s cost was $20.

Here's an example:

If you bought an item for $40, sold it for $200, and Amazon Marketplace took a cut of 15% ($30), you would have a profit of $130 and a return on investment of 325%.

Profit is your Revenue ($200) - Cost ($40) - Fees ($30) = $130. Cost is the amount it cost you to source your product, which is $40 in this example.

ROI is your Profit ($130) / Cost ($40) = 325%

Profit Margin vs. ROI: What’s the difference and which should I use?

Now that you understand what Profit Margin and ROI are and how they are calculated, you may be wondering what exactly the difference is and how you should determine which measurement to use for your business.

Ultimately, there is no “better” choice - some businesses prefer to prioritize their Profit Margin, and some choose to prioritize their ROI.

Let’s break down the basic difference between the two approaches: Profit Margin ultimately focuses on a company’s overall profitability, whereas ROI ultimately focuses on the efficiency of a company’s investments.

Here’s some of the main reasons that a company might focus on their Profit Margins:

• Helps to identify immediate profitability trends, such as on a monthly or quarterly basis
• Showcases exactly how much of your revenue is profitable
• Ultimately shows how effectively a business generates profit from its operations

And here’s some of the main reasons that a company might focus on their ROI:

• Helps to identify long-term trends, such as seeing if investments have paid off over time
• Showcases how valuable a business investment is
• Ultimately shows the efficiency of an investment by analyzing the returns of that specific investment

We ultimately recommend choosing the metric that best suits your business needs since each metric focuses on different aspects of your business’s financial performance. Profit Margin is a great choice if you want a holistic view of your business’s financial health, while ROI is a great choice if you’re looking to identify the most profitable investment opportunities and optimize resource allocation.

Using Profit Margin and ROI to determine price thresholds

One of the most beneficial ways you can use these metrics is by utilizing Profit Margin and ROI when setting price thresholds for your listings.

It can be a major pain point for online sellers to figure out what the minimum and maximum prices for their listings should be and many sellers don’t know where to start. Utilizing Profit Margin and/or ROI in your price threshold calculations is a very effective way to set prices for your listings that will ensure all of your sales will be profitable.

Here’s how to use Profit Margin to set price thresholds:
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1. Decide what you want your minimum target profit margin to be. You could have an across-the-board target profit margin for all your listings, or you could group your listings into different categories with various target profit margins. For example, if you know a certain category of products you sell typically yields higher profit margins, you may want to set a higher target profit margin for those specific listings.
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2. Be realistic about your target profit margins. While it would be nice to make a 90% profit margin on every sale, this is not going to be realistic for the majority of listings and products. Research industry benchmarks for your specific product categories to determine what realistic margins are.
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3. Set your minimum prices based on your target profit margin. For example, if you’ve decided you want all your listings to sell at a minimum 25% profit margin, simply calculate what a 25% profit margin would be and set that as your minimum price threshold for each listing. You can do this manually, or use a repricing tool such as Informed Repricer to do this automatically for all of your listings in just a few minutes.

Here’s how to use ROI to set price thresholds:
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1. Decide what you want your minimum target ROI to be. You could have an across-the-board target ROI for all your listings, or you could group your listings into different categories with various target ROIs. For example, if you know a certain category of products you sell typically yields higher ROIs, you may want to set a higher target ROI for those specific listings.
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2. Be realistic about your target ROIs. While it would be nice to make an 800% ROI on every sale, this may not be realistic for the majority of listings and products. Research industry benchmarks for your specific product categories to determine what realistic ROIs are.
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3. Set your minimum prices based on your target ROI. For example, if you’ve decided you want all your listings to sell at a minimum 200% ROI, simply calculate what a 200% ROI would be and set that as your minimum price threshold for your listings. You can do this manually, or use a repricing tool such as Informed Repricer to do this automatically for all of your listings in just a few minutes.

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