The importance of a healthy profit margin for eCommerce businesses must be recognized. Companies can quickly find themselves in financial trouble without maintaining a healthy profit margin. To ensure long-term success, it is essential to understand the elements that make up a profitable eCommerce business. This article will delve into these components to provide insight and advice on constructing a healthy profit margin for eCommerce businesses. With the right strategy and knowledge, entrepreneurs can ensure their business is profitable and prosperous for years to come.
What’s so tricky about eCommerce profit margins?
It’s easy to become preoccupied with how much money you bring in through your business, thinking that your operations are successful as long as revenue increases. However, the sale can result in a loss if its costs have not been considered and factored into pricing or discounts offered.
Some expenses are straightforward to understand, such as the cost of purchasing or manufacturing products and covering the shipping, storing, and marketing costs. However, other expenses might not be so obvious—but these hidden costs can quickly add up. Think returns, taxes, transaction fees, and referral fees owed to third-party marketplaces. To accurately understand your profits, you must have meticulous bookkeeping and business accounting.
How do I calculate my eCommerce profit margins accurately?
There are two eCommerce margins to consider: gross profit margin and net profit margin. Understanding how these margins are determined and the difference between them can help you identify the source of any issues with profitability.
Gross Profit Margin
Your gross profit margin measures how much money your business retains after subtracting product costs but not accounting for expenses. The formula is as follows:
Gross Profit Margin = [(Total Sales Revenue – Cost of Goods Sold)/Total Sales Revenue] * 100
Cost of goods sold (COGS) comprises costs directly related to the procurement or production of products, such as the price of raw materials, shipping fees for incoming items, and storage expenses. It does not cover charges like delivery of products to customers, marketing those items, website design, taxes, or rent.
Your gross margin gives you an instantaneous indication of whether your business is turning a profit or not. For instance, if your gross margin is 25% and total monthly revenue equals $100,000, you will make $25,000 each month before allocating money for other expenditures. To put it another way, you will keep 25 cents out of each dollar earned in revenue.
If your gross margins are decreasing, consider seeking out more affordable suppliers, raising product prices, scaling back on promotional spending, and cutting labor costs. Conversely, if your gross margins are in good shape, consider investing in additional marketing initiatives or stocking up on new inventory.
Net profit margin
Your net profit margin is the ultimate measure of your profitability. The formula:
Net Profit Margin = (Net Profit / Revenue) * 100, where Net Profit = Revenue – COGS – Operating and Other Expenses – Interest – Taxes.
The net profit margin measures your business’s profitability, considering all operational costs such as transportation, utilities, marketplace fees, and wages. The higher your net profit margin, the more money you have to reinvest into your business.
It also gives you an understanding of how efficiently your operations are running, allowing you to identify if your overhead costs are too high or too low.
What’s a good profit margin in eCommerce?
On average, online retailers can expect to see 41.5% gross and 7.3% net margins, according to research from NYU Stern School of Business. However, the same profit margin will depend on various factors such as product category and size/scope of the eCommerce store.
Pandemic’s effect on margins
The outbreak of the COVID-19 pandemic has caused an increase in online shopping, prompting many to establish or expand their retail businesses. What impact has this had on eCommerce profit margins?
Researchers from Alvarez & Marsal and Retail Economics analyzed the profit margins of more than 250 retailers across the UK, Spain, Switzerland, France, Italy, and Germany. The study included both online and physical stores.
The study’s results revealed that pre-tax retail profit margins have declined as eCommerce penetration rates increased in Europe, dropping from 5% pre-pandemic (2018 to 2019) to 4.5% during the pandemic (2019 to 2020). The average pre-tax profit margin for online retailers was 1.4%, significantly lower than the industry average of 5.4%, which factors in both multichannel and brick-and-mortar stores.
Researchers anticipate that pre-tax margins will diminish to 3.2% by 2025 due to increasing rates of returns, escalating costs of raw materials and logistics, and increased rivalry between physical stores and online retailers.
How do I improve my eCommerce profit margin?
Many online sellers who have encountered a bump on the road to profitability can find success by making some critical changes. Following these seven steps can help diagnose and resolve any potential issues:
Perform a break-even analysis
Conducting a break-even analysis enables you to analyze your fixed and variable costs against your profit. This can give you an insight into how specific issues, such as lost shipments, damaged inventory, or rising returns, affect your profitability.
By understanding these factors better, you can make more informed decisions that can positively impact your eCommerce business’s profit margins.
You’ll be able to identify the required margins and price points to make a profit more easily if you complete a break-even analysis. Learn how to do this.
Determine your most (and least) profitable products
If you need to differentiate between your high-margin and low-margin products, then it is essential to analyze your financial data thoroughly. Take a close look at the costs of goods sold (COGS) and operating expenses to understand your finances accurately.
Next, calculate the gross and net profits for each item or product type you offer. You can form more precise replenishment schedules and pricing tactics with this information.
Diversify your shopping channels
Additional sales channels may incur extra costs. Nevertheless, an efficient multichannel selling strategy has the potential to bring more visitors (and revenue) to your e-commerce store. Plus, it presents an opportunity to introduce your products to a new client base – you could discover that Amazon consumers may be keener on acquiring your high-margin items than eBay shoppers.
You can experiment with different sales channels, such as online marketplaces like Amazon, mobile marketplaces like Wish, social media platforms like Instagram, or comparison shopping options like Google Shopping. Consider setting up a physical pop-up store in a busy area to determine if having a brick-and-mortar presence is the correct route for your business.
Raise prices
This strategy can be beneficial for businesses with a large customer base that is satisfied with their products and services, as well as those with a strong reputation of being a top-tier brand.
On the other hand, raising prices may not be viable if your customers are used to discounted or low-priced items.
If you’re concerned that raising your prices may discourage customers, minimize the risk by trialing new costs on specific items and experimenting with different messaging. Analyze how language can impact the way shoppers view and assess your product’s value. For instance, emphasizing that it is made from “premium materials” or “handcrafted in the U.S.” could convince customers to pay more for your products.
Lower your operating costs
Excessive operating expenses may be cutting into your profits. Ensure this is not the case by performing an expense audit and using the outcomes to pinpoint areas where costs can be decreased without sacrificing quality.
Another great suggestion is to consult your staff regarding which activities take up much of their time. Attempt to automate processes that are leading to inefficiencies. For example, if your team has been dedicating many hours manually updating inventory records, install software such as Shopiroller to automatically sync inventory across all sales channels.
Likewise, it would help if you tried eliminating any unnecessary or excessive SaaS subscriptions and services. Most importantly, don’t remove anything that negatively impacts your customers’ experience.
Increase average order value (AOV)
A larger AOV can lead to a more profitable order. The expense of fulfilling an order does not necessarily double if the products in an order are doubled; as such, a greater AOV could result in better margins.
Increase AOV by experimenting with these tactics:
- Include product recommendations on your site’s product and checkout pages to create more upselling and cross-selling chances of higher-value items.
- Offer bundles of high-margin and low-margin products at a lower cost per unit, increasing the perceived value while raising the Average Order Value (AOV).
- Give shoppers incentives to spend more, such as discounts on orders over $50 or free shipping above $75.
- Focus your marketing towards high-margin items, highlighting them on your website, social media ads, and promotional emails.
Start a loyalty or rewards program
Brand trust is a significant consideration for consumers, with 81% only likely to purchase from a company they perceive positively. Implementing a loyalty or rewards scheme is an effective way of building that trust while boosting customer retention. By providing incentives such as discounts and rewards for repeat customers or referrals, companies can benefit financially without investing heavily in marketing for new customers.
Remember that in addition to providing rewards, it is essential to ensure an enjoyable customer experience. This usually begins with having a user-friendly website and culminates in outstanding customer service from start to finish of the buying and delivery process.
QUESTIONS ANSWER
- What can help minimize the risk of raising prices?
- Minimizing the risk of raising prices can be done by trialing new costs on specific items and experimenting with different messaging to emphasize value and quality.
- How can businesses decrease operating costs?
- Businesses can decrease operating costs by performing an expense audit and consulting their staff regarding which activities take the most time. Automating processes leading to inefficiencies while eliminating any unnecessary or redundant SaaS subscriptions and services can also be beneficial.
- What strategies can increase Average Order Value (AOV)?
- Strategies that can be used to increase AOV include including product recommendations on product and checkout pages, offering bundles of high-margin and low-margin products at a lower cost per unit, giving shoppers incentives to spend more such as discounts or free shipping, and focusing marketing efforts towards highlighting higher margin items.
- How can businesses build trust with customers?
- Building trust with customers can be done by offering loyalty or rewards programs that provide incentives such as discounts and rewards for repeat customers or referrals. Additionally, providing an enjoyable customer experience from start to finish of the buying and delivery process is also essential.
- What strategies can help businesses increase their profit margin?
- Strategies to increase profit margins include minimizing risk when raising prices, decreasing operating costs by performing an expense audit and automating inefficient processes, increasing Average Order Value (AOV) through product recommendations and incentives, building customer trust with loyalty programs, and optimizing internal processes.
CONCLUSION
Whether you are a veteran eCommerce store owner or a novice, it is essential to identify the source of your profit margin issues. Once you know the areas where you have inefficiencies and weak points, you can start enhancing the customer experience and optimizing internal processes so that your business will secure more income.
