Retailers tell you that retail is a brutal business. Trends shift. Consumers are bargain hunters. Expenses are high. Several years ago, retailers began to shift into the credit card business to pursue higher margin lines of business.  The rationale being that traditional retail was making so little money but, with such high traffic into the store, the retailer might as well sell something a little less labor intensive and with higher margins. Hence, Walmart attempting to obtain a banking license and retailers like Canadian Tire and J. Crew issued credit cards.

Yet, you hear about Nike shoes being manufactured for under $10 and selling for over $150 and wonder if the retailers are pulling your leg. Are they making a bundle but crying poor?

I took a look at a completely random sample of public traded retailers to see who is zooming whom.

Walmart is the largest retailer in the United States.  As a discount retailer, its margins should be low since it works on volume and not margin. For the quarter ending January 31, 2009, its operating income (which is earnings before interest and taxes so think of how much the store itself brings in) was 5.6%.

The Gap Inc. consists of a mixture of low end (Old Navy), mid-market (the flagship Gap store) and higher end (Banana Republic) clothing stores. I could consider this a middle-class retailer since it has a little bit of everything thrown in- low, medium and high. When you mix it all together, the Gap reported operating income of 13.9% in Q3 2009.

Lulu Lemon Athletica has convinced all of us that paying $90.00 for track pants (albeit stretchy ones) is not only acceptable but trendy. Most would consider Lulu Lemon on the high end of the retail market and, unlike the Gap Inc., is not dragged down by any lower end lines. For the quarter ending November, 2009, its operating income was 18.5%.

For mature businesses, a profit margin in the high teens is respectable. However, this is a far cry from the belief that retailers have a huge mark-up on their product. Is this an urban myth or is there truth to this?

It depends on how you look at the numbers. If you looked at net sales minus cost of goods sold- in other words, the retail price minus the direct cost of making the good (the materials and labor to make the good)- the margins tend to be outrageously high. For example, the Gap’s margin is approximately 42% while Lulu Lemon’s is approximately 50%. So, yes, developing country workers are sharing very little based on the profit made at the counter.

But add in operating expenses- the rent, the store employees, the warehouses, transportation etc.- which are not related directly to the cost of the goods and that margin gets reduced significantly. How significant? Try going from 40-50% gross margins to the teens.

Thus, there is some nugget of truth that retailers are making a killing selling us goods.  Alas, they cry, if only we could do it without all that overhead!

Hence, retail e-commerce is hailed as a savior for retail. Now, if only they could sell their goods on-line significantly cheaper than at the store…