How Do Retail Stores Make Money? The Simple Guide

How do retail stores make money? More importantly, how do they make sure they’re constantly optimizing and increasing their profits?

On a broad level, retail is essentially a “service” industry, where store owners make money by providing the “service” of making products available to customers. In today’s world, retailers don’t even have to manufacturer the goods they sell themselves, they simply need to ensure that purchasing those goods is convenient.

Right now, the retail sector is going through a significant change, thanks to the rise of technology and digital transformation. New business models are constantly emerging, alongside new opportunities to increase profits. Here’s what you need to know if you’re launching your own retail store in 2024.

In this article:

• Retail stores can use various strategies to generate revenue, from selling products, to delivering services, and offering access to subscription and membership programs.
• To ensure they’re earning the highest profits, retailers need a comprehensive strategy for everything from pricing, to effective inventory management.
• Investing in customer acquisition and retention strategies, customer experience, and promotional campaigns can help retailers increase revenue.

Revenue Streams in Retail Stores

Ask most people “How do retail stores make money?” and they’ll give you the same answer: by selling products. Product sales are the primary source of income for most retailers.

But how products are manufactured and sold can vary. Some retailers purchase materials from a third-party vendor and manufacture items themselves to sell for a profit.

Most, however, purchase goods at wholesale prices, and sell them to customers with a “markup” cost added. The markup percentage applied by a retail can vary based on everything from the product category, to the perceived value of the item, and even the costs incurred by the retailer.

However, there are other ways for retail stores to make money too, such as:

• Delivering services: Some retail stores sell “services” alongside physical products. For instance, fashion companies might offer tailoring and alteration services. General retail stores can offer home delivery options. Some organizations even offer installation, maintenance, or personal shopping services to generate extra revenue.
• Subscription models: In the last decade, the subscription economy has grown by an incredible 435%. Retailers can access recurring income, by allowing customers to automatically purchase certain items on a weekly, monthly, or yearly basis.
• Membership programs: Membership programs can sometimes be free to access (such as loyalty programs), but they can also incur an additional fee, which gives customers access to extra benefits. For instance, Walmart+ subscribers get unlimited free grocery delivery.

Pricing Strategies in Retail Stores

Various factors can affect how much money retail stores actually make. Perhaps the most significant is the approach a company takes to “pricing” its products. Effective pricing strategies are how retailers ensure they can not only maximize profits, but attract customers (and potentially entice consumers away from competing stores).

Here are three of the most common pricing strategies, and how they affect retail revenue.

Markup Pricing

Probably the most common pricing strategy, markup pricing involves adding a fixed percentage to cost of creating or accessing a product, to determine the final selling price. The average “markup” varies based on your industry. Retail grocers, for instance, often add a markup cost of 15%.

Markup pricing ensures retailers can pay for the cost of actually accessing the products they’re going to sell, while still retaining a profit. For instance, if it costs $50 for a retailer to buy a product, and they sell it at a marked up price of $75, they get a profit of 25%.

The challenge is making sure the markup percentage is high enough to generate a good income, but low enough to attract customers.

Competitive Pricing

Competitive pricing, or competitor pricing involves setting prices for retail products based on what other companies in the same industry are charging for similar items. There are a few ways to adjust your pricing based on competitor prices. For instance:

• Price matching: Matching your prices to your competitors can be a good idea, as you already know that customers are willing to pay that amount for a similar product.
• Lower pricing: Undercutting competitors by charging a slightly lower price can be a good way to attract customers to a new store, but it can also be a hard strategy to sustain.
• Higher pricing: Choosing a price that’s higher than your competitors can tell customers your solution is the better (more advanced) option, but it can also drive customers away.

Dynamic Pricing

Dynamic pricing is becoming more common among retailers. Even companies like Amazon and Costco use this strategy. Essentially, it involves adjusting pricing strategies in real-time, based on market conditions. You might change your prices based on inventory levels, demand fluctuations, and changing customer preferences or trends.

This is a good way to enhance profits by constantly optimizing your prices based on what you know customers are willing to pay for your items. However, frequent price changes can also alienate customers if you’re not implementing them with caution.

Customer Acquisition and Retention

Alongside effective pricing strategies, using the right methods to attract and retain customers also significantly influences how much profit a retail store will earn. Implementing the right acquisition and retention methods usually incurs a cost, but it also facilitates long-term growth and success.

Marketing and Advertising

The most effective way to acquire customers as a retailer is with advertising. In the past, retail companies frequently relied on “traditional” methods like television ads, direct mail, and radio to capture customer attention.

These methods are still common today, particularly among companies seeking local consumers. However, digital marketing has become the new norm for most.

Digital marketing methods can range from using search engine optimization (SEO) and content to ensure customers can find your website when looking for products, to utilizing social media advertising, pay-per-click advertising, influencer marketing, and email marketing. The right strategy requires a clear understanding of your target audience, and their buyer journey.

Loyalty Programs

Loyalty programs are one of the fundamental tools retail companies use to retain customers. Studies show that members of loyalty programs generate 12-18% more incremental revenue growth each year than non-members. Additionally, 84% of consumers say they’re more likely to stick with a company that has its own loyalty program.

Ultimately, retaining customers through loyalty programs, whether they offer access to exclusive rewards (like free shipping), discounts, or points that can be redeemed, is more cost-effective than acquiring new customers. It also helps companies to generate advocates for their brands, who can drive new business to a retail store through referrals.

Customer Experience

Customer experience is a factor that affects your ability to both attract and retain customers in the retail world. Overall, customer-focused brands achieve profits 60% higher than their competitors, because they focus on building relationships with consumers.

Investing in delivering an excellent in-store experience, and convenient customer service with personalized, fast, and effective support boosts your chances of attracting new buyers, and retaining your existing customers. Alternatively, a poor approach to customer experience will drive customers away, harming your revenue (and your reputation).

Inventory Management

Effective inventory management is a concept many retailers overlook when looking for ways to increase revenue and profits. However, properly managing inventory is how companies ensure the right products are available at the right time, improving customer satisfaction and reducing costs.

Retailers need to invest in:

Stock Optimization

Optimizing stock levels ensures retail companies can reduce storage costs, and waste from unsold goods, while freeing up capital for additional investments. Strategies like “Just in Time” (JIT) inventory management involves strategically ordering and receiving stock “as needed” for changes in demand and sales, minimizing holding costs and the risk of over-stocking.

This method can lead to higher profitability, by ensuring companies are using their resources effectively, and enhancing their cashflow, though it does require careful forecasting to ensure “stockouts” don’t occur.

Inventory Turnover Management

Improving inventory turnover rates is how retailers ensure products are fresh, and in line with current market demand, boosting sales, and reducing the need for markdowns on unsold items. Efficient turnover reduces holding costs, and can also improve a company’s agility.

To achieve the right inventory turnover strategy, companies need to calculate their inventory turnover rate to understand how items are sold and replaced. This involves dividing the cost of goods sold, by the average inventory. Typically, higher turnover rates indicate more effective inventory management.

Loss Prevention

Losses can happen in any retail store, due to damaged items, theft, and unpredictable issues. Companies need to implement effective loss prevention methods to reduce risks like theft, shoplifting, and damage to inventory.

Implementing employee training initiatives, strict inventory controls, and security systems can help to minimize shrinkage, which has a direct impact on profit margins.

Loss prevention techniques can also help companies to maintain accurate inventory levels, and ensure the right products are always available for sale.

Sales and Promotions

Promotions and strategic sales are common for virtually every retail store because they help to drive revenue, improve customer experiences, and move inventory. Retail companies leverage a range of different promotional strategies, but here are some of the most common:

Seasonal Sales

Seasonal sales are everywhere, from the Black Friday sales we all look forward to each winter, to sales specifically tied to certain holidays.

We’re all aware of some of the most common seasonal sales, from the festive sales in December, to promotions that take place during the “Back to School” period. However, some companies launch sales connected to different “seasonal” events, like World Health Day.

These strategies drive traffic to stores, help to encourage impulse purchases, and significantly increase revenue during peak shopping periods.

Clearance Sales

Clearance sales are generally the promotions retailers use to get rid of excess old stock. Many companies discount older, slow-moving items in their inventory to make space for new products and opportunities. Usually, these sales take place at the end of a product cycle or season.

Though clearance sales reduce profit margins on various items, they also help to clear out stagnant inventory, which gives companies more capital and shelf space for potentially more profitable items. Plus, they’re great for attracting customers in search of a bargain.

Bundling and Upselling

When retail companies want to increase the average order value of their customers, and potentially customer lifetime value, they use bundling and upselling techniques.

Bundles are a great way to get customers to buy more items (as part of a package deal), while upselling gives you a chance to convince your customers to buy a better (more expensive) version of a product they’re already interested in.

By offering customers access to a collection of complementary products, or enticing upgrades, retailers can increase sales and profitability, while keeping costs low.

Understanding How Retail Stores Make Money

Ultimately, retail stores can make money in a variety of different ways, from selling products and services, to offering access to subscription and membership models. However, various factors will affect just how much money a retailer can make, from their pricing strategy, to their approach to acquiring and retaining customers, hosting sales, and managing inventory.

To achieve the best profit margins, retailers need a comprehensive and ever-changing strategy for capturing the attention of their target audience, and increasing revenue potential.

Frequently Asked Questions (FAQs)