The 10 Business Types With The Lowest Profit Margin
You’ll find plenty of information online about businesses with high profit margins. This article shows some of the lowest profit margins to help you when deciding the type you want to start.
What is Profit Margin?
Profit margin comes in several types. It can lead to confusion when people discuss the topic. In many cases, the net profit margin ratio is the one business owners refer to, but the others have an impact as well.
When a company sells its products or services, some costs are associated directly with the production and total sales of those products. These are known as the cost of goods sold (COGS). Subtracting the COGS from revenues leads to gross profits. Dividing the gross profits by the revenues yields the gross profit margin.
An income statement also reports operating expenses that aren’t related directly to the production of products. When these costs are subtracted from the gross profits, the result is the operating profit. Dividing the operating profit by revenues yields the operating profit margin.
Several other costs don’t fall into either gross profit or operating profits. Interest payments and earnings are netted. Then, companies must pay taxes.
Subtracting out these costs results in the net profit. Dividing the net profit by revenues yields the net profit margin.
Companies may differ in how they define these profit margins. For instance, a service-based business may not define its cost of goods sold the same as a manufacturing company. It may deal directly with operating profits and net profits.
Why Does Profit Margin Matter To A Business?
You may have heard the term swimming upstream. It refers to actions that certain types of fish, like salmon, take when they’re spawning. It takes much effort for them to get upstream.
A business with a low profit margin is much like trying to swim upstream. Any problems that occur during normal business operations can leave a company vulnerable to unexpected costs. Every business experiences unexpected costs, but ones with higher profit margins can weather the storm more effectively.
Low profit margins are often the result of hyper-competitive industries. Most of the competitors compete on price and it becomes a race to the bottom. Many companies will keep prices low and take losses to drive competitors out of the race. However, the low prices eventually hurt all the companies, even the ones that stick around.
Savvy investors will flock to companies with high profit margins. If you’re looking to raise capital for your company, you’ll find it much easier to present a company with high profit margins rather than ones with lower margins. Financial backers put their money where they believe it’ll generate the highest returns. Think about what types of companies you would want to own.
The Businesses With The Lowest Profit Margins
The following are some of the lowest margin business types. With a few of them, it’ll be obvious why they’re on this list. Others may surprise you, however. The discussion of each should give you a feel for why they are included.
The reasons for these low-margin business types vary. Costs can be considerable. For other types, it can be more subtle, such as regulations and insurance needs. It’s these subtle reasons that take people by surprise when they learn about them being low margin businesses.
1. Lawn and Garden Supply Stores
Before Home Depot and Lowes, you’d likely find lawn and garden supply stores in many towns. These small businesses catered to the community, and people can pick up whatever they needed from these stores. However, it’s too difficult to compete with the big chains. Many of these chains are within driving distance of community members.
Homeownership trends are shifting as well. Millennials are waiting until later in life to buy homes. They either can’t afford the down payment or enjoy spending weekends in a community of renters. Baby boomers are also trading in the weekend chores for more leisure.
2. Car Dealerships
With the high cost of automobiles, you’d think car dealers are raking in the big bucks. However, the margins on cars are lower than people believe. This is due to the various costs associated with selling a car. Dealers must know the hottest selling cars, or they’ll have to discount them to get them off the lot.
There are also unusually high costs associated with selling cars. To start a car dealership, you’ll need to purchase the equipment to maintain the cars, as well as the inventory. Car dealerships are affected by changing laws with automobiles and may be required to retrofit equipment due to these laws.
3. Furniture Stores
Furniture stores sell high-end merchandise, which gives the impression that the margins are high. However, the cost to make quality furniture is high, too. While quality furniture is built to last, people are mobile today. They don’t want to be stuck lugging around furniture from place-to-place.
Stores like Ikea have shown that people are choosing function over form. It’s easier to justify getting rid of cheaper furniture. Consumers can even shop on Amazon and eBay to find furniture for low prices. These deals often include shipping costs.
The prices of antique furniture have plummeted in the past several years. People can scoop up amazing deals on high-quality furniture instead of buying new furniture.
4. Assisted Living and Retirement Homes
Starting an assisted living business requires significant start-up capital. You’ll need to buy the real estate and fix it up. Equipment for assisting residents may need to be installed. Then, you’ll have to furnish the units.
Most states will require some form of licensing. Often, residents will pay partially with state funds like Medicaid or Medicare. This increases the regulatory requirements for the facility.
The government offers funding under its Assisted Living Conversion Program (ALCP). It’s a grant that allows funding to convert existing units into assisted living ones. There is no guarantee that the government will grant the money, though.
5. Travel and Accommodations
If you’ve traveled recently, you may have discovered that finding the lowest prices for travel-related services is easy. Online websites such as Expedia or Skyscanner allow you to enter your travel information, and they find you the best deals possible. These sites are categorized as travel aggregator services.
It’s difficult to compete with established aggregators, as the margins are slim. Some of these websites may allow you to form partnerships or join their affiliate programs. However, they are subject to the rules of the vendors, and the payouts may not be lucrative enough.
6. Recreation and Amusement Services
Would you continue to use recreation services if your job was in jeopardy? How about when the economy has taken a turn for the worse? These are two main problems that plague the recreation and amusement services industry.
Most businesses in this category require significant initial funding. They also require heavy outlays of cash for normal operations, depending on the type of business.
Venture capital firms aren’t keen on funding these businesses due to the cyclical nature of them. Unless you have a concept that rivals the Walt Disney Company, it is a tough business to get off the ground.
7. Home Healthcare Services
The demand is strong for home healthcare services. However, Medicare has a fund that supports paying for home healthcare services, and it is projected to run out of money soon. Couple this with an aging population and the margins for this business may run into negative territory.
The services often try to cut costs by paying low salaries. However, this leads to high turnover. It’s not an easy job to care for others. When workers discover they can earn the same rate or more in other industries, they head for the exits.
8. Real Estate Services
It doesn’t take much capital to start in the real estate business. The barriers to entry for real estate services are comparatively low. Of course, low barriers to entry lead to fierce competition. That’s the main reason for the low margins in this business.
While the commissions are attractive, not every potential buyer will purchase. If they do, it can take months of showing homes before they find ones that are right for them. A listing agent can make the full eight percent. However, if another agent is involved, there’s usually a split on the commissions.
9. Medical Supply and Equipment Manufacturing
Consumers pay high costs for medical care. This should translate into generous profits for the medical supply and equipment manufacturers. However, the margins aren’t as good as people believe.
Hospitals often mark up the costs of the use of equipment and supplies. They also tend to mark up costs charged to insurance companies. These costs don’t translate to the suppliers.
The manufacturers require specialized equipment with a well-trained staff of medical practitioners and researchers. These come at a high cost, which also eats into the margins. The research and development costs for these products are also high.
10. Gas and Oil Extraction Services
How would you like to start a gas and oil extraction service? If so, be prepared to rev up serious capital expenditures. When prices of oil are high, the industry tends to boom. However, this is usually short-lived, as oil prices have been low for several years.
There’s also a global movement to move away from fossil fuels. That targets the oil industry directly. This trend isn’t letting up anytime soon, as politicians are gearing up to increase regulations to reduce the use of fossil fuels.
Other Types of Business With Low Profit Margins
You can still buy a newspaper on newsstands today, but that doesn’t make the publishing business a profitable one. Companies like the New York Times understand they must publish a hardcopy of their newspaper. However, the money is made for these publishers online.
There is a big movement to go green these days, but profits from renewable energy are negligible. The infrastructure costs are prohibitive for most business owners, especially small businesses. Uncertainty with current and future government administrations is also an issue.
Grocery stores are extremely low profit margin businesses. Many of the products sold won’t see margins higher than three percent, even smaller. However, the grocery stores make up for these low margins with volume, and they often use upselling techniques at the cash registers. You have probably participated in a few impulse buys when shopping in your supermarket.
Our Final Thoughts
Every type of business has its challenges. However, when deciding which type of business to start, choosing higher profit margin businesses can put the odds in your favor. It doesn’t mean the business will be easy to start or run, though.
Whatever business you decide to start, Fora Financial can help you with funding it. We offer funding options for different stages of your business. Call one of our Capital Specialists for a free quote to see how you can get started.
Frequently Asked Questions
What makes a good profit margin percentage?
There’s no set number that business owners can target for a good profit margin. It depends on the industry and the products sold. The maturity of a company is also a factor as companies with longer durations have proven themselves.
Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.