How to calculate product profitability to balance sell-through rates with profit margins.
Reporting & Analysis
Jan 26, 2024
E-commerce product profitability is determined by understanding revenue, costs, and key metrics like Gross and Net Profit Margins, and ROI. Use Airboxr to automate reports of products’ daily gross profit margin for Shopify stores.
Product profitability is a crucial measure in e-commerce that tells us how much money a product brings in after all expenses are deducted. In simpler terms, it's about figuring out if selling a particular product is making you money or costing you. You can have many customers on your website, but if the products aren't selling profitably, your business won't survive...much less thrive.
Understanding product profitability helps you make smart decisions - like which products to push, how to price them, and where to spend your marketing dollars. It also helps you balance sell-through rates for your products. Sometimes, prioritizing higher profits is more important than selling quickly, while other times, the opposite is true.
Understanding product profitability in e-commerce
Product profitability analysis in e-commerce is like a health check for each product you sell. It tells you if a product is doing well financially. To understand this, think about two main aspects: how much money you make from selling the product (revenue) and how much it costs you to sell it (expenses).
Key components of a product profitability analysis include the following:
This is the money you receive from selling the product. It’s not just the price of the product but also includes any shipping or handling fees you charge.
2. Cost of goods sold (COGS)
These are the costs directly tied to making or buying your product. It includes things like the price you pay to get the product manufactured and delivered to you.
3. Marketing expenses
Money spent on advertising or promotions to sell the product. This could be online ads, social media marketing, or email campaigns.
4. Other expenses
These are other direct and indirect costs related to selling the product, like website hosting fees, payment processing fees, marketplace commissions, or staff salaries.
By subtracting all these costs (COGS, marketing, and other overhead expenses) from your total revenue, you get a clear picture of how much profit each product is making. It's not just about selling a lot; it's about how much money you keep after the sale.
Approaches and formulas for product profitability in e-commerce
To accurately measure and analyze product profitability, you can use different formulas and approaches. Each method gives you a unique perspective on how well your products are doing financially. Learn more about different levels of profitability in our article on profit metrics.
1. Gross profit margin
This tells you what percentage of each product sale is profit accounting for all direct costs, before considering other expenses like marketing. It’s a quick way to see how profitable your product is at a basic level.
Formula: (Revenue - Cost of Goods Sold) / Revenue
2. Net profit margin
This gives you a clearer picture of the actual profitability of a product after all costs are considered. This is different from Gross Profit because Net Profit Margin takes into account all costs associated.
Formula: (Revenue - All Expenses) / Revenue
3. Return on investment (ROI)
ROI measures how much profit you make compared to what you spend to get that profit. This could be the cost of buying the product, plus any marketing or operational costs associated with producing it.
Formula: (Net Profit / Cost of Investment) x 100
4. Break-even analysis
This tells you the minimum price at which you should sell your product to avoid losing money. This is crucial for more informed pricing decisions since it helps you understand the minimum amount of sales needed to cover production costs.
Formula: Fixed Costs / (Selling Price per Unit - Variable Cost per Unit)
These different formulas help you see product profitability from various angles. Gross and Net Profit Margins give a quick snapshot of profitability. ROI shows the efficiency of your investment in the product. Break-even analysis guides pricing strategies.
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Using Airboxr to calculate product gross profit margins
Airboxr makes it easy for Shopify stores with our Profit by Product Variant over Time Hop. This hop automatically calculates your product's daily gross profit margins and presents the output right into your Google spreadsheet. You also get a complete breakdown of your product's sales metrics such as orders, gross sales, net sales, and total sales revenue. You can use this report to prepare other reports and inform decision-making to maximize profitability.
Significance of product profitability calculation in e-commerce
Understanding the profitability and overall financial performance of your products is more than just knowing numbers. It's crucial for several reasons:
Knowing which products are profitable guides key decisions. For instance, you might allocate resources to stock more of a high-profit item or revise the marketing strategy used for a less profitable one. It affects everything from pricing and marketing to inventory management.
Long-term business sustainability
Profitable products are the backbone of a successful e-commerce business. By focusing on them, you ensure your business not only survives but thrives. It's not just about making sales; it's about making profitable sales.
Competitive analysis and market positioning
Understanding your product profitability helps you see where you stand against competitors. Maybe your competitors sell similar products but at different prices. Knowing your profitability can help you find the best position in the market.
In e-commerce, resources like time and money are limited. Knowing your product profitability helps identify opportunities to allocate these resources more effectively. For instance, investing more in marketing for products that have a higher return.
Customer satisfaction and retention
Sometimes, the profitability of a product is linked to customer satisfaction. Products that meet customer needs and expectations can lead to repeat purchases and customer loyalty, which in turn boosts revenue-generated profitability.
Strategies to improve product profitability in e-commerce
Improving sales volume and product profitability is crucial for e-commerce success. Here are some strategies:
Cost reduction techniques
Look at your supply chain and find ways to lower overhead costs. This might mean negotiating better deals with suppliers or finding cheaper shipping methods for raw materials. Also, manage your inventory efficiently to avoid the cost of holding excess stock.
You can experiment with different pricing strategies. For example, tiered pricing appeals to different customer segments, offering various price points for different versions of a product.
Enhancing product value and customer perceptions
Increase the perceived value of your products. This can be through quality improvements or better presentation on your website. Encouraging customer reviews and testimonials also builds trust and can justify a higher price point.
Marketing and customer relationship management
Invest in marketing campaigns that target the right audience effectively—especially through organic and earned channels. Focus on building strong relationships with customers through personalized communication and loyalty programs.
Expand your product range by introducing complementary items. This can increase the average order value. Testing new products in small quantities first can help gauge market interest without a large initial investment.
In conclusion, mastering product profitability is crucial for the success of any e-commerce business. It goes beyond just making sales; it's about maximizing profitability and ensuring these sales are financially rewarding. Make sure to review the profitability of each product over time: to predict when a hot product is going out of fashion. Balancing the speed of sales with profit per product is an essential part of building a profitable business.