– Paul Waddy, Co-Founding Director – Ecom Nation
The most important metric in eCommerce is gross profit margin. If you don’t know yours, look away now, this isn’t going to be pretty.
Gross profit, or GP, is your everything – It’s your wiggle room, it’s the loosening and tightening of your trouser belt that holds up your paid media pants, it dictates your wage budget, your sexy HQ fit-out budget, and most importantly, your net profit.
Put simply – your gross profit, minus your operating expenses, equals your net profit.
The number of eCommerce businesses that prioritise revenue over gross profit never ceases to amaze me. Any mug can grow sales – as an advisor I’m looking to improve the lives of the founders I work with, which is also why we founded Ecom Nation – we believe it’s profit that improves lives, not revenue.
The good news is, there are two ways to improve your gross profit – reduce your cost of sales, or increase the price of your products – the bad news is that neither of these options is an easy thing to do so it’s important to get your gross margin right from the start.
Here’s a quick example. Johnny wants to grow his ecom business 100% year on year (don’t we all Johnny…), and Johnny wants to know how much to spend on marketing. Now, a super aggressive ecom business spends 20% or more of their online revenue back into marketing but there’s a problem – Johnny’s GP is 30%. If Johnny spends 20% on marketing then he only has 10% left to spend on running the rest of his business, and even if he did (which he won’t if he ever hopes to scale) then he’s left with a grand total of 0% net profit!
Johnny’s situation is not unique and in my experience sends many online retailers belly up.
Let’s assume Johnny actually needs to spend 15% of online revenue to run his business (wages, rent, subscriptions etc.) and wants to pocket a small profit of 5%. That leaves only 10% of his revenue to be invested in marketing, the problem is, these days 10% isn’t a big budget, and it’s likely to result in dreaded slow and steady growth, not the boom Johnny was hoping for.
If Johnny can’t improve his gross margin beyond 30% then he is left with 2 options:
- slow and steady growth, with a 5% net profit margin, or
- he can put his head in the sand and hope that fast growth will miraculously improve his gross profit margin (I’ll let you in on a secret, it won’t)
That’s the beauty of expressing gross profit as a percentage – no matter how fast your sales grow, it won’t improve your gross profit margin, which can actually mean that growing faster can actually accelerate your losses.
Don’t be Johnny. Worry about your gross profit as much as, or even more than, your sales because a small profit is better than no profit, and despite popular belief, unprofitable businesses don’t always sell for multiples of revenue – profit is still the name of the game.