You’ve set up your Shopify site, picked the perfect product to sell, stocked up on inventory, and even hung a motivational poster right above your desk. You are ready to become a real Shopify seller.
All that’s left is to determine how much to sell your products for.
In theory, this sounds easy. If your product costs you $50 and you sell it for $65, you will make a profit. Simple, right? Not exactly.
Understanding the real cost of each sale is key to making sure you price your products correctly. If not, the more you sell, the more money you can actually lose. (Yes, you read that correctly.)
Read on to get a crash course on how to determine your product's target profit margin and ideal selling price. You can also check out Finaloop's Profit Margin Calculator to help you determine how much to charge your customers so you can earn the profit you need to run your business while keeping the customers happy.
Let’s start with the basics
Let’s talk unit economics for ecommerce. It may sound like a snoozefest but before you skip ahead, understanding this subject could be the difference between seeing your business make money or being in the red for the foreseeable future.
Unit economics helps you understand your revenues and costs per ‘unit’ sold. Once you understand your cost per unit you can calculate gross margins and break-even points, determine the best price for your product, forecast your profits, and optimize your product offerings. That’s where the real fun begins.
For this purpose, we are defining a unit as one item - one jar of your homemade hot sauce, one ‘Save the World’ t-shirt, one tube of organic toothpaste, or any other product you sell on your Shopify store.
Determining the price, starts with the expenses. Since not all costs are created equal, we’ll start by diving into the relevant costs of selling products for your ecommerce business.
The cost of making money
Your business incurs a lot of costs in order to operate.
Some of these costs are fixed which exist completely independent of sales and are the same amount no matter the order volume. For example, even if you don’t make any sales, you still need to pay rent, payroll, and utilities.
Other costs are variable. These are created or directly impacted by how much you sell. As you sell more products, these costs increase. Examples of these costs include shipping to customers and merchant fees.
The variable costs are the main costs to consider when determining the cost per unit sold. For ecommerce stores, these generally include the following main costs:
Cost of goods sold (COGS) - these are the costs of getting a product ready for sale, such as: costs of purchasing or manufacturing the product, packaging costs, and shipping-in / freight-in costs to get your product to your warehouse (this last cost doesn’t apply if you are dropshipping directly to the customer). You can read more about how to calculate this important metric in this blog.
Shipping and fulfillment costs - the cost of shipping the product to your customer. This cost varies depending on carrier, product weight, and how quickly it needs to be delivered. For DTC and CPG brands, this is usually the largest expense after COGS. In order to reduce the impact of this cost, many ecommerce stores charge the customers for shipping as well.
Merchant fees - Merchant fees, also known as transaction fees or payment processor fees, are the fees charged by credit cards, Stripe, Shopify Pay, Paypal, Afterpay, etc. for processing the transaction. These fees usually include a fixed percent fee charged per transaction and a fixed amount charged per transaction. Usual rates start at around 2.9% +$0.30 per transaction but can be lowered in certain circumstances.
All of these costs should be taken into account when determining the pricing of your products. You can calculate this using Finaloop’s profit margin calculator to help you find the ideal selling price for your product.
Calculating your profit margin
In order to determine your selling price, you need to calculate your target profit margin. This can be a tricky part. There are so many ratios and information out there to consider. Where do you start to find the ideal profit margin for your business? How do you find the right profit strategy?
It all starts with your gross margin.
What is gross profit margin?
Gross margin is a measurement that tells you how much money you walk away with from each sale, after you consider the costs related to making and selling the product.
The formula for calculating your gross margin is:
(Revenue - COGS)/ Revenue x 100
The higher the gross margin, the more profit you hold onto after each sale.
What is net profit margin?
Net profit margin is your profit margin over revenue when considering not just COGS but also operating expenses - like rent, labor, and utilities - and taxes, interest, and any other expenses, also known as “your bottom line.”
This is your true indicator of your business’s profitability. The higher the number, the more money you have to pay shareholders, repay loans, or invest back into the business.
The formula for calculating your net profit margin is:
(Revenue - all costs)/ Revenue x 100.
What’s a good target profit margin?
According to January 2022 data from NYU Stern School of Business, a good gross profit margin for online retail is about 41.54% and net profit margin for online retail is about 7.26%. Of course, this can vary significantly based on many factors.
As a general rule of thumb, you can consider an average net profit margin to be about 10% while 20% is considered high and 5% a bit low.
As an ecommerce brand, it's key to price products to optimize profitability while understanding how much your customers are willing to pay.
Unit economics should be at the forefront of your business decisions so you can really understand how much each sale costs you.
Once you understand your costs and you determine your target profit, Finaloop’s profit margin calculator can help you find the ideal selling price for your product so you know exactly how much to charge your customers.
Looking for ways to increase your profit without increasing your prices for customers? In this economy, it requires some creativity. Check out tips and tricks for ecommerce businesses to increase your profit margin in an economic slowdown.
We are a technology company providing automated end-to-end accounting service to ecommerce businesses. Our system connects to your apps, syncs all your data, and reconciles your books in real-time, replacing your bookkeeper. We offer reconciled books available 24/7, tax-saving insights, and a single place for all your financial data.
*The information provided on this website does not, and is not intended to, constitute legal advice. All information, content, and materials available on this site are for general informational purposes only. Readers are advised to consult with their attorney or accountant with any questions or concerns.*