What is e-commerce profitability, and what is the formula?
What are the different steps, and what do you not include?
As with many other things, it depends on who you ask and in what situation. Most people in the industry suggest that e-commerce profitability is the profitability of the e-commerce commercial operation. That would then mean taking gross sales minus returns, cost of goods sold (COGS), logistics and fulfillment, and marketing cost.
In this profitability calculation, you don't include overhead costs such as the head office, salaries (outside the warehouse), etc.
Why is e-commerce Profitability critical in 2024?
What happens if I don't focus on profitability as an e-commerce business?
Given the world economy, households in many countries have a lower buying power than before due to inflation and high-interest rates. In some countries and industries, we've also seen many layoffs.
This means that buying power is down in the world economy. If not precisely right now for you, it can happen any day. Then, you must fully control your profitability and cash flow to avoid going out of business.
Given the pressure on the e-commerce industry and higher interest rates, investors are less interested in investing in e-commerce businesses. There are simply less capital to invest and more attractive alternatives.
Since the old mantra "growth at any cost" depends on investors to cover the unprofitability, the previous lifeline for companies that were unprofitable but growing is gone. All e-commerce companies, in general, need to show that they are "default alive" to be attractive to investors.
Benefits of focusing on profitability
Tracking your e-commerce profitability is crucial for several reasons. First, it lets you understand whether your business is making money. E-commerce professionals often need to determine if their business is making money, as in profit. When you follow your contribution margin (read more about it here) daily, per market, per product category, etc., you can start to make a change. When monitoring your profitability over time, you see if your efforts are paying off and adjust as needed.
Additionally, tracking your e-commerce profitability helps you understand if your acquired customers are profitable, making the Customer Lifetime Value-thinking a part of your routine. When it's easy to split profitability between new and returning customers and dig deeper and understand what cohorts of your returning customers are good or bad, you can start to make educated decisions about customer acquisition strategies and leave as little as possible to guessing and hoping.
Why profitability is especially important for e-commerce businesses
As described above, e-commerce businesses no longer have the same luxury as other growth companies to access investment capital easily. The investor community has not been keen on investing in e-commerce post-pandemic, and it looks like that will stay the same for a while.
What causes profitability problems and how to prevent them
There are several reasons why e-commerce companies risk profitability issues. Still, the fundamental issue is when growth or short-term cash flow is prioritized above securing the profit on an order level.
How do you calculate your e-commerce profitability?
Start to understand your profitability through the monthly income statement
First, your income statement, i.e., "Profit & Loss" (PnL), will state your profitability. To get your profitability from the income statement, you need to ensure that the different costs we include in this definition of e-commerce profitability are not mixed up with costs we exclude when discussing e-commerce profitability. After that's done, you can just deduct the expenses from your gross sales, and there you have your e-commerce profitability.
The easy part is to deduct the Cost of Goods Sold (COGS) and the Marketing Cost, which are most commonly on their rows in the income statement.
Something that can be tricky is the logistics costs. Different companies include/split group costs around "logistics" differently and use different naming conventions. However, in the best and most accurate way of looking at your profitability, you state and separate these to see what is genuinely overhead (not part of your e-commerce profitability) and what is not overhead. And those not overhead parts should be included in your "picking costs," which is a central part of your logistics. But often, e-commerce Income Statements are more challenging to read about this part, and you might be forced to dig deeper or make an assumption based on your overall logistics and warehouse costs.
Another part that can be difficult to examine from the income statement is the payment fees as part of your fulfillment cost. For example, you might use Shopify, which charges a percentage on all transactions, and so does PayPal. The list goes on with services that charge different order-related fees that are difficult to find in your income statement.
With that said, there are some parts that you won't see that easily in the monthly income statement, but it can take you from zero to one, and it is a start, at least.
What is the problem with tracking your e-commerce profitability on your income statement, i.e., accounting?
More than the issue of genuinely understanding what operational profit, i.e., e-commerce profitability, and what is overhead, resulting in the complete business profitability is, there are a few other things that are problematic with relying on your income statement:
- The delay is the main issue with relying on accounting, i.e., bookkeeping, to understand and improve your profitability. It's always last month's data.
- Another critical area for improvement is the ability to dig deeper and analyze something. You can't do that and need to ask for help. And connecting all that data to understand your profitability on an order or product level is nearly impossible if you go the "income statement"-way. You need to have all the data around your profitability automatically gathered, mapped, cleaned, and made available for analysis in some visualization tool.
If you need a complete solution to this, you might want to check out dema.ai
Why is it important to track your e-commerce profitability regularly?
As Peter Drucker famously said - What doesn't get measured doesn't get improved.
You need to track your profitability daily, weekly, and monthly to learn what drives profitability for your e-commerce. And most importantly, you won't find all those profitability drainers. Some are often very obvious if you invest the time and track it.
By monitoring your profitability daily, you can quickly course-correct issues that may arise before they become more significant problems. It could be as easy as increasing the free shipping threshold, adding exclusions to a discount code, or removing a discount.
Also, tracking your profitability regularly allows you to make better strategic decisions about your business. Common themes to improve profitability would be pricing strategies, marketing efforts, prioritized markets, or even product offerings.
How to Optimize E-commerce Profitability
Optimizing e-commerce profitability is a never-ending journey. It's all about understanding what drives and prohibits the profitability of your business and then prioritizing. First, you take the low-hanging fruits and then continue to the more difficult parts, where you often find 80% of the value.
Here is an extensive list of what to consider when optimizing e-commerce profitability.
- Free Shipping Threshold - read blog post here
- Optimize marketing for profitability - read blog post here
- Product Page tactics - read blog post here
- Budget allocation between markets - read blog post here
- Selecting the right markets - read blog post here
- Stop steering your teams on Vanity Metrics - read blog post here
- Visual Merchandising to maximize profit - read blog post here
- Processes for profitability
- Negotiate better deals with shipping providers
We will continuously update this list with more actionable content and write more about each point in the list above. If you have any suggestions on a specific area that we should cover, please reach out!
Need An e-commerce profitability platform?
Introducing dema.ai, your comprehensive solution for tracking and optimizing e-commerce profitability. With dema.ai, you gain access to real-time, accurate data, enabling you to make informed decisions about your business. No more waiting for late reports or being unable to delve into your profitability on an order or product level - all data is automatically gathered, mapped, cleaned, and visualized for easy analysis. For those ready to make tough decisions, tackle challenges head-on, and go the extra mile for data, dema.ai is your partner in achieving e-commerce success.