The Role of Gross Margin: GMROII
Within a narrowly defined merchandise category, such as screwdrivers, items will tend to have somewhat similar costs. As a result, an item with a high GMROI is most likely truly more profitable than one with a low GMROI, although there is no absolute certainty of that. When the level of aggregation reaches up to the department level, the ratio really has no value at all. Some departments may be dominated by items that are expensive to sell and require costly support. Other departments may be home to items with very low sales costs and requiring almost no support. A department with a high GMROI may or may not be more profitable than one with a low GMROI. Comparisons across departments with GMROI should not be made .. In summary, as an absolute yardstick, GMROI should be limited to two cases. First, SKUs with very similar expense structures (all within a narrowly-defined merchandise category, for example) can be compared directly on the basis of their GMROI. Second, year-to-year changes can be evaluated with some degree of confidence. If the 100.0% GMROI SKU achieves a 150.0% GMROI during the next year, then things are getting better. The firm will not know when the SKU stops being terrible and becomes simply bad or even graduates to good or excellent. Higher is better than lower is all you get.