E-Commerce Profit Margin
I’ve built ecommerce businesses for more than two decades, and I’ve invested in ecommerce companies for the past ten years. Through that experience, I’ve come to rely on Gross Profit After Advertising Cost (GPAAC) as the perhaps the most important metric in evaluating the financial health of an ecommerce company. When I was running ecommerce companies, we (usually) tried to optimize GPAAC above all other global financial metrics, and I push our portfolio companies to do the same.
Here’s a quick refresher for those of you unfamiliar with ecommerce profit and loss statements:
- To determine your GPAAC, first start with Gross Revenue — this is the top line of your P&L.
- From this Gross Revenue number, subtract Returns and Discounts — this gives you Net Revenue.
- From Net Revenue subtract Cost of Goods Sold and Shipping / Fulfilment Costs — this is known as Gross Profit.
- From Gross Profit subtract all Advertising Expenses — this (finally) yields Gross Profit After Advertising Cost (GPAAC)
With positive GPAAC, a company can cover operational expenses like salaries, technology and rent… ideally with a fair bit of profit remaining after expenses are paid.
Over the past half-decade we’ve witnessed the rapid rise of dozens of new ecommerce brands. Given powerful new marketing channels like Facebook and Instagram, revenue growth can be staggering. In my case, we quietly grew Country Outfitter from $1 million in annual revenue to a $100 million annual run rate in a matter of 6 months!
Unfortunately, despite headline grabbing revenue growth, these companies were wildly unprofitable. They relied on ever-expanding ad spend budgets and/or low-margin flash sales to drive sales. Due to an over-reliance these tactics, the companies generated very little GPAAC. When the next round of venture capital failed to materialize, the companies died a painful death.
They say people in glass houses shouldn’t throw rocks — I made this mistake myself.
Shortly after we raised $100 million in venture capital, our marketing team started spending money like drunken sailors. After bootstrapping an incredible, profitable business by diligently focusing on organic growth and highly profitable paid customer acquisition, our crack team (led by me) lost their way. Just like other higher profile implosions, we were guilty of pursuing growth at all costs to satisfy our egos and our (large, influential, scary, New York) investors who demanded revenue growth.
You see, top line gross revenue can be deceiving. GPAAC is nearly impossible to manipulate — it’s akin to a truth serum that reveals the true health of an ecommerce company.
Like most other ecommerce metrics, GPAAC can be controlled by focusing on unit economics. Namely, making sure customer lifetime value far exceeds customer acquisition cost for each and every marketing channel and keeping discounts under control.
For the vast majority of healthy product-based ecommerce businesses, GPAAC should grow in tandem with revenue growth. While rare exceptions can be made for companies with incredibly high organic repurchase rates or recurring revenue (think Amazon and Dollar Shave Club), these companies are the exception not the rule. As such, GPAAC is my favorite ecommerce financial metric, and increasing GPACC is a worthy goal of any ecommerce CEO and CFO.
In the past two decades, I’ve learned many hard lessons about improving GPAAC. As the founder and CEO of Engine, a marketing-technology focused ecommerce platform, I’m excited to impart those learnings to our clients. If you’d like discuss how the Engine team could increase your company’s GPAAC, let’s chat — email me: john at enginecommerce.com