So, you’ve started your first e-commerce store and sales are going well. However, you’re not turning a profit, or not making as much of a profit as you believe that you should, despite the increasing amount of revenue that you’re bringing. What’s going on?
Well, there’s a science to pricing strategy behind every ecommerce product that many beginners overlook. It’s not necessarily as simple as just looking at the revenue that’s coming in. Because of all the costs associated with driving traffic to the store, fees, and ‘overhead,’ the profit margin can get slimmer and slimmer from what you originally believed it to be.
Steve Tan is an ecommerce expert himself and has created an online educational platform called LeapVista with his brother Evan to teach aspiring ecommerce entrepreneurs how to succeed online. He shared the basics of the pricing strategy that he teaches his students – with the goal to help them make a profit from every single sale they make. By understanding what costs to prepare for and how to price your items accordingly, you can maximize your profit margin.
Understand Your Costs
First, having an understanding of what exactly your costs are is paramount. “I teach that the following list are the costs that need to be understood and considered,” shared Tan. The list is as follows:
- Facebook Ads Cost, or when you pay for Facebook ads to drive traffic.
- Cost per acquisition (CPA), which refers to how much it costs to ‘acquire’ a customer. For example, say you spent $200 on a Facebook ad campaign and it led to four sales. The CPA for this campaign would’ve been $50. If your product has a profit margin of $20, this is where you can get into trouble.
- Cost of goods sold (COGS). How much do you pay for the product you’re selling? How much does it cost to purchase it or manufacture it?
- Shipping costs (understand a range depending on where you’re shipping to).
- Credit card fees.
- Return on ad spend (ROAS). To understand this, imagine that you spend $100 on ads, which leads to five purchases at $100 each, or $500 in sales. Your ROAS would be 5X. “There should be a minimum of 1.8X ROAS, and ideally something between 2-3X is healthy. Anything higher is exceptional,” noted Tan.
- Taxes (where applicable).
Rule of Thumb for Controlling Costs in Dropshipping
Tan recommends that costs should be controlled within 30-35% of the Selling Price. This means that your COGS, shipping costs, credit card fees, and miscellaneous fees combined should only comprise 30-35% of the selling price for an optimal pricing strategy. “Around 30 percent is the sweet spot,” added Tan.
However, notice that these costs that should be controlled within this target of 30-35% do not include ad spend. “It’s best to have the remaining 70 percent as freedom for ad spend,” explained Tan. “This means that if you then control your ad spend within another 30-50%, you’ll still be making a profit on the product.” Allocating some of your profit to more ad spend is what will enable your business to continue scaling and expanding.
Establishing a Maximum CPA
You should also determine your maximum cost per acquisition (CPA), or the maximum amount you’re willing to pay before you lose money. This could be different at different points in your business. At first, perhaps you set aside an amount of money to get off the ground, so you’re willing to use that money to experiment with different ad campaigns on Facebook.
“Imagine that, based on the price of your product and the costs, your profit on a product is $70. When you’re getting started in your business, your maximum CPA might be as much as $70, so that you at least make the sale and can get that review. Your maximum CPA wouldn’t exceed $70, because then you’d be in the red,” Tan explained. Or, maybe you’re betting on bringing some profit into your pocket, so your maximum CPA would be $50 so you profit $20 on each product. It’s up to you depending on what your goals are: for some brands, this will be to break even or be minimally profitable at the front end because returning customers have 0 ad cost. In this case, they make the majority of their profits from returning customers.
How to Control Costs
Tan noted that a major reason many do not make a profit (or enough of a profit) is because they don’t have a proper plan for managing their cost of goods sold or their ad spend. Then, once they start to see an increased volume in sales, hidden fees start to pop up. Tan recommends creating a buffer in your estimation for your profit margin just in case any type of chargeback or unforeseen costs come up.
Some ways that you can control costs include:
- Factoring an expected or estimated percentage of refunds into the costs
- Negotiating better prices as volume increases
- Constantly optimizing ads instead of settling for ads that perform ‘well.’
- Expanding into new traffic sources
All of these ways of decreasing costs help to maximize your profit margin. Consider these costs when you price your products, too. Get a sense for how your competitors price the item, then see how much you can charge.
To learn more about getting started in dropshipping, visit Tan’s course, Leapvista.
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