Retailers are being squeezed by rising costs. At the same time, consumers expect seamless service across physical, digital, and social channels. To maintain their relationship with customers, retailers are building AI-powered shopping agents and immersive digital experiences inside the store.
Now retailers are increasingly looking to operating margin to fund these initiatives. But traditional efforts to improve margins like across-the-board cost-cutting moves are losing their effectiveness. Retailers instead need to focus on opportunities across the operating model to address structural costs.
Three Reasons Companies Must Focus on Operating Margins
While gross margin can signal a strong brand, unique products, or other factors that allow for premium pricing, operating margin is more a sign of management’s ability to control costs and generate sales. It accounts for the operational costs, including rent, labor, technology, and marketing, that can shrink a gross margin of 50% to single digits. Three reasons stand out for focusing on operating margin now.
The pressure keeps building. For a brief window at the height of the pandemic and when restrictions began to ease, retailers could use their pricing power to expand margins. Those days are over.
Product costs, labor, and operational expenses continue to climb. A weighted-average index of 55 North American retailers reveals that operating margin fell from 6.7% in 2021 to 5.9% the last twelve months. Over the same period, gross margin declined from 26.1% to 24.9%. (See Exhibit 1.)
Years of “always-on” cost management have stripped away the effectiveness of traditional tools such as squeezing suppliers on price alone and reducing headcount. Opportunities for cost reduction are increasingly found in structural moves, such as taking a comprehensive view of spending and rebuilding workflows and operating models.
Retail investors reward operating margin expansion more than revenue growth. In general, shareholder returns strongly correlate with revenue growth, but retail is different. Longer-term total return is driven more by margin expansion. Over six-year horizons, total shareholder return of those 55 publicly traded retailers correlates more closely with operating margin than with growth. (See Exhibit 2.) In fact, three- and four-year total shareholder returns are two times more correlated with operating margin than revenue growth.
Investors know that expanding operating margin creates a stronger P&L and provides more room to sustain investment, absorb shocks, and maintain a consistent narrative with boards and investors.
Expanding operating margin creates a stronger P&L and provides more room to sustain investment, absorb shocks, and maintain a consistent narrative with boards and investors.
Retailers must fund their AI future. Integrating AI into operations is no longer optional. Even as AI becomes more affordable over time, it still requires near-term investment—at exactly the moment many retailers feel most constrained. Many of the consumer companies we surveyed are planning to double their investments in AI in 2026. (See Exhibit 3.)
They also need to fund other growth investments in areas such as customer experience, products, formats, and e-commerce. Without fatter operating margins, retailers risk falling behind.
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Getting It Right: Key Lessons
In the past three years, we have worked on more than 40 operating margin projects that delivered from 100 to 300 basis points of improvement. One pattern is consistent: winners simultaneously attack the “what” and “how” of their operations.
The What
The “what” involves the prioritization, sequence, and execution of the right operating margin levers.
Leaders should unlock value across the entire value chain—not isolated cost silos. Retailers that run separate workstreams (procurement here, labor there) consistently leave value on the table, because the biggest pools sit across boundaries. (See Exhibit 4.)
Examples include:
- Renegotiating supplier terms not just on price, but on the fundamental nature of the buying relationship—connecting assortment decisions, planogram planning, and pricing into a single negotiation rather than treating them as separate conversations
- Evaluating indirect spend holistically across demand, specifications, and operational impact, rather than simply running a request for proposal for the lowest unit cost
- Redesigning organizational structures from the ground up—not just removing layers, but rebuilding workflows and operating models around AI-enabled processes
Leaders should pursue quick wins, then build sustainable change. Strong programs prioritize initiatives that balance value and organizational capacity. Sequencing is a discipline. Some measures generate near-term cash and credibility. These should be priorities. Others require longer and deeper operating model change that must be coordinated.
Leaders should incorporate AI capabilities to boost efficiency when the fundamentals are ready. AI creates real value when the underlying process, data, and ownership are strong enough to act on AI outputs.
Some recent areas where retailers have found value include:
- Pricing and Promotion. AI moves retailers from static pricing rules to SKU-level dynamic optimization, pinpointing where promotional spending drives incremental sales and where it simply discounts purchases that were already going to happen.
- Labor and Scheduling. AI matches staffing to predicted demand at the store and department level, cutting overstaffing costs without sacrificing customer experience. IT also gets smarter over time as it learns from actual patterns.
- Forecasting and Inventory. AI-driven demand forecasting reduces excess inventory and markdowns, with a connection to gross margin and working capital.
- Indirect Spending and Procurement. AI consolidates accounts payable data and surfaces opportunities for cost reduction, then supports the creation, generation, and analysis of requests for proposals that manual review processes could not generate at scale.
The How
The “how” concerns the desired culture, people and leadership engagement strategies, and tools and mechanisms to deliver results.
Leaders should encourage a mindset shift by making operating margin everyone’s job. Operating margin improvement stalls when it lives only in the finance department; it scales when merchants, store operations, supply chain, technology, and marketing own the outcomes and understand why it is important to their day-to-day responsibilities. This requires a cultural shift supported with a story-centric communications strategy and visibility into overall company goals and progress to date.
Leaders should put the right people in the right roles—and hold them accountable. Critical workstreams need trusted, capable leaders—not just available ones. A “many reasons but no excuses” culture acknowledges headwinds while holding the line on commitments. Leaders can reinforce the shift through targets, business rhythms, and incentives that reward step-change results, not just activity.
Leaders should establish an activist program management. A margin management office is a small cross-functional team that tracks value weekly, escalates decisions, enforces owner accountability, and maintains a single source of truth for initiative financials. Without a central nerve center, workstreams do not generate their targets.
Taken together, these lessons point to a different standard for margin work. This is not another cost reduction cycle; it is a structural transformation designed to continuously create the headroom retailers need to invest and compete—especially as AI spend accelerates and investors increasingly reward profitable growth.
