When I was a little kid, I had a toy cash register in my room. I loved to play store, so I priced everything in my room and would randomly pick up items and ring them into the cash register for a total. Clearly, I had my eye on the numbers from early on.
An ecommerce business is a perfect business model for someone who likes numbers and one of the most powerful is Gross Margin. Gross Profit and Gross Margin are interchanged and can be expressed as a dollar amount or percentage. The simple definition is the difference between selling price and cost.
One of the easiest ways to grow the profits of an ecommerce site is to gain a solid understanding of gross margin. Too many people stay focused on gross sales and ignore the benefits of focusing instead on gross margins. Whether I am evaluating a business for sale or planning a growth strategy, my first step is to compute gross margin for every item.
As an example, I have created a fictitious medical supply ecommerce site that carries about 400 items. This is a typical sales report with the top 5 items sold last year ranked by Gross Sales
I don’t like to look at a sales by item report without costs and margins included. The gross sales of an item is meaningless by itself, but becomes valuable with costs and margins included. Here is how I look at it:
We are going to look at two different scenarios for growing the profits of this ecommerce company.
- Increasing Gross Sales
- Increasing Sales of High Margin items
If we want to grow sales, the quickest path is to focus on the higher priced items or the ones already generating the most gross sales. For comparison we will have the other products stay at the same sales volume and set a goal to double the sales of our two biggest sellers:
To increase Sales of High Margin items, we would put all our marketing efforts behind the two items with the highest gross margin and aim to double the sales of those items:
Comparing these two projections to the prior year show that increasing the biggest sellers will grow sales dollars by 49% and the gross margin dollars increase 34%. While doubling the sales of the higher margin items only increases sales by 30%, but the gross margin dollars increase 42.8%. So while gross sales in dollars did not increase as much, we see an increase in the gross profit dollars.
Focusing your marketing efforts on the higher margin items actually moved the aggregate gross margin from 42.9% to 47%, however if you focused on your biggest sellers your total gross margin dropped from 42.9% to 38.5% – that is a tremendous 8.5% difference between the two growth strategies. If your ecommerce business is generating a million per year in sales, that 8.5% difference in gross margin is $85,000 cash in your pocket.
This is a simplistic example since we are only looking at 5 products out of 400. However, most businesses do follow the 80/20 rule when it comes to sales – meaning that 80% of your sales come from 20% of your products. In this sample store of 400 items, 80% of their sales are from about 80 products (20% of 400). The same is true for Gross Margin, most likely 80% of their gross margin dollars come from only 20% or 80 products. But this is where it gets interesting, those two lists of 80 products are probably not the same.
The place to find the real gems in a business is to use the Gross Margin report to identify the 20% of your products that are generating 80% of your gross margins. I can guarantee you, that there will be a product or two that make the list that you did not expect or even an entire category. So lets go back to our initial example and look at this report sorted by Gross Profit instead of gross sales – the largest gross dollar items have moved down the list:
Why pick just two items? We know the things we should be working on in ecommerce – creating epic content, photos, videos, infographics, CRO, PPC, etc. – while engaging in the communities of our customers. Doing that for 400 different products is overwhelming and many business owners end up paralyzed by too many options. Focus on two products for one year and complete all the tasks, then next year pick two more, just pick the right two to hang your hat on.