Too often, I’m in a meeting reviewing a quarterly marketing plan that is focused on the budget: how much money will be deployed, where it will be spent and when. And almost always I listen to stakeholders hesitate because they want to know whether or not there will be ROI…without actually knowing what ROI means.
Imagine your Marketing Manager coming to you with a marketing campaign that included not just the spend but also the potential profit of each customer acquired (or, if you’re that marketing manager, imagine booking a meeting with your boss without having to break out in a sweat because you’re afraid you can’t prove what you’re talking about).
You’d be a lot less hesitant approving this sort of spend when presented with the potential profit outcome.
But in order to do that, you need to understand what real ROI is – and not the “theoretical” ROI too many marketers have been trained to talk about.
I’m speaking about the only three key value variables that you want to focus on when building an eCommerce business.
The 3 Most Important Variables for eCommerce
- Customer lifetime value (CLV) – How much will a customer spend with you over their lifetime?
- Product/category contribution margin – How much profit margin does each product or category of products add to your business?
- Customer contribution margin (CCM) – Who are your most profitable customers? Hint: they buy your profitable products
That’s it. If you know these three variables, you can pretty much do anything with regards to scaling up sales. Why? Because you can figure out actual return on investment rather than just talking about theoretical ROI.
Customer Lifetime Value
As an industry, we focus a lot on top line CLV.
While I am certainly the guy who continually hounds my clients on this key metric, it’s also easy to lose sight of the profit side of the equation. After all, show me a business without a repeatable method to generating profit and I’ll show you a business that will eventually fail.
Measuring CLV is not enough.
Customer Contribution Margin
Typically, contribution margin is something finance geeks talk about when referring to a specific product or group of products and how much gross profit they generate for the company.
In retail (digital and physical), I also like to try and measure the customer contribution margin. I think it’s an important element of the profit story and a key element in distinguishing bad customers from good customers.
After all, do you really care if you have a high CLV on a specific customer if they really only buy products at extreme discounts and therefore generate no profit?
Ideally, you want customers that come back and buy high-margin products frequently that you acquired through the lowest cost channel of acquisition in the first place. This is the dream!
To actually achieve that dream, shoot for the stars, or just at least understand the following segments:
- Acquisition channel – Which traffic source did you get this customer from?
- Campaign – Which campaign did you get this customer from?
- Price – Did the customer buy on discount or regular price?
- Time of year – When was the purchase made? (Some businesses are highly seasonal)
Beginner’s Guide to CCM
If you are about to start digging into CCM, I recommend keeping it simple. For the CCM beginner, there’s really only one question to focus on:
If we’re going to attempt to acquire new customers through X new sales channel, what will each of these customers generate in profit in year one and subsequent n-years?
Knowing the CCM for these two big-bucket time periods means knowing if you can sustainably acquire customers through almost any channel.
In other words, there’s no such thing as customer lifetime value without knowing customer contribution margin.
Understanding your CCM can also get quite complex depending on the type of business and scale of business you operate.
For eCommerce businesses, there’s a myth that building the biggest possible company will result in economies of scale and therefore lower variable costs of servicing customers. As we saw with almost all of the “flash/private sale” merchants born from the 2008 financial crisis, a bad business model cannot be scaled into a good business model.
Finding Your Sweet Spot
I believe that every business has a sweet spot. A size and scale that lets it operate at maximum efficiency. I’ve seen a lot of eCommerce companies that have managed to find this size. If they try and scale up from this spot, they start to lose their profit margins due simply to the business requiring significant up-front investment to achieve new scale.
The reason I think commerce businesses are more prone to these sweet spots is mostly due to the nature of the product being sold. It’s physical goods. Goods that need to be picked, packed and shipped. And unless you have a high margin product that can forever be fulfilled by a third-party logistics company, you are going to be operating your own warehouse/fulfillment facilities.
If you need to operate your own warehouse, then outgrowing space, processes, and technology can be very expensive. Sometimes you won’t get back to a healthy profit margin for a very long time while the business catches up with the new cost structure of operating.
Of course, this all really depends on the type of product/customer and the geographies you sell into.
Which brings me back to why Customer Contribution Margin is so damn important.
You wouldn’t know if you’ve left the land of profitability with your newly turned on sales channel. You could wind up going super deep into some strategy because it’s producing great top line numbers while actually costing you money.
I don’t know about you, but I’d rather know that the money I’m investing in my customers is coming out the other end as profit and not just top line sales growth. After all, your budget – and business – is on the line.