The Smart DTC Playbook: Unit Economics, Contribution Margins, and Profitability

Carla Penn-Kahn always had an entrepreneurial mindset. Coming from a family of business owners in Australia, she had similar aspirations, but an internship during her studies turned into a full-time job in investment banking at Credit Suisse.

While at Credit Suisse, Penn-Kahn worked with high-net-worth individuals and “got really inspired about how I wanted to build my business.” In 2010, after less than two years as an investment banker, she founded her first ecommerce brand. Since then, she has gone on to launch three more ecommerce ventures, the last of which – Kitchenware Australia – was turning over $30 million when it was sold last year.

Now, after positioning herself as an industry leader, Penn-Kahn warns DTC and pure play ecommerce retailers that their playbook – growth through ads – is no longer sustainable. Ad platforms, she explains in a recent interview with Mi3Australia, are becoming “increasingly more expensive. We saw the cost to advertise – cost per acquisition – double between 2019 and 2023.”

Penn-Kahn offers Temple & Webster, Australia's largest pure play ecommerce retailer in the furniture and homewares market, as a cautionary tale. In the last fiscal year, Temple & Webster increased its advertising and marketing costs by 62%, while revenues grew by only 26%. “That's an incredibly inefficient way of growing your business,” said Penn-Kahn. “Ultimately, no matter what economies of scale you get, you can't sustain 26% growth on 62% rising advertising costs.”

The Profitability Imperative

Instead of trying to drive revenue at all costs, Penn-Kahn implores DTC brands to focus on profitability. Doing that requires in-depth knowledge of ecommerce unit economics. The problem, she says, is that “shipping and advertising costs are typically unknown to most ecommerce businesses on a product level. It’s only the really sophisticated guys who actually know what unit economics is, and then I even question how many of them do from the conversations that I’ve had.”

What most DTC operators know is how to calculate gross profit margin, which measures the profitability of the core operations of a business. The calculation is straightforward: you subtract the cost of goods sold (COGS)—which includes direct expenses like labor and materials—from net sales (gross revenues minus returns and discounts).

However, many brands may not factor ecommerce shipping costs and merchant fees into their COGS—something the more financially sophisticated DTC operators and ecommerce-focused accountants do.

But even then, while gross profit margin is an important financial metric, it still doesn't give a complete picture of profitability on a per-unit (SKU) basis.

Understanding Contribution Margins in Ecommerce

To truly understand per-SKU profitability, you need to examine the contribution margin. This metric measures the profit earned on each product sold after deducting additional variable costs, particularly variable marketing expenses like affiliate fees, influencer campaigns, and paid advertising.

As mentioned earlier, ecommerce-savvy service providers (including us here at Finaloop) already include all variable costs except marketing in the gross profit calculation. This makes the only difference between gross profit and contribution margin the exclusion of variable marketing expenses, which is a more e-commerce-friendly approach.

Regardless, as Penn-Kahn puts it, "Every business, regardless of industry, should be looking at their contribution profit daily to track real profitability."

The last step of the unit economics journey is checking if your contribution margin covers fixed costs. Also known as operating expenses (OPEX), these costs include rent, office supplies, wages, insurance, legal fees, etc. “Every dollar of contribution profit that you bank over your fixed costs is where you get into profitability territory,” explains Penn-Kahn. “And if you do that breakdown on a product level, you can really understand which 20% of products drive 80% of your business's profitability.”

The Importance of Financial Acumen for DTC Brands

Unfortunately, ecommerce brands often lack the tools to apply the 80-20 rule (Pareto Principle) to their business. The reasons are twofold. First, while many DTC brand founders excel in areas like marketing, design, and product development, financial management doesn't appear to be high on their agenda.

Enhancing your financial management skills doesn't mean becoming an accounting “guru.” Instead, it's about building a solid understanding of financial fundamentals and applying them to the high-velocity and dynamic reality of ecommerce accounting. This knowledge will allow you to make informed decisions based on accurate numbers, accurately interpret financial reports, and pinpoint potential risks and opportunities in your business model.

The second reason ecommerce businesses struggle to identify their highest-yielding products is their reliance on outdated financial reporting systems. Many are stuck with manual practices or legacy systems that can’t integrate with the rest of their tech stack. These systems fail to keep up with the fast pace of ecommerce and don’t provide the detailed breakdowns needed for multi-product or multi-channel businesses. As a result, numerous DTC brands lack real-time data on key metrics like marketing spend, shipping, and fulfillment costs, all crucial for understanding their unit economics.

In this challenging ecommerce landscape, mastering unit economics is a matter of survival. The days of relying solely on aggressive advertising for growth are numbered – DTC brand founders must now pivot toward a more sustainable model, which requires a deep understanding of contribution margins at the product level. One way to do that is to keep Penn-Kahn's principal question at the forefront of our minds: “As a business, how do you move the needle if you don’t know the most profitable parts to hone in on?”

In other words, it starts with having confidence in your financial numbers.