3 Profitability Drivers for eCommerce businesses

"How can I make profitable sales?"

Acquiring new customers can get expensive really fast.

Paid advertising, email marketing, social media, SEO, brand ambassador programs, and affiliate programs are some of the top revenue streams and customer acquisition strategies for eCommerce companies.

All of these open up incredible opportunities, and sometimes, at a very high cost.

Here is the truth, retaining new customers can also get expensive and time-consuming very fast: improving operations, dialing in our fulfillment, hiring and training our customer support team, social media, email marketing... all these are mines of opportunity, and it takes strategy and execution to get results.

These 3 eCommerce metrics will help you to assess where your business is bleeding money and what areas of opportunity you may be missing.

This blog is for those who have an eCommerce business, have a product and market fit, and are experimenting with ways to make marketing and sales processes repeatable, scalable, and profitable.

Knowing these three elements will help you set up KPIs for marketing & advertising to increase your profits month after month.

In this blog, you will get a better understanding of the three key ecommerce metrics that will help to drive profitability in your ecommerce company. You will learn more about CAC, AOV and LTV (also called CLTV).

Why Are These 3 eCommerce Metrics So Important?

How can the three eCommerce metrics I mentioned help?

For starters, they help you gather the data you need to see a clear picture of what is going on in your business and make the right decisions to maximize your ROI (Return on Investment).

In eCommerce, there are SO many metrics and key performance indicators that can be tracked. However, it doesn’t make sense to try to get a handle on dozens of different eCommerce metrics if they don’t directly apply to your company or the data you need right now.

For this reason, I’ve chosen to focus on the three main eCommerce metrics that are going to make the most difference for your profits. You will learn what they are and how to calculate them, so you have a better understanding of how your business is doing and where you should be putting your efforts to improve profitability in your online store.

A Closer Look at the Three Main eCommerce Metrics

Let’s look into each of these three acronyms to get a better understanding of what they mean:

• CAC – Customer Acquisition Cost

Definition: The customer acquisition cost is the cost ($) of getting a customer.

It’s simply how much you spend on your sales and marketing efforts to get a customer. It’s important that you don’t confuse this with CPA, which is the cost of acquiring a lead. Remember that a lead is someone that entered your sales funnel, but not necessarily someone who is or will become a paying customer.

There are two levels of CAC you can calculate.

1. CAC including only paid ads spend. This is a good number to track weekly with your paid ads manager and marketing team to track the performance of ads.

2. CAC including all Marketing and Sales expenses, including paid ads spend, marketing, and sales teams' salaries and commissions, the cost of any brand awareness, and non-conversion-related marketing efforts. This is a good number to track monthly and quarterly.

Here is how to calculate your CAC: The way to calculate CAC is by dividing advertising spend ($)/number of new customers (#). For example, if your marketing and sales spend was $3,000 and that spend brought in 100 new customers, then $3,000/100 customers = $30/customer. Your CAC would be $30 per customer.

To decrease your CAC consider re-evaluating your pricing and improving traffic quality & quantity, your marketing and ads' Click Through Rate (CTR), your landing page's Conversion Rate (CVR), and your follow-up and retargeting efforts.

• AOV – Average Order Value

Definition: AOV refers to the average dollar amount ($) that your business receives when you make a sale.

Here is how to calculate your AOV: To calculate AOV divide total sales ($)/number of transactions (#). For example, if your total sales are $20,000 and you had 100 customers, then $20,000/100 transactions = $200/transaction. Your AOV would be $200/transaction.

To increase your AOV: My recommendation is to find ways that you can increase the average order value as much as possible on your eCommerce store. To increase your AOV, consider bundling, upselling, and cross-selling.

• LTV (or CLTV) – Customer Lifetime Value

The customer lifetime value refers to the average total dollar amount ($) that your business receives from one unique customer during the lifetime of the relationship.

Here is how to calculate your LTV (for non-subscription businesses): · LTV = AOV (Average Order Value) x Gross Margin (%) x Customer Lifespan (in months or years)

The Gross Margin is the amount of revenue left over after deducting the cost of goods sold (COGS) incurred in the period.

Subscription business? Here are other variables to consider when calculating customer lifetime value. These include the churn rate and the discount rate of .75.

Churn Rate: Let’s say that your customers normally come back to purchase from you five times a year, with a churn rate of 10%. This means approximately 10% of customers do not return five times a year.

Here is a common misconception "churn happens only with subscription businesses." There is also such a thing as non-subscription churn, which happens in eCommerce businesses that don’t run subscription models. "Non-subscription churn" occurs when customers gradually stop purchasing from you, suddenly don’t buy from you again, or end the relationship with you before than expected. Customer retention can be difficult, so it is important to account for this.

Discount Rate: It is common practice to assume a discount rate of 0.75 when calculating LTV. This will give us a more conservative number based on the risks of revenue lost during the time repeat purchases occur.

LTV Formula for subscription businesses: LTV = AOV (Average Order Value) x Gross Margin (%) x Customer Lifespan (in months or years) x Churn Rate x Discount Rate.

When calculating LTV, it is important to calculate LTV for a specific and closed timeline.

To increase your LTV: To increase LTV is to increase your customer retention, I would focus on increasing your nurturing efforts through email marketing nurturing flows, loyalty & rewards programs, and providing added value & community to your existing customers. And also, customer support and fulfillment, ensuring that their experience is "to come back for".

Your ideal CAC, LTV, and AOV for profitability

Your ideal CAC for profitability varies, but there is a known golden rule.

The ideal ratio for profitability is CAC 1: LTV 3 (1:3).

It is important to note: The CAC explained above are metrics that take into account only "Marketing and Sales" costs. The CAC that you will normally track in the short term and that will help you set daily, weekly and monthly KPIs does not include all costs of running your business: your cost of goods sold and your operating costs.

Cost of Goods Sold: cost of manufacturing, labels, quality control & quality assurance costs, payment fees, shipping costs, returns, dispute fees

Operating Costs: salaries not related to Marketing and Sales, taxes, contractors, paying platforms and systems such as Shopify, Adobe, Canva, TaxJar, etc.

Considering your Cost of Good Sold and Operating Costs when deciding your ideal CAC, AOV, and LTV is crucial to get a full picture of where your profitability stands.

Calculate Key Performance Indicators Separately for Each Channel

One of the most important things that you need to keep in mind with these data points is that you should find them for each of the channels you are using for your marketing and ad campaigns and do so separately.

For example, if you are running ads on Facebook Ads, Google PPC, Pinterest, Etsy, etc., you will want to find the numbers to these data points for each of those channels separately.

A Summary of the Ecommerce Metrics Discussed

Today, I talked about the top three key paid ads metrics that eCommerce companies need to optimize to become profitable. Here’s a simplified refresher.

• Key Metric 1: Customer acquisition cost, CAC, which is simply the amount that it costs to acquire a single customer.

• Key Metric 2: The average order value per transaction, AOV, which is how much someone spends on their average order.

• Key Metric 3: The customer lifetime value, LTV is the amount a customer will spend over the course of a specific period.

Taking the time to understand and become fluent in these terms can help you to get a better understanding of your business and how to operate it effectively. You will know how the numbers relate to one another, which is important when you are setting your new eCommerce key performance indicators for your marketing, fulfillment, sales, and operations teams.

The goal is to drive profitability in your company, and these metrics are there to help you understand why you are bringing in sales but still losing money and to help you find ways to make improvements.

When you know how to calculate the numbers, they should be included in your reporting. By gathering historical data, you can establish clear benchmarks of the sales data, trends, and results. You will know what has worked in the past and what has not worked. The numbers can be used as drivers to forecast data, allowing you to better predict, control, and create profitable marketing and business initiatives.

When you can create profitable and repeatable processes to acquire new customers and retain them, you can then scale your operation and grow. However, you must take the time to understand these eCommerce metrics, so you can find processes that can be repeated and that are truly profitable.

What are the best methods that have worked for you when calculating the profitability of your eCommerce company? Please, share your insights in the comments!