In the 4th quarter of 2016 I dramatically raised prices across the entire website.
To give an idea of the scale of the increase previously we were charging $14.95 for some shirts that now sell for close to $29 with free shipping. The free shipping was added due to some other changes in the way the business was operated, but even if we account for $3 for shipping (about my average cost for shipping tees via a USPS consolidator) we are looking at a price increase of $11, which is huge for a $14.95 item.
Of that $11 price increase most goes straight to gross profit except for the percentage fees the merchant bank or Paypal would charge. Let's say that amount to 2.2% or $0.22. So that is $10.76 straight to the gross profit column.
Now let's look at some of our costs for this item. I've created the spreadsheet pictured below as a way of analyzing different profitability under different pricing strategies.
I am going to assume that it will be twice as hard to get an order at the new higher prices than before. So we will assume $3 acquisition cost for the low prices and $6 for the higher prices. Both of these numbers are estimates and not really reality. Reality is that acquiring a customer is usually more expensive than this unless we have something really hot. But we also have organic search engine traffic and email lists and customers ordering more than one item that all help to bring the cost of selling one item down. So consider these acquisition costs a blend of the free and cheap traffic with the more expensive paid traffic.
We also have to assume that since I'm selling less volume I can no longer take advantage of volume discounts. (Bulk discounts were a key piece of strategy for me for a long time. I determined that I could beat my competition on pricing on a select few items by buying a lot of them. This is a very risky strategy that can lead to a warehouse full of losers and not enough cash to restock the winners because all the cash is sitting in the warehouse in the form of losers. I've also learned that products that are hot now are not guaranteed to do well in the future.) So in the picture below you'll notice my price cost to buy the tee jumped from $5 to $8.
Pay attention to the columns where the costs remain the same. These are a huge drain on gross profit at smaller dollar amounts and these are costs that have such a dramatic effect on overall profitability.
Finally, notice that I assume the percentage of returns will be the same regardless of how many I sell and therefore selling more leads to higher costs since we'll get more returns. That's devastating to the "make it up in volume" strategy.
Behold the Spreadsheet of Ecommerce Survival
As you can see in the first column my gross margins are within 4% of each other in both columns, this is because I lose volume pricing with lower volume.
So what does this spreadsheet tell me? It tells me that I can sell 1/5 the volume and make 1/2 profit before other costs.
But Wait, There's More (costs, that is)
What doesn't the spreadsheet tell? It doesn't tell me how FREAKING BIG a deal those other costs are. So I have to factor in the following:
- Cost difference between a facility that is capable of storing and shipping 1/5 of my current volume. Think about rent, utilities, taxes, insurance
- More orders = more employees. More employees = higher payroll, higher benefits cost, higher administration costs, more potential for bad employees, etc.
- Many subscription software tools charge you on volume, which means that you pay more for the tools in the higher volume scenario.
- Need to carry more inventory in the higher volume scenario. That means less free cash, more sunk cash.
- Replenishment is harder and more urgent with higher volume. That leads to more stock outs (this is especially hard when trying to get volume discounts with items that have sizes like clothing. We frequently would run out of a few sizes but didn't want to meet another minimum order to qualify for the low tier of pricing.).
Let's play with advertising costs
The only difference between this spreadsheet and the one above is I've raised the advertising costs to $10 in the low volume scenario and $5 in the high volume scenario.
Holy CRAP!! Look what just happened. The lower volume scenario is actually more profitable than the higher volume scenario. And don't forget we have all of the those pesky OTHER COSTS to carry as well.
Beware the psychological impact
No one ever said making sound decisions was easy psychologically. Humans are not rational, and as of the time of this writing only humans open up ecommerce sites.
It is tough to see your volume shrink. Shopify does not have a report for gross profit. But I see revenue and number of orders. Also, when was the last time anyone ever asked you what's your NET PROFIT at the end of the year? When did you see the INC 5000 of the most NET PROFITABLE companies? Has anyone ever asked your Net Profit Per Hour Worked?
It is also tough to get berated by customers, most likely former customers, for jacking up your prices. But the reality is I was not making much money off of them anyway.
Revenue is a terrible measuring stick
It is my assertion that the NET PROFIT will be larger under the lower volume scenario once you account for all of your OTHER COSTS. It's possible if you use a fulfillment center and get volume pricing that could potentially make it easier to win at higher volume, but it's also likely you'd end up paying more in storage fees under that scenario as well.
I personally have decided that I don't care to measure my success by volume of orders, number of employees, gross revenue, etc. I am focused on NET PROFIT, and I contend that outside of some grand ambition to achieve a crazy exit (and let's face it if you are reading my blog that's most likely not in the works for you because you are in ecommerce and going big is rare and usually leads to not so good things like with FAB, NastyGal, Modcloth) you are better off thinking like me than striving for growth.