This post is by Jae Jun, a seven-figure Amazon seller and founder of Gorilla ROI.
In this article, I’ll take you through the steps to analyze your profit margins and find benchmarks to make sure your business is running at optimal levels.
Using the methods I outline below, I was able to take our business from a low 30% gross profit range to 35-45% margins for many of our products.
This helped us break out from a sales plateau of $250k in revenue to over $2M in a few short years. Our sales continue to grow quickly today.
Business is a competition.
You are competing against hundreds, if not thousands of similar products and sellers.
If you watch any cycling, racing, golf or sporting event, there are always leader packs that separate themselves from the rest of the competition.
The point of benchmarking is to keep up with the leader pack and not drop down the ranks.
But here’s the good news. Before I started implementing this mindset and process, our business was near the bottom, but in a few short years, our business became leaner, faster, focused, more competitive and more profitable.
This is all despite the fact that:
- My products are priced below $15
- My products are in competitive categories
- I’ve been copied with prices racing to the bottom
Step #1: Clearly define your business model and objective
A big mistake I see with most small businesses is how they stumble around in the dark hoping to get from point A to point B. There is no clear direction. They have no identity. No goal or objective about pricing and margins.
This is one of the worst positions to be in. You are just another “me too” seller hearing about the glories of selling on Amazon FBA and wanting to get a piece of the action.
I know because I did the exact same thing. Random products, pricing all over the place, forgetting to include important costs into the pricing like refunds, warranties and taxes.
The first big step is to clearly identify the type of Amazon business you are trying to run.
I categorize Amazon business models into four groups.
- Group 1: the supermarket store model that resells other brands at razor thin margins (Target, Walmart store strategy)
- Group 2: the specialty store model that focuses on a specific category (Best Buy, Willams Sonoma)
- Group 3: the OEM branded store model (Etekcity, Anker strategy)
- Group 4: the Alibaba product store model (slap a different name on the same Alibaba products strategy)
Each model can be broken down further. For example, the supermarket model could be selling all items related to health supplements, or an FBA branded store could focus on just swimwear or barbecue related products.
Business models and sourcing strategies
Most often, Amazon sellers are grouped into either:
- Private label
- Online arbitrage
- Retail arbitrage
This is why there’s a lot of bad advice out there. Because depending on the strategy, a lot of things change and the way you source, operate and make money changes.
We operate on the Group 3 (OEM) model above, where we design and manufacture everything from scratch.
An eight-figure seller that focuses on selling wholesale products has a different perspective and strategy for operating their FBA business. And because they don’t have experience with OEM, their advice is not always suited to how we operate.
On the flip side, if an FBA seller is a 60-year old woman who just wants to make some extra money on the side in her spare time at home, the objective is very different. The goal isn’t to hire people and scale up. In this case, margins can be lower for the same profit because there is no insurance, payroll and warehouses to worry about.
This is why it is very important you first clearly identify your business model and objective so you know who your benchmarks are and which direction you need to head in.
Write down your business model. Write down your objective.
Done? Let’s move to step 2.
Step #2: Know the difference between gross, operating and net profit
To do business, you need to speak the language of business.
That language is accounting.
Another big reason why small businesses can’t scale and get stuck in the losing pack of the race is due to misusing these terms.
Something so simple creates a big issue because it creates blind confidence.
When accountants talk about net profit, they are referring to profit after cost of goods sold, expenses and taxes.
When Amazon sellers talk about net profit, they often mean profit after cost of goods sold and Amazon expenses. This is called net operating profit or operating profit. Not net profit.
It’s a huge mistake and can lead to a cash shortage.
By mixing up net profit with operating profit, you are making it seem like there is nothing else to pay. Everything is your profit.
At the end of the quarter or year you will pay taxes and if you have any loans, you need to pay interest on those loans. This eats into your margins and can potentially leave you strapped for cash when the tax man wants his money.
If you end the year with a profit of 10% and your tax bracket is 15%, your net profit is really 8.5%.
May not seem like much if you make $1,000 and pay $150 in taxes, but if your business is doing $100,000 and you have to suddenly come up with $15,000, that is a big chunk of change.
Don’t get caught surprised because of a basic terminology mix-up.
- Gross profit = Sales Price – Cost of Goods Sold
- Operating Profit = Gross profit – operating expenses
- Net Profit = Operating profit – interest and taxes
Step #3: Find your big business benchmark company
Now that you know your business model, objective and the different profit terms, it’s time to find your target gross profit margin.
The quick and dirty method
The simplest method is to aim for 40% gross margins if you do private labeling or OEM. I say this because it’s what the majority of Amazon sellers aim for.
With 40% gross margins, your operating expenses is going to be anywhere between 20-30%. This leaves 10-20% in operating profit. From there you pay taxes and interest which leaves you at 8.5-17% net profit.
Finding a benchmark business
When choosing a benchmark, it’s important to find a company that is the leader and kicking butt in the industry.
I compare my business numbers to Proctor & Gamble. I’ve had people scoff at the idea of comparing myself to a multi-billion dollar business.
My counter to that is, who wants to operate their business like the rundown convenience store down the street? I want to know why and how a business like P&G got to where they are. The big companies have a reason for doing things the way they do. They understand everything about margins, supply chain, merchandising and operating expenses.
Simply knowing the margins that big companies shoot for will help you keep up with the leader pack.
Reading the financial data
Take a look at the gross profit, operating profit and net profit for Proctor & Gamble:
By looking at their margins, I know that if I’m selling under my wholesale accounts, I should aim for 50% gross margins. Before looking at P&G, my prices were all over the place because I didn’t have a clear reference.
As you go down the financials, note that operating profit is 20%. This means that 30% of the revenue goes into business expenses like advertising, insurance, payroll, rent, utilities, travel, auto and all the things that add up.
Keep going down the financials and see that taxes are real. They should be included in your calculation. Finally you get to net income where P&G shows 16.4% in the last twelve month period.
What can Amazon sellers do with this information?
Before, when we were selling at 33% gross margins, I thought we were doing fine. I was able to quit my job and run the FBA business full time, but there always seemed to be a lack of cash and I wasn’t able to pay myself enough.
Now I have my benchmark, I’m continually looking to drive down costs and find categories that can meet my margin requirements.
- Find a publicly traded company that fits your business model from Step #1. It could be Target, Costco, Proctor & Gamble, Best Buy and so on.
- Or type “publicly traded distribution companies” into a search engine for more ideas.
- Enter the stock symbol on a site like Yahoo Finance and click “Statistics”.
- Look up the gross profit, operating margin and net profit to understand your benchmark.
- Open up your accounting software and compare your gross, operating and net to your benchmark.
Step #4: Find a benchmark Amazon seller
By now you know your Amazon business model, objective, profit definitions and who your ideal benchmark company is.
Now it’s time to find an Amazon seller (or sellers) as another benchmark.
Calculate your gross margin first
Before looking for benchmark sellers, make sure you know your own financials accurately.
Let’s say I’m selling protein shake bottles from the brand “Bottle Blender”. I buy it wholesale and then resell it on Amazon and I want to know who my top competitors are and how I’m ranking against them.
For this example, let’s say my wholesale cost is $3 for the product. By the time it lands in Amazon’s warehouse, it costs an additional $0.2 per unit.
- The product is currently selling for $9.50.
- The FBA fee is $3.27 which includes storage costs.
- Amazon’s 15% fee comes to $1.43.
Based on these simple numbers, the gross profit is 9.5 – 3 – 0.2 – 3.27 – 1.43 = $1.60.
Gross margin = 1.6 / 9.5 x 100 = 16.8%.
Remember in step 3 how P&G have expenses that take up 30% of revenue?
Even if you operate very efficiently, this product is a money loser. With gross margins under 20%, there is no breathing room.
Look for benchmark Amazon sellers
Now I see that another seller is selling a private label copy of Blender Bottle at $9.99. I can find the same product easily on Alibaba and see that it costs around $1.50 landed.
- The product is currently selling for $9.99.
- The FBA fee is $3.27 which includes storage costs.
- Amazon’s 15% fee comes to $1.50.
Gross profit = 9.99 – 1.5 – 3.27 – 1.5 = $3.72
Gross margin = 3.72 / 9.99 x 100 = 37.2%
Do the same thing for other competitors and get the average gross margin.
What can Amazon sellers do with this information?
If you find that your gross margins are higher than the competition and your product is selling well, then that is great. But understand that more copies or competitors will enter the market, when they see your fat margins.
If you find your gross margins are lower than the competition, then there is room for improvement. Your competitors are doing something that you are not:
- Maybe they are getting better prices
- Maybe they are going straight to the manufacturer and not a trading company
- Maybe they are sending the product straight to Amazon’s warehouses to reduce freight charges
- Maybe your prices are just too low and you need to increase them
Whatever the reason, you’ve found a gap if your margins are lower than the competition.
- Find 3 competitor products and reverse calculate the margins
- Compare with your own margins
- Apply the same method across your products and find the products that are losing money
Step #5: Stop leaking money
If you’ve reached step 5, you now have a list of products that are not as profitable as you once thought.
Every couple of months, I review my products and go through the exercise from step 4. Each time, I find a handful of products getting squeezed because Amazon has changed the fees or it cost more than I expected for the freight.
To fix price and margin gaps, here are seven action items you can try to improve margins.
- Get pricing info from your supplier for higher volume orders. See if there is anyone else that can split volume with you, so that you can get the product at better prices without taking on all the inventory.
- Shop the price quote across different suppliers and see if you can bring prices down while keeping the quality the same.
- Increase your prices slightly and see whether sales volume is affected.
- Improve the listing images to increase the perceived quality of the product.
- Create a simple video of the product being used or installed to increase conversions.
- List the product on other platforms to offset some of the lost margins from FBA.
- Try to sell it as a two-pack or in bulk to maximize order value for the same FBA fee.
Step #6: Kill off losers
This is the hard part.
Being objective and discontinuing products that do not meet your new margin requirements requires discipline and letting go of emotions.
Unless such products are being used as loss-leaders or marketing for a clear purpose, most low-profit products should be discontinued.
Low-margin products eat up valuable resources. They take up space, storage fees, employee hours, mind space and energy. It’s better to cut them out and refocus resources into your profitable existing products, or a new product that meets your target margin.
As you go through this cycle:
- Your margins will increase
- You will become more profitable
- You will have more cash on hand for growth and opportunities
There you have it.
In six steps I showed you the framework needed to get fatter margins.
- Clearly define your business model and objective
- Know the difference between gross, operating and net profit
- Find your big business benchmark company
- Find a benchmark Amazon seller
- Stop leaking money
- Kill off losers
Follow the instructions and ideas from each step and you’ll be able to increase your margins to build a stronger and more profitable FBA business.
To make this interesting, in the comments below, let me know your business model, your current margins and where you need your margin to be. I’ll answer any questions and do my best to help.
This post was by Jae Jun, a seven-figure Amazon seller and founder of Gorilla ROI, software that connects Seller Central data to Google Sheets.