E-commerce is hard, but the math behind optimizing the revenue of an online store is surprisingly simple.
Sure, there are complicated nuances, but the general health of an e-commerce business can usually be determined by looking at a simple equation that can be understood by anyone who passed 8th grade math.
There are 6 variables that go into this equation.
- Average Order Value (AOV) — simply take total revenue and divide by number of orders.
- Cost of Goods Sold (COGS) — how much does the product to fulfill an average order cost?
- Fulfillment Costs (F) — how much does it cost to fulfill an average order? Take all your expenses — shipping costs, credit card fees, labor, rent etc. and divide by the number of orders.
- Conversion Rate % (CR) — how many site visitors out of 100 complete a purchase
- Lifetime Purchases (LTP) — how many times will the average customer purchase over their lifetime (including the first purchase.)
- Lifetime Site Visits (LTSV) — how many times with the average visitor return to your site?
Here’s the equation to figure out the value of each new visitor to your store:
$$ / visitor = (AOV – COGS – F) x CR x LTSV x LTP
Let’s try an example — Kate’s store has a $100 average order, a $50 cost of goods, and $10 fulfillment costs. 1% of site visits result in a purchase with the average new customer visiting the site 1.2 times, and purchasing 1.3 times.
(100 – 50 – 10) x 1% x 1.2 x 1.3 = $0.62
Kate’s store makes $0.62 of profit per visit. If she can acquire a new customer for substantially less than 62 cents, she will reliably turn a profit from that sale.
Most stores looking to grow their profits spend an inordinate amount of time optimizing the first three variables — average order value, cost of goods sold, and fulfillment costs. While these three variables cannot be ignored, in my experience the vast majority of stores looking for growth should be focusing on the last three variables — conversion rate, repeat visits to the store, and customer lifetime value.
Let’s look at two examples, letting math be the guide once again!
Kate has decided to focus on the first three variables. She implemented aggressive cross-selling and upselling techniques on her website to improve average order value, she beat up her suppliers to reduce cost of goods, and she beat up Fed Ex to get better rates.
Through this process, Kate was able to increase her AOV by 10%, decrease her COGS by from 50% to 45%, and reduce her fulfillment costs by 10%… how much will she improve her $0.49 profit from each visitor? Here’s the new equation that reflects her improvements:
($110 – $49.50 – $9.00 ) x 1% x 1.2 x 1.3 = $0.80
An impressive improvement, but improving those variables even further will be quite challenging.
Kate’s sister Abby has an identical business. But she decided to focus on the final three variables — conversion rate, lifetime visits, and lifetime number of purchases.
Abby tested every element of her site and improved her conversion rate to 1.5%. She started capturing visitor email addresses and started an email marketing program which increased number of visits per new visitor to 5 — most visitors still visited only once, but a lot of subscribers visited the store every time she sent her bi-weekly email. She implemented automated lifecycle marketing to encourage repeat purchases from her customers increasing the average number of lifetime purchases to 1.6. Here’s the results of Abby’s work:
($100 – $50 – 10) x 1.5% x 5 x 1.6 = $4.80
While Kate improved the revenue of her store by a respectable 29%, Abby improved hers by 674%!
Think this is impossible? It’s not. The numbers are representative of the improvements we made at our last e-commerce business. The improvements detailed above allowed us to grow our revenues exponentially, and raise over $100 million in venture capital.
We grew monthly revenue from well under $1 million / month to $14.5 million a few short months… here’s the revenue graph:
More recently, our team helped Menguin go from the brink of failure to being acquired for $25 million after implementing the same strategies.
To help more companies, we’ve baked our knowledge into Engine, our new cloud-hosted e-commerce platform. Engine makes optimizing those final three variables easy… our e-commerce platform makes it easy to improve your conversion rates, grow your email list, and increase the lifetime revenue of each customer through automated, personalized marketing messages triggered by their specific actions on your site.
Looking for to upgrade your store? Let us build it for you. Email me at firstname.lastname@example.org to see if we can help.