Margins

My father-in-law is in the grocery store business. They are successful but they operate on razor-thin margins and rely on high volume sales. Fortunately eating is universal and shopping at the grocery store comes with the added benefit of not being guilted into tipping +20%.

Last week we were talking about how margins work in different industries and he brought up a restaurant group that has absolutely insane margins - pizza. A pizza restaurant typically operates on 80% gross margins. So when they advertise an “amazing deal” for that large pepperoni pizza for only $10, they are still generating $8.

Another item that generates crazy margins is alcohol in restaurants. From beer and wine to spirits, restaurants can generate between 75-85% gross margin with very low overhead compared with preparing a meal. This is why they push drinks - “why don’t you wait at the bar while we prepare your table?”

There is even psychology behind it. Waiters are trained to offer a “refill” or “top-up” when a diner has 1/4 - 1/3 of their drink left. We are much more likely to accept the waiter’s kind offer of another drink if we still have some left compared to if our glass is empty.

In the former scenario, we are likely to order another drink ~75% of the time. If the restaurant waits until our drink is empty, that drops to just 25%.

While we all wish we could operate on those kinds of margins in trading, we (or most of us) are not that lucky! Our margins are extremely precious and that is why understanding hedging, logistics, foreign exchange, and financing is paramount to our long term success. Risk management matters as small mistakes can wipe out entire margins.

And unlike the grocery store, we don’t have the luxury of people needing to eat aluminium.