Building a Profitable eCommerce Business
You’d think growing your eCommerce business would just mean making more sales. But from your own experience, you’d know that it’s not at all that straightforward.
What we really want to do is make more profit. Beyond ‘just’ increasing our volume of sales, we’ve got multiple levers we can pull. In this article, we’re going to look at three of them:
- Using SMART sales and discounting strategies;
- Being clever with inventory;
- Leveraging third-party logistics;
Let’s unpack how we can make that happen.
Gross Profit margin is one of the most important financial metrics because it tells how much profit is generated from sales. It also shows the quality of revenue by considering all of the ‘direct costs’ associated with generating that revenue.
To calculate Gross Profit, consider all of the direct expenses associated with selling the product. These direct cost expenses include:
- Cost of Goods Sold (the cost of your product)
- The inbound shipping costs/freight costs
- Merchant and selling fees (Amazon, Stripe, Paypal and Afterpay fees)
- Fulfilment costs
As a rule of thumb, any expenses that are variable in nature, (costs that increase as your sales volume increases) are typically the cost of goods sold. This is important to accurately determine gross profit margin.
The gross profit margin will vary depending on the item sold. It goes without saying – the higher the gross profit margin, the better. The best businesses in the world have strong Gross Profit margins.
As a founder and manager, the goal should be to innovate the product and service to explore ways to maximise the gross profit margins.
So, next time you’re looking at your financial reports – look at Gross Profit, not sales. It’s a far more representative picture of how your business is really doing.
If you’re curious, we do a deep dive into Gross Profit Margin here.
Discounting is a legitimate tool if it’s used strategically – not as a ‘run-of-the mill’ approach to magically improving your top line. Sales or discount codes can be used to:
- To move old or slow-moving stock;
- To acquire new customers in certain scenarios
Let’s go into more detail…
To sell old or slow-moving stock
Obsolete and slow-moving stock are the culprits behind bloated inventory balances. These are the products that have become dated because a newer version has been launched in the market. The reality is old stock is a cost to businesses because it takes up valuable warehouse space. It’s collecting dust and devaluing every day.
Discounting is an effective tactic to clear the old product in order to make room for new items that sell. Ideally, you may have to sell these products at a lower margin, or even at cost. Consider it a sunk cost.
Discounting as a customer acquisition tool
Marketing people love to use discounting as a tactic to attract new customers. This is prevalent in discounting campaigns like BFCM, EOFY sales, Boxing day… the list goes on. And it’s because it works, right?
Whilst discounting is a valid customer acquisition tactic, it’s rare for eCommerce managers to do the hard work and actually measure the efficacy of the discounting campaign.
Managers should be asking these questions when designing a discounting campaign:
- What’s the discounting budget we should set to attract this new customer?
- Is this the type of customer we want to attract?
- What is the payback period of this new customer?
The common rhetoric for marketers is that discounting is an effective tactic to get a new customer into the door. You may make a small profit, or even a loss to acquire that customer now, but the hope is that they become profitable over their lifetime. This is on the assumption that they become a repeat customer and pay full price for future products. This is a big assumption and one that should be tracked and monitored via a cohort analysis.
Of course, all of this assumes you can get that customer to pay full price in the future… which as operational finance experts, we often challenge.
Discounting sets a price anchor
The main risk of attracting new customers via discounting is that it sets a ‘low’ price anchor at the beginning of a new relationship. Once the bar is set, it’s often challenging to reset the customer’s expectations back to full price because they have anchored themselves to the discounted price – and anything above that is perceived as ‘expensive’ in their eyes.
Equally, discounting can set a dangerous precedent because this customer becomes trained to only buy the product when it’s on sale. This can quickly evolve into a vicious cycle of artificially boosting sales by discounting. From a topline perspective, sure you’re maintaining revenue – but from a financial perspective, you are probably losing money.
So, what can you do instead? We’ve put together some alternatives to discounting here.
Cash flow is a constant challenge for e-commerce businesses founders and managers. This is because business growth is directly correlated to the craft of inventory management. In order to grow, the business needs to order more stock. But, if there is too much stock, the business has cash sitting in the warehouse, doing nothing. If there is too little stock, the business runs the risk of selling out and having nothing to sell – which cripples the sales.
And that’s just ordering stock. You then need to figure out your margins – which can be eaten up by discounts, returns, Afterpay fees, fulfilment, advertising spend, rent, payroll….the list goes on.
Inventory management requires data and an acute understanding of the market to get the balancing act of inventory purchases just right ( for example, too much stock or too little stock).
Measuring metrics like stock turn and inventory days is an approach to help e-commerce businesses manage this delicate balancing act. This can be calculated by inventory days with the following formula:
Inventory days = Inventory Value / Monthly Cost of Goods Sold x 30
As your business grows, there will be an inflexion point when it makes sense to utilise a ‘Third Party Logistics (3PL for short) versus absorbing all the fixed costs yourself with hiring more staff and getting a bigger warehouse.
Logistics setup requires warehouse rent, wages for packaging and fulfilment staff and other equipment. Using a 3PL, all of these fixed costs are now outsourced to a provider who charges a rate per product instead of a fixed overhead cost.
Of course, the financial aspects are just one consideration in any strategic decisions. The other issues that you need to consider if shifting to a 3PL include:
- Committing to a lease for a warehouse
- Making warehouse staff redundant from your business
- Finding the 3PL right provider
- Less quality control measures
- Less flexibility to personalise/tailor orders for specific repeat customers (with personal notes, random gifts etc.)
Overall, deciding to move to a 3PL is a big, strategic decision that shouldn’t be done half-heartedly. Like every strategic decision in your business, it’s important to understand the true costs and risks associated.
We recommend checking out this article if it’s something you want to consider in more detail.
We can indeed make more money without waiting for the winds of customer demand to change.
In this article, we looked at just three ways to do that.
Stay tuned to find other ways to increase profitability in practical ways.
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