Stop shipping unprofitable e-commerce orders: Align marketing & buying

A brief introduction to the fundamental issues of driving profitable growth in e-commerce

The most important thing to understand about profitability in e-commerce is that it is not the same as in physical retail. Some parts are much easier to understand and steer, and some are more complex and demand more control of your data, internal processes, and business fundamentals.

The defining difference between offline and online when it comes to variable costs per order is that offline has close to none since everyone is coming to the store and you “just have to charge them,” but online is the opposite—every order includes some fixed costs and some variable costs. Therefore, it matters a lot what products are in every single order, where to ship them, and whether they will return them or not.

This is primarily where merchants go wrong - they don’t have full control of their order profitability, and that is due to silos both in regards to the data and the teams.

But the data is there, and all online orders have a customer ID, which makes it much easier for online retailers to understand: Do we acquire customers that...

i) ...are coming back

ii) ...are profitable on the first or future order(s)

iii) and what is a typical good first product, and what is a bad one?

And so on.

Why aligning marketing and buying is a must in e-commerce but not in traditional offline retail

The problem, still to this day, is that many e-commerce organizations work as if they were offline retailers. In offline retail, you don’t need to focus as much on the order profitability measured in dollars. Each team can more easily work with their margin (%) KPIs. And as long as they are good - you’re good. This means that as long as buying secures a good Gross Margin, marketing/sales secures a good Cost-Of-Sales, and we keep the set top-line target - we will succeed.

Marketing and buying don’t need to work that closely in offline retail to achieve profitability.

That is not the case in e-commerce. If buyers don’t keep a high gross profit (Product price - purchase price) per order, there will be no money to pay for the picking, packaging, shipping, potential returns, and return handling thereafter.

But this cannot only be a buying responsibility. The marketing team effectively decides which products get exposed to customers in normal display ads, feed-based ad formats, and on the site by sorting product listing pages, curated pages, recommendations, etc.

If marketing and buying act like two different teams, as the offline retail companies can do, the math very seldom works out well. You start to ship low, or negative, profit orders with good Gross Margin and good Cost of Sales.

I witnessed this with my co-founders when scaling the Babyshop Group globally, and it was brutal.

When we solved the data silos and finally got the numbers on an order-per-order basis, we had a majority of our orders unprofitable. A symbolic and easy-to-understand example was LEGO orders.

Case Study: LEGO, and how to be fooled when you don't have control over your data

To the LEGO story. Most likely, you know the toy brand LEGO. And perhaps it was an important part of your childhood. As one of very few, if not the only, global toy brands globally, LEGO has managed to be a successful toy brand for kids and somewhat of a collector/lifestyle brand for adults.

To say the least - LEGO is a strong brand.

What did this mean for us?

• High sales
• High competition → High marketing cost
• Low Gross Profit (consumers used price comparison sites a lot)
• High costs of shipping (relative to the Gross Profit)

All this leads to one thing: low profit for us.

But why didn’t the marketing or buying team demand that we stop selling LEGO?

Sales were really good. And on the total, the margin x sales resulted in an ok Gross Profit. So, buyers were ok with selling LEGO.

And since sales were really good, the high marketing cost still delivered an okay cost of sales if you only looked at that KPI.

No one had bad KPIs due to LEGO since no one was fully responsible for each order’s contribution margin 3, i.e., the profit after deducting the cost of goods sold, fulfillment, and marketing costs.

Everyone also considered the relatively cheap Customer Acquisition Cost of LEGO customers. “They should come back to us to buy fashion, etc., later and become profitable customers” because, on average, that was the case for new customers.

But they did not. When all data were under control, we had order profitability as part of the daily and easy-to-use reports, AND we had done the heavy lifting to develop our own LTV model; we saw that;

1. The LEGO order was, in general, a new customer, so thanks to LEGO, we acquired many customers.
2. The LEGO order had, in general, no other products in the basket. The Gross Margin was low due to high competition, and the shipping was relatively expensive compared to the Gross Profit, including the marketing cost; the order profitability was one of the worst we had.
3. So, did the LEGO customers return and make the first costly order worth it? No, they were one of the least loyal customer groups we had. They came to us because they were loyal to LEGO, and we happened to offer a good price and paid enough to get in front of their eyes with the product they were searching for

A hypothetical P&L for a LEGO order

To get in control of your order profitability, you need to do this

First, ensure you have the data to determine whether an order is profitable. This can easily be solved by using a service like Dema, but it can also be done by building your own data warehouse and then collecting, connecting, and visualizing the data in a BI tool.

Second, you must align the marketing and buying teams and measure both on Contribution Margin 3, i.e., Gross Profit 3. Nothing will likely change if they are still optimizing for the classic KPIs: Cost of Sales, Revenue, and Gross Margin (1).