eCommerce is booming and the industry offers immense potential for entrepreneurs and businesses to reach a global audience and maximise profits. However, like any business, profitability depends on various factors, some of which are heavily impacted by external factors beyond ones control.
Understanding profit margins and what factors influence them is therefore crucial to the success of any eCommerce business.
Read on to learn the profit margin formula, what factors influence profitability, and how to improve profitability by adjusting the pricing strategy accordingly.
What Are ECommerce Profit Margins?
Put simply, ecommerce profit margins refer to the difference between the revenue earned and the cost of goods sold (COGS). This metric is an essential aspect of measuring the overall profitability of an ecommerce business. Profit margins are typically expressed as a percentage and are calculated using the following formula:
Profit Margin = (Revenue - COGS) / Revenue x 100
Here, Revenue refers to the total amount of money earned from selling products online. Cost of Goods Sold (COGS) is the total cost of the products sold, including the cost of manufacturing, materials, labour, and any other direct costs associated with producing the products. Operating Expenses are the indirect costs associated with running the business, such as website maintenance, marketing, and shipping.
It's important to note that ecommerce profit margins can vary widely depending on the industry, market conditions, and the business model. Therefore, profit margins need to be monitored regularly and adjustments made as necessary to ensure long-term profitability.
What Are Landed Costs And Why Do They Matter?
When calculating COGS, the landed cost is one of the factors that is taken into consideration. The landed cost refers to the total cost of a product including cost of goods, transportation, insurance, customs duties, and other fees incurred in the process of bringing the product from the suppliers location to the warehouse or distribution centre.
Landed cost is important when calculating COGS because it reflects the true cost of acquiring the product for resale, including all expenses incurred in the process.
Recently, we have witnessed significant fluctuations in the landed cost of products due to their origin. Changing shipping rates and customs duties make it important to regularly monitor these costs and check profit margins to safeguard business profitability.
What Is A Good Profit Margin For ECommerce Businesses?
As a general guideline, a healthy (net) profit margin for an ecommerce business is at least 10-15%. A good profit margin provides the resources necessary for growth, expansion, and investment in new products and services. Furthermore, a high profit margin can provide a cushion for unforeseen expenses and economic downturns.
Understanding your profit margin also allows you to identify areas for improvement and make informed decisions about pricing strategies, marketing campaigns, and cost-cutting measures. For example, if a business has a low profit margin, it may need to adjust its pricing, reduce its expenses, or focus on increasing sales volume to improve profitability.
Factors Affecting ECommerce Profit Margins
Several factors can affect the profit margins for an ecommerce business. Here are some of the most significant factors to consider:
- Shipping and Fulfilment Costs: Shipping and fulfilment costs can significantly impact profit margins with shipping costs often making up a large expense for ecommerce businesses. Managing these costs with a 3PL partner can help improve profit margins due to the significant discounts that a 3PL partner attracts from their suppliers. A good 3PL will take on the management of these costs for you so you can focus on other areas of the business.
- Advertising and Marketing Costs: Advertising and marketing costs are essential to driving traffic and sales for your ecommerce business. However, these do impact your profit margins as they contribute to the COGS. Continuously monitor your advertising spend and adjust strategies accordingly to achieve the best ROI. You'll also need to consider the experience on your website to increase conversion rates and consider bundling products or free shipping deals to bump the average order value (AOV) up to optimise your ROI.
- Product Costs: The COGS direct affect your profit margins so sourcing products at lower prices can help increase your profit margins. Be sure to speak to suppliers as soon as your sales volumes increase, you may be able to renegotiate the product costs.
- Returns, Refunds and Breakages: Returns, refunds and breakages are a guaranteed occurence for ecommerce businesses. In our experience, it is very common for ecommerce businesses to ommit an allowance for this in their COGS. To reserve an allowance for refunds, returns, or breakages, estimate the expected cost of these events based on historical data if possible, otherwise industry benchmarks will help. For example, let's say an ecommerce business sells $100,000 worth of products in a year, and it estimates that it will experience $2,500 in refunds, returns or breakages. To calculate the COGS with this allowance included, the business would follow these steps:
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- Calculate the COGS without the allowance: COGS = beginning inventory + purchases - ending inventory
- Calculate the allowance for refunds, returns, or breakages: Allowance = estimated cost of refunds, returns, or breakages
- Add the allowance to the COGS: COGS with allowance = COGS + Allowance
This will help you make more informed decision about pricing, inventory management, and profitability by revealing the true COGS.
How To Improve Ecommerce Profit Margins:
Improving eCommerce profit margins requires a comprehensive approach that involves identifying areas where you can cut costs and optimise your pricing strategies. Here are some tips to help improve ecommerce profit margins:
- Streamline shipping and fulfilment processes: By optimising your shipping and fulfilment processes, you can reduce costs and improve efficiency. The easiest way to do this is by ensuring your shipping and order fulfilment is handled by an experienced ecommerce 3PL. 3PL's are structured to streamline these processes so that thousands of orders can be picked, packed and despatched every day. They attract better courier rates due to their high volumes and can pass those cost savings down to you. Ultimately, your COGS are reduced as you:
- remove cost of daily wages for a staff member to fulfil orders
- receive items like address labels and packaging at a fraction of the cost
- no need for a warehouse and all of the costs that come with it (rent, power, utilities, printers, scales, racking, forklift, security)
- Optimise product pricing: conduct market research to identify pricing strategies that work best for your business. Test different pricing strategies and analyse the results to determine the most profitable prices for your products. These could include bundling, free shipping deals, spend x and receive % off.
- Negotiate with suppliers: Regularly check back with your suppliers, especially if market conditions have recently changed or if your sales volumes have increased. If you can improve your supply rates this will directly affect you COGS and improve your profit margin.
- Reduce returns and refunds: By identifying the root cause of returns and refunds, you can take steps to reduce these costs. Consider offering better product descriptions and customer support to reduce the likelihood of returns and refunds. It is also important to treat the return or refund process as a way of impressing your customers during what is usually an unfortunate occurence. Blow their socks off with a special offer or with an amazing and easy returns or refund process to increase the likelihood that they will try buy from you again.
In conclusion, if you are an ecommerce business owner, understanding and managing landed costs is essential for achieving long-term profitability. By factoring in landed costs into your pricing strategy, you can ensure that you are charging the right price for your products and services, and cover your costs while still making a profit.
Remember that monitoring your profit margins and adjusting your pricing strategy accordingly is an ongoing process. By staying aware of your landed costs and making adjustments as necessary, you can maintain a competitive advantage in the ecommerce marketplace and achieve long-term success.
If you're looking for an ecommerce 3PL partner that can help you streamline your shipping and fulfilment processes and reduce your COGS, speak to Mailshops 3PL experts today.