“We’re first purchase profitable” said the Head of Marketing.
The scheduled Zoom time with the client was over but the Head of Marketing and I had stayed on to dive deeper into customer acquisition.
“So why aren’t we making more money?” I asked. Silence.
“Maybe it’s OpEx?” She was right that our OpEx was too high. Too many people trying to manage too much complexity. OpEx was part of the problem. But not as it pertained to customer acquisition.
Our problem was that our best customers and products were hiding the losses generated by our worst customers and products. The client’s product catalog had SKU’s that ranged from $35 to $600. Complicating this were multiple bundles of products with a focus on sets of the most expensive products. Some sets drove cart sizes over $1,200. And then there were the occasional purchasers buying multiple sets. These customers were fantastically profitable.
While we had these awesome profitable customers, we also had a ton of first time purchasers who came in to buy our lowest priced and mid priced SKU’s but were not buying our core and most expensive SKU’s. And the data on these customers was clear. As a whole, they came back less often than the higher price first purchasers and worse, when they came back, they rarely bought the most expensive items but instead bought more of the least expensive items.
Customers who bought our most expensive products came back more frequently and bought more of the most expensive products. Customers who bought our lowest priced products came back less frequently and just bought more low priced products.
The CAC’s swung up and down as the company chased revenue, but over time averaged around $200. These were not easy customers to acquire. But when we got one, they could be very profitable. So what was going on?
“But we’re first purchase profitable.”
I realized before we could make improvements to profitability, I had some work to do to help the team understand what was happening.
1/ We were using averages, not actual unit costs
Marketing was using averages to understand first purchase profitability. From our P&L, our average contribution profit pre-marketing was 30%. Total net sales in a period multiplied by 30% minus ad spend in the period and we looked first purchase profitable.
This wasn’t Marketing’s fault. We had lousy data on unit costs. We understood FOB per unit. But after that, all inbound freight, shipping, duties, tariffs, 3PL stocking, packaging, pick & pack, outbound shipping and returns were educated estimates. We didn’t know with any precision how much we were making on the most expensive SKU’s and sets versus the least expensive.
Even with the limitations in the data, it was clear we weren’t making much. On the very lowest priced SKU’s we were generating maybe $4 in contribution profit and on the mid-priced items, we made maybe $35 in CP.
These customers weren’t coming back enough and buying enough to ever get profitable. If we spent $200 to acquire a customer and they generated $4 of CP on their first purchase, we could expect to see an additional dollar or two over their lifetime. For the mid-priced customers, we maybe saw an additional $15.
We were spending $200 to acquire a revenue stream that totaled less than $50.
But when you zoomed out to the whole P&L averages, it looked OK because our best customers were so profitable. They were masking the losses generated by these low value customers and products.
2/ We had to rotate our customer mix and SKU mix to higher profit
This meant we had to stop the bleeding. We can sell the low priced items when bundled, as part of a set or individually to repeat customers. But we couldn’t continue acquiring customers at $200 in order to make $4.
Marketing objected here. “But our CAC on the low price sales isn’t $200, it’s much lower.” “OK” I replied. “How do you know?” The answer was they didn’t. They had some ideas, which could be explored to show varying CAC’s, but after some back and forth, we agreed that until they could provide data to support CAC’s by product, we were going to stick with $200 and we were going to stop the bleeding.
So how do we track our progress in rotating towards more profitable customers and products?
First Purchase Contribution Profit per Unit is a good metric. We can use real unit costs (or as close as we can get them) for each SKU combined with the actual counts by SKU in each period. We can look at our CAC and quickly know how far above our minimum threshold we are. And with time, we can incorporate OpEx so become first purchase EBITDA profitable.
If we can’t stay above our threshold, we know we have other problems. Maybe our marketing or channels aren’t right. Maybe we can improve our repeat purchasing. Maybe we need to focus on higher priced/higher CP SKU’s. But what we won’t be doing is using our best customers and products to mask these problems.