Thoughts on Pricing and Profitability
Last week for the first time we listed our products for sale on Amazon.com. I put up about half of the Tastefully Driven catalog because products must have a US UPC code to be on Amazon and some of our detailing products and supplements do not have UPC codes. The entire process was a complete pain in the ass (at least compared to Google Product Search and Yahoo Shopping) and the whole time I was saying to myself “this is a waste of time and money”. Amazon charges $39.99/month and 15% of the purchase price, which eats into profit quite a bit. On top of that, Amazon is a price-driven marketplace so you really need to have the lowest price if you want to get any sales. For that reason, let’s just say it’s $39.99/month and 20% of the purchase price.
Is it worth it? My first thought was hell no. George convinced me to try it for a month or two and then go from there. Before I even finished uploading all of the products, we had our first sale. Since then we’ve had steady sales via Amazon and have even run out of a few products due to volume from Amazon.
But what about our profits? Well, here’s the thing: you don’t have any marketing cost associated with putting your stuff on Amazon. The products literally sell themselves just because of the shear mass of people buying stuff everyday. There’s no sales process or customer service questions to deal with. The sale just comes through and we ship it with an Amazon invoice in it (and of course some coupons to entice them to shop on TD). I’d say our average product is $30 - 20% of which is $6, meaning we end up selling a $30 product for $24. Most of the time, I’d say we spend more than $6 of marketing expenses (including sales related customer service) on that same product when we sell it through the site. When I look at it that way, I feel a lot better about it.
The more intriguing question to ask - how important is profitability? Consider two online web businesses who both sell blue widgets…nah, blue widgets is played out, let’s say they sell the same high-demand DVD player, which is the only product they sell. Their cost on the DVD player is $50. Suggested retail price is $100. Company 1 sells it for $99, while Company 2 sells it for $80…becoming the low-cost leader for the product.
Assuming all else is equal, Company 1 will profit more (24% more) per unit. I know a lot of people who would rather be Company 1. They want to profit as much as they can per unit. But if the product is in high demand, it’s already being sought out thousands of times each day via product searches like on Amazon, Google, Yahoo, and a slew of other ones. Those searchers are likely solely buying based upon price - if your site doesn’t totally suck you’ll probably get the sale every time if you are Company 2.
Now - for funsies - let’s say that each company profits $100k for the year. Company 1 sells 2,041 units (x $49 profit/unit) and Company 2 sells 3,333 units (x $30 profit/unit). Again, I think that a lot of people would rather be Company 1.
I disagree. Here’s why: Company 1 has the advantage of less customer service and less work packing/shipping, but has the disadvantage of having to work a lot harder for each sale. In reality, a lot of that $19 difference goes away when you factor in the time/expense of marketing a product when selling it at the same price everyone else is. Company 2 spends more resources on packing/shipping and servicing customers, but minimal time marketing because the sales just come to them. Company 2 also gets purchasing discounts and shipping discounts because of their extra volume. In addition, they cycle through inventory faster…meaning they don’t tie up money/space with inventory that isn’t going to move fast. Over time the advantages of Company 2 are more valuable to me: it’s easy to find warehouse workers and customer service reps relative to how easy it is to generate sales. Generating sales is the hardest thing to do in the world of business. If I find a hands-off way to drive sales AND can turn over inventory faster by doing it, I’ll gladly sacrifice some profitability.
Think about it from the outside as a venture capitalist or someone trying to acquire your company. Taking the example to the extreme, would you rather have a company that ends the year with $100k in revenue, $10k in expenses, and profits $90k (a web design company could look like this) OR would you rather have a company with $10 mil in revenue, $9.91 mil in expenses, and also profits $90k? They both profit the same at the end of the year. But the second company has far more cash passing through their hands and because of that revenue they will be able to secure outside financing (bank loans, private investments, venture capital, etc) easier because their cash flow will allow them to manage their debt. The company is simply more valuable because they generate a lot more revenue.
I’m not sure if this is intuitive or counterintuitive to people or what. All I know is that it’s been on my mind a lot lately, and profitability is becoming less and less important to me.
*side note: salaries are being factored into our expenses whenever I discuss expenses, so breaking even is just fine with me for now. In addition, this does not mean that we aren’t constantly trying to improve our processes and systems so that we can maximize our profitability. I’m solely referring to pricing and how it impacts the bottom line…not all of the other factors that contribute to the bottom line of a business.
On April 14th, 2008 at 5:41 pm
Adam -
First off - loved your last article about post-launch time. It was dead on.
Regarding this one - I think the big caveat & elephant in the room regarding your “praise” of your high-volume/low-profit/low-marketing-expense Amazon model is this: What happens if Amazon drops off the face of the earth tomorrow? Or, more realistically, decides to radically change the structure of the program you’re using? The way I see it is, relying on one giant to fuel massive revenue just isn’t the way to go. And you’re smart. You know that. Which is why you’ll still spend just about as much as you would have before to continue to market via more traditional channels, in *addition* to selling on Amazon. So when you look at in that regard - sure, I guess it couldn’t hurt to put your products on Amazon, but I sure as hell wouldn’t encourage doing that *instead* of spending money marketing elsewhere. Channels such as Amazon must be considered supplemental, not reliable.
And while I, for the most part, agree with your analysis of profit vs. revenue in regards to outside financing - I do think it’s important to note that a potential investor might be troubled by a company that lacks a client/sales channel “portfolio”, relying mostly on just one or a few major channels. If it’s Amazon, Google, et al, helping you go from a few hundred thousand/yr to a 10m/yr company, then I think a potential investor HAS to ask - is this company anywhere near as valuable without the true big shots? And what’s the difference between this company and some guy in his house who just distributes stuff on eBay?
On April 14th, 2008 at 6:15 pm
When I first read this I also thought about the long-term aspects of having more volume and less profitability NOW.. Although Pure Adapt is hardly a ‘new startup’, TD is a ‘new project’.. and it’s important to get cash flowing asap. And when you can CONTINUOUSLY market to past customers to get REPEAT business (capture their email, sending coupons, etc..) having lower profits now will help you develop a much larger client-base (and profits) down the line..
As far as Anthony’s comment, I know some other business owners that ONLY use craigslist for their marketing.. imagine that!? The problem comes when CL finally figures out how to stop ppl from using quick-posting programs.. then your income is shot.
But knowing how you drive sales and traffic, you’ve got PPC and many other sources going besides Amazon or whoever..
Keep up the great work, and I can’t wait to see the post about Pure Adapt/DI/TD hitting the $83,333/mo mark!
On April 15th, 2008 at 8:21 am
Thanks for the in-depth comments guys. I was oversimplifying things a bit: clearly shopping sites and PPC are just a small portion of the overall marketing plan…but a very important one as we’re getting started and need to move product and draw visibility to the site…as Adam mentioned above.
The long term focus is definitely on quality content and a tight-nit community (which allows you to do a whole new slew of highly focused marketing), but that stuff takes years to build.
One thing I didn’t mention - that we’re starting to do with Detailed Image - is wholesaling. We have a handful of large wholesale accounts (mostly professional detailers) where margins are lower but they order repeatedly with no work on our part, and when they do place orders they buy 100 of a product and not 2.
I’m not saying we want to become a middleman (I think we’ve got more to offer than that), but being able to turn over high volumes of product in addition to getting sales direct to consumer is something we overlooked in the past more than I think we should have.
I guess you can sum everything up by saying: I/we are starting to see value in doing some higher volume / lower margin business whereas in the past it never entered our minds.
On April 17th, 2008 at 6:56 pm
Hey Adam great post. If I was to look at it from a venture capitalist view or a business owner I would pick the first option of spending not so much and making more money. I think it just shows that you are more money management efficient and it also shows that you are pin pointing your market alot better than just through money at everything and seeing what works.
I can see in your case right now that it is only wise to throw money at all possible money funnels, because you never know unless you try all the choice you can think of. Again great post about how you and your partners are thinking and doing to grow your business.
On April 17th, 2008 at 10:33 pm
Adam,
I have disagree with you on part of this.
Who wants to buy a company with horrible margins?
“We have this big company, doing tons of business, with all sorts of employees and a giant infrastructure, but we still haven’t found a way to make more than the guy down the street who has 1/10th the infrastructure and staff”
Now they may be more valuable because they have more potential because they have more customers, brand recognition etc but running a business with low profit margins isn’t something to aim for simply because you have a lot of cash running through the business. One spike on oil prices and you are in the red, while the small guy is still in the black.
On April 18th, 2008 at 8:16 am
I was (somewhat) intentionally stretching my point a bit - but that’s exactly the reason: they have the customers and the brand recognition and then can focus on profitability moving forward…much easier in my opinion than running a tiny profitable business that needs to scale.
There’s no “right” answer here, and in truth I don’t always feel the way I did while I was writing this post, but it’s a different way of looking at things that I never considered much previously.
On April 18th, 2008 at 11:55 am
Adam,
I know the feeling - sometimes I start writing and I’m writing a new opinion i’m not sure I agree with but it seems to be working so I run with it…
On April 21st, 2008 at 1:49 am
To the investor the 10m/10k company is worth more then the 100k/10k company. The question is why exactly. I think the answer is ‘potential’.
{The 10m/10k company can feasibly become a 10m/500k company without breaking any records.}
It’s not the extra revenue. It’s the potential. Revenue is an indicator (to the outsider) of potential.
So what is the Amazon sale worth to you, outside of the profit?
You put in some coupons, do they end up leading to anything? Do you get permission to keep in touch. Do you get participation in your online community? Does the scale you get help you in some way?
And if we’re pushing things to extremities, how does this model scale? If you sold 100X as much on Amazon, would it help/hinder your business?
On April 21st, 2008 at 7:58 am
Netcan,
Thanks for the insight. To answer your questions:
“You put in some coupons, do they end up leading to anything? Do you get permission to keep in touch. Do you get participation in your online community? Does the scale you get help you in some way?”
Definitely yes to all of the above. In addition, it moves more inventory which allows us to negotiate lower rates with our suppliers and with FedEx.
“And if we’re pushing things to extremities, how does this model scale? If you sold 100X as much on Amazon, would it help/hinder your business?”
It would help, but that’s only assuming that I/we automate the process a bit more. Amazon provides an API so it’s do-able, but right now we’re manually spending an extra 5 minutes with each Amazon order. I’m already close to pulling the trigger and spending time trying to further automate everything with Amazon and our system, so it’s safe to say that if we hit that pt it would run like a well-oiled machine.