The 10 Business Types With The Lowest Profit Margin
When the industry you choose falls into the high profit margin category, you’re already ahead of the curve. In this post, we’ll explore industries with the lowest profit margins so you can select the right venture.
What is Profit Margin?
Profit margin comes in several types, but the net profit margin ratio is the one business owners refer to often. However, 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 directly related to product production. 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, and 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?
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 are more likely to survive.
Low profit margins are often the result of hyper-competitive industries. Most of the competitors compete on prices to attract customers.. However, low prices eventually hurt all of the companies, even the ones that remain.
Savvy investors will flock to companies with high profit margins. If you’re looking to raise capital, you’ll find it much easier to gain funding with high profit margins rather than low margins. Financial backers put their money where they believe it’ll generate the highest returns.
The Businesses With The Lowest Profit Margins
The reasons for these low-margin business types vary, as 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, but it’s become too difficult to compete with big chains.
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 the lack of commitment that renting allows. In addition, older generations are trading in their weekend chores for more leisure.
2. Car Dealerships
With the high cost of automobiles, you’d think car dealerships would be lucrative. However, the margins on cars are lower than people believe. This is due to the various costs associated with selling cars. Dealers must recognize the best selling cars, or they’ll have to discount them.
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 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, it’s costly to make quality furniture.
In addition, stores like Ikea have shown that people often choose function over form, as it’s easier to justify getting rid of cheaper furniture during a move. Consumers can even shop on Amazon and eBay to find furniture for low prices, which often includes shipping costs.
4. Assisted Living and Retirement Homes
Starting an assisted living business requires significant start-up capital. You’ll need to purchase real estate, invest in health equipment, and furnish the units, in addition to other costs.
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’s no guarantee that the government will grant the money, though.
5. Travel and Accommodations
Most likely, you’ve heard of travel aggregator services such as Expedia or Skyscanner that can help you find the best travel deals.
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.
6. Recreation and Amusement Services
Would you continue to use recreation services if your job was in jeopardy? How about when the economy plummets, as it has this year due to COVID-19? These are two main problems that plague the recreation industry.
Most businesses in this category require significant initial funding and heavy outlays of cash flow for normal operations. In addition, venture capital firms aren’t keen on funding these businesses due to their cyclical nature.
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’s projected to run out of money soon. Couple this with an aging population and the margins for this business may face profound challenges.
8. Real Estate Services
The barriers to entry for real estate services are comparatively low. However, 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 the right one. Plus, if another agent is involved, you may have to split 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, but the margins aren’t always lucrative.
Hospitals often mark up the costs 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
If you’d like to start a gas and oil extraction business, 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.
Our Final Thoughts
Every 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.
Once your business is up and running, Fora Financial can help you with funding. Call one of our Capital Specialists for a free quote today.
Frequently Asked Questions
What makes a good profit margin percentage?
There’s no set number that business owners should target for a good profit margin. It depends on the industry and products sold. The maturity of a company is also a factor.
Editor’s Note: This post was updated for accuracy and comprehensiveness in November 2020
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.