The complete conversation, in order. 4,751 words.
Nathan [00:00:11] Contribution margin and net profit is the be all end all 2
[00:00:14] for a lot of different angles when it comes to marketing. 3
[00:00:16] it's just hard to essentially, tell the algorithm to optimize for it. 4
[00:00:20] You have to be aware of the actual financial side of business too. 5
[00:00:23] We're in a very different position. 6
[00:00:24] We shouldn't be scaling acquisition. 7
[00:00:25] We should be fixing acquisition first and potentially we should 8
[00:00:28] be changing our retention strategy so we're not discounting. 9
[00:00:35] Hey, how's it going everyone? 10
[00:00:36] So upon popular request, we have Nathan back here. 11
[00:00:40] going more into the technical side of things that hurt my 12
[00:00:43] brain, but also helped me learn. 13
[00:00:45] so yeah, anything you want to say in a little introduction back to the platform? 14
[00:00:49] I don't think we made a video for us so late either. 15
[00:00:51] So it's cool. 16
[00:00:51] been a little while. 17
[00:00:52] no, thanks for having me. 18
[00:00:53] I'm looking forward to this one. 19
[00:00:54] It'll be, it'll be good talking about CFO, CMO kind of topics again. 20
[00:00:58] So this is going to be a very technical video from what we've been discussing. 21
[00:01:02] and so Nathan has a lot of good insights on. 22
[00:01:04] how CFOs think and what are some areas of improvement. 23
[00:01:07] were talking a little bit about contribution margin, and this is 24
[00:01:11] one of those topics that is being discussed more and more, however, 25
[00:01:14] there's a lot of variables to that. 26
[00:01:15] it's not as simple as just saying, Hey, this contributed to this. 27
[00:01:18] There's so many other factors that are outside of marketing, that we 28
[00:01:22] don't really have control over. 29
[00:01:23] So measuring the right ones are, Obviously the most important set of things. 30
[00:01:26] So yeah, I'll let you jump right into it. 31
[00:01:28] I think tracking contribution margin for most e com operators 32
[00:01:32] is the best North star. 33
[00:01:34] You can look at MEI, you can look at CAC, but at the end of the day, contribution 34
[00:01:37] margin is going to tell you whether you're covering your OPEX expenses or not. 35
[00:01:42] And then I'm probably going to start talking about contribution margin now. 36
[00:01:44] And some people are watching going, what even is that? 37
[00:01:46] So let me define it. 38
[00:01:47] And let's zoom out because when people say contribution margin, they're often 39
[00:01:51] talking about different things because. 40
[00:01:53] There's actually three contribution margins. 41
[00:01:55] There's contribution margin one, two, and three. 42
[00:01:58] One is the same as product cost. 43
[00:02:00] So you could almost look at it as gross margin as well, where it's just the 44
[00:02:03] price of the product minus the cost to buy the product from the factory. 45
[00:02:07] So that's contribution margin one. 46
[00:02:08] That's really what I'm referring to there. 47
[00:02:11] contribution margin two is the cost of delivery. 48
[00:02:14] So it's the price of the product minus the cost. 49
[00:02:17] But also minus the cost to deliver it. 50
[00:02:20] So that's the shipping fees, the 3PL fees, and then the transaction fees as well. 51
[00:02:24] So now you're starting to get lower down the P& L. 52
[00:02:27] And then contribution margin three is where you also take away CAC. 53
[00:02:31] So you take away the cost to acquire the customer. 54
[00:02:34] And now you're all the way down at the bottom of the P& L where the 55
[00:02:36] only last thing to minus off is OPEX, and then you've got net profit. 56
[00:02:40] And so contribution margin three is what most e com operators should 57
[00:02:44] be tracking on a day to day basis. 58
[00:02:45] And you can do that very easily using. 59
[00:02:48] Really any software you can use data studio, and it's just basic 60
[00:02:51] equations on minusing off average cogs. 61
[00:02:53] You can pull in cogs from Shopify. 62
[00:02:55] And so you can actually have cogs being dynamic. 63
[00:02:56] You can have average shipping, average transaction fee assumptions. 64
[00:03:00] And so you can see what your contribution margin is on a day to day basis. 65
[00:03:04] Where it starts to get even deeper and where you can draw more insights is 66
[00:03:09] when you start to look at where you can gain efficiencies and contribution 67
[00:03:12] margin at all different levels within the business, And this is where, as a 68
[00:03:16] marketing partner or an e com operator, you can look at contribution margin at 69
[00:03:21] the product level, or the order level, or you could look at the time level, which 70
[00:03:26] is what I was just talking about, and you can start to figure out, are we driving 71
[00:03:30] orders that aren't even profitable? 72
[00:03:31] Or are we driving orders that have 5 profit or 1 profit 73
[00:03:35] on them, but our cap's 30? 74
[00:03:37] And so we're not actually driving any incremental profit to the business 75
[00:03:40] because the bottom 20%, quartile of orders are just negative cash flowing. 76
[00:03:45] you can track contribution margin one at the product level. 77
[00:03:48] And that's what I would recommend to most e com operators do is what I'd 78
[00:03:51] recommend most agencies do if you onboard a new client, which is to have a basic 79
[00:03:55] Excel sheet, have all of the products. 80
[00:03:57] And now this is going to be really difficult if they have 81
[00:03:59] 60, 000 products, Let's assume that they have 30 to 50 products. 82
[00:04:03] You can very easily pull all product titles and then have associated cogs. 83
[00:04:07] pull out a basic price export out of Shopify or whatever platform they're on. 84
[00:04:10] And then you can see what the gross margin is per product. 85
[00:04:13] And that's going to be really indicative of where you should be 86
[00:04:16] allocating budget, across campaigns. 87
[00:04:18] And that's why understanding contribution margin across all of 88
[00:04:21] these levels is really important in the actual campaign creation. 89
[00:04:24] Because I know one thing that Sol8 talks about a little bit, I talk about it quite 90
[00:04:28] a bit, which is that anytime that you can consolidate campaign structures, you're 91
[00:04:32] generally going to see better performance. 92
[00:04:34] Because you're going to have tighter allocation of conversion data, which is 93
[00:04:37] going to enable better customer modeling. 94
[00:04:40] And so you'll see better performance, but the issue there is that you give 95
[00:04:42] away all of this control to Google. 96
[00:04:46] And so you do still want a degree of segmentation in your Google campaigns. 97
[00:04:49] You do still want a degree of segmentation in your Facebook campaigns, 98
[00:04:52] but it has to be very strategical. 99
[00:04:55] Based on contribution margin in most instances, which is, do we have products 100
[00:05:00] with 20 percent margins and then we have products with 80 percent margins. 101
[00:05:03] Okay. 102
[00:05:03] We probably shouldn't be trading them the same and we probably shouldn't be having 103
[00:05:06] a blanket target row as across them. 104
[00:05:08] in terms of implementation and all that, so would you say that it's a 105
[00:05:11] good idea then to, let's say a client has like a thousands and thousands of 106
[00:05:15] products, So they're just, breaking down every single bit in a spreadsheet, 107
[00:05:18] they're going to look at it and just, their head's going to blow up. 108
[00:05:20] Would you say like a good starting point or something you've seen is like starting 109
[00:05:24] with for example, the top sellers and then working your way down from there, 110
[00:05:27] or is there another way that you've seen work best for clients that maybe have 111
[00:05:30] passed that, a hundred product range? 112
[00:05:32] that's normally good start is sold by top sellers. 113
[00:05:35] we have an automated, model, which is going to be very difficult to build. 114
[00:05:39] So I'm not going to try to walk you through how to build it, but what 115
[00:05:41] it does is you could, if anyone's technical in Google shades, they'll 116
[00:05:44] be able to do this quite quickly. 117
[00:05:45] Which is you can take an order export of all previous exports 118
[00:05:48] with product titles associated. 119
[00:05:50] And then you can do an equals unique, pull in all unique titles 120
[00:05:55] into a separate sheet, and then you can do an equals count. 121
[00:05:58] If title is in the order and you can count how many orders are associated 122
[00:06:02] with each title, and then you can, just do basic pivot tables and look 123
[00:06:06] at all the top selling products with the associated gross margins that have 124
[00:06:09] already been tagged in there because they're in the Shopify order export. 125
[00:06:13] And so you can actually automate the whole thing. 126
[00:06:15] If you really want to get into the. 127
[00:06:17] technical details of it, but if you want to be like start off basic, you have 128
[00:06:22] barely understood what I've ever been talking about for the last five minutes. 129
[00:06:25] Just take the top five to 10 products, get the gross margins on them, and then 130
[00:06:29] that's going to be a big indicator of how you should be structuring campaigns 131
[00:06:33] across all platforms moving forward. 132
[00:06:36] Got it. 133
[00:06:36] No, that makes total sense. 134
[00:06:37] It's like one of those nice parts about if you have all these products, you have 135
[00:06:41] tons of growth opportunities as you go and develop it further down the line. 136
[00:06:44] So make the biggest impact first and those top products makes total sense. 137
[00:06:48] and then as you grow from that, then look for other opportunities. 138
[00:06:51] You might find that a product that doesn't sell anything and 139
[00:06:53] hasn't sold, much at all, and you've been using for a marketing. 140
[00:06:56] might actually be a really good source of new customers and the 141
[00:06:58] contribution margin is great. 142
[00:07:00] So it makes a lot of sense having if you can, like you're saying in that 143
[00:07:04] whole spreadsheet, organize it all. 144
[00:07:05] but if you just started out more of a, smaller client, then makes 145
[00:07:08] a lot more sense to have it more. 146
[00:07:10] So from like the top down, what's going to help us right away and 147
[00:07:12] then go from there for sure. 148
[00:07:14] And then there's also at the order level. 149
[00:07:16] So you can look at the product level and that's Really helpful in terms of what 150
[00:07:19] products you should be prioritizing. 151
[00:07:21] cause as we said, if you have an agency that isn't looking at margin at a product 152
[00:07:24] level, they might see a product performing really well, and then go and push it. 153
[00:07:28] And in fact, I could almost guarantee this is the case for probably 154
[00:07:31] clients that you manage right now. 155
[00:07:32] Clients that sold out, clients at other agencies, which is brands that stock Nike 156
[00:07:37] or brands that stock like Adidas shoes. 157
[00:07:39] They will always have a ROAS, but the distributor margin on those products, and 158
[00:07:46] like I know this because I've seen behind what they sell for, it's about 18 to 22%. 159
[00:07:50] And so you're actually barely profitable even at a 10 ROAS if you 160
[00:07:54] take into consideration shipping costs and any kind of free shipping 161
[00:07:57] thresholds that are within your offer. 162
[00:07:59] So right away, an agency that's not looking at gross margin or 163
[00:08:02] isn't looking at these things, Is going, okay, that's a good product. 164
[00:08:04] Push it, let's push more spend to it. 165
[00:08:06] And you're just pushing a product that has terrible gross margins. 166
[00:08:09] Isn't driving any profit. 167
[00:08:10] And then at the end of the quarter or at the end of the year, when the 168
[00:08:13] Ecom operator gets their P and L, they look at it and they go, what? 169
[00:08:16] Revenue's up 70 percent for profits to say, profits down 170
[00:08:19] how is this even possible? 171
[00:08:21] And it's because they didn't have that extra degree of nuance of looking at how 172
[00:08:25] much contribution profit was actually being pushed an individual product level. 173
[00:08:29] That was a spiral away from talking about orders though. 174
[00:08:32] And you can also do an order export you can just look at contribution 175
[00:08:36] profit at an individual order level. 176
[00:08:38] The softwares that do this store hero does this really good job at this. 177
[00:08:41] And so you can definitely look into store hero or any other SaaS solution, but it's 178
[00:08:46] a simple equation, which is you take your gross sales, you might as well discounts. 179
[00:08:51] You then minus off COGS, and then you minus off an assumed 3 percent 180
[00:08:55] transaction fee, and then you minus off an assumed shipping and fulfillment fee. 181
[00:08:59] You could pretty much get an average based on your, historical 90 day data. 182
[00:09:03] And then you have profit contribution at an individual order level. 183
[00:09:06] And then you can do a pivot table, sort by lowest contribution profit, 184
[00:09:10] and you'll start to discover things like, wow, we're selling this 185
[00:09:13] product, but it costs 16 to ship it. 186
[00:09:16] And the cogs are pretty high. 187
[00:09:18] We're getting 1 profit. 188
[00:09:19] And then you can go into your Google campaign and go, how much 189
[00:09:21] are we spending on this product? 190
[00:09:22] And you'll go and look and you'll see the CPA is 19. 191
[00:09:25] And you can go, we're just losing 18 on this product, trying to sell it. 192
[00:09:28] This is not a profitable order. 193
[00:09:30] or you might find that people are combining. 194
[00:09:32] individual products in a way where they're getting a discount, and 195
[00:09:35] it's ruining your margins again. 196
[00:09:37] Or you might find that when people hit a free shipping threshold, once again, it 197
[00:09:41] erodes your margins again, and you start having all these unprofitable orders. 198
[00:09:44] At the end of the day, what's the point of fulfilling an order if 199
[00:09:46] there's no contribution profit on it? 200
[00:09:48] And so that's another really good analysis that you can start to pull together. 201
[00:09:51] even if you were just to look at yesterday's orders, or maybe two days 202
[00:09:54] worth of orders, you don't have to go and look at historical three year order 203
[00:09:57] data, you could do this on much smaller, More simplified time horizons so that 204
[00:10:01] you can get a better idea of identifying where the inefficiencies are within 205
[00:10:05] the business and then Working on that. 206
[00:10:06] So what I'm hearing from all this, is be careful of sales because you might find 207
[00:10:12] that, Oh yeah, our overall sales are up. 208
[00:10:14] But then you look at, like you were saying, you're well, contribution 209
[00:10:16] margin is just not profitable. 210
[00:10:17] It's not worth it. 211
[00:10:18] I could see all the CFOs that are just like, Oh my God, finally, someone 212
[00:10:22] that's like speaking my language. 213
[00:10:23] It's not just about rows. 214
[00:10:24] It's about actual like net profit sales. 215
[00:10:27] because I see that a lot in accounts too, where, they'll run a sale and 216
[00:10:31] I'm like, Oh, we're doing great. 217
[00:10:32] NCAC is a lot better. 218
[00:10:33] Everything looks great profit. 219
[00:10:34] And then you go into the actual net profit and you're like, wait a minute. 220
[00:10:37] Something's off. 221
[00:10:37] What happened? 222
[00:10:38] Oh, this product that, should have been moved, didn't move. 223
[00:10:41] And they actually did a sale on this other product that didn't have as 224
[00:10:43] big of a margin trying to move it. 225
[00:10:45] And so then it caused a lot of other issues in the actual business. 226
[00:10:48] makes a lot of sense that contribution margin and net profit is, The be 227
[00:10:52] all end all for a lot of different angles when it comes to marketing. 228
[00:10:54] it's just hard to essentially, tell the algorithm to optimize for it. 229
[00:10:58] You have to be aware of the actual financial side of the business too. 230
[00:11:01] which for, marketers like me that are more on the creative 231
[00:11:03] side of things, it's a headache. 232
[00:11:05] And so having tools that allow you to do that, like you're talking about just in 233
[00:11:08] spreadsheets, simplify the process a lot. 234
[00:11:09] And especially if. 235
[00:11:10] you have a business owner that, can't afford a CFO or, wants to make 236
[00:11:14] this a lot easier in the process of just saying, okay, I need to 237
[00:11:17] get 80 percent accurate with this. 238
[00:11:18] you could totally do that in a spreadsheet, like we're talking about. 239
[00:11:20] that's a huge value, bomb for people just because it's, I still have clients that 240
[00:11:25] will be looking at end up numbers and I'm trying to slowly pull them away from it. 241
[00:11:28] And it's going from okay, we're not looking at ROAS. 242
[00:11:30] We're looking at, global, like what's your MIR? 243
[00:11:32] What's your, It's okay, now let's look at your overall profitability. 244
[00:11:35] It's like slowly trying to pull them away from that. 245
[00:11:37] for the case of just, helping them understand like net profit is the 246
[00:11:40] be all end all for everything. 247
[00:11:42] even LTV, you can't fully rely on. 248
[00:11:43] So that's an added benefit of looking at contribution margin 249
[00:11:46] is it will take out discounting. 250
[00:11:48] And so if you're running discounting, it will appear within the 251
[00:11:52] contribution margin that you're reporting on a day to day basis. 252
[00:11:55] I also visualize this for clients it's hard to conceptualize this if you're not 253
[00:11:59] in the weeds of finance, but what this shows, and there's a lot of numbers on the 254
[00:12:02] screen, but the premise of it is that as you increase discounting from 5 to 40%, 255
[00:12:09] your breakeven ROAS goes up significantly. 256
[00:12:13] And so if you're running a 20 percent discount, you no longer need a 1. 257
[00:12:16] 8 ROAS to be breaking even, you need a 2. 258
[00:12:19] But more importantly, if you have a target contribution profit per order, 259
[00:12:24] your target ROAS goes up exponentially. 260
[00:12:26] And you can see that in the graph here, because you're approaching an asthmatope, 261
[00:12:31] which is the target contribution, and so you don't have much to work with. 262
[00:12:34] And so it squeezes so quickly, so much faster than anyone typically thinks. 263
[00:12:38] Which is that, Oh, we'll do a 20 percent discount. 264
[00:12:40] And yeah, okay. 265
[00:12:41] We need a little bit of a better ROAS, but it's no, you now need like 266
[00:12:45] ROAS because you've cut your profit, which was on the top end in half. 267
[00:12:49] If you're operating on, let's say 30%, gross margin. 268
[00:12:53] So I thought that was a really good way to visualize for clients that as you 269
[00:12:56] start to escalate in discounting, you need your units per transaction to increase. 270
[00:13:01] So you need your average order value to inflate as well. 271
[00:13:04] you can't just be discounting and expecting that a higher ROAS is going 272
[00:13:08] to drive more profit because it won't. 273
[00:13:10] So I guess going further down that pathway for clients that have a good 274
[00:13:13] LTV, so what would you say is the impact of contribution margin and 275
[00:13:17] the relationship of that with and how do you look at it in that sense? 276
[00:13:20] this is the thing about LTV is. 277
[00:13:22] I think people hear LTV and then they think they know what it is 278
[00:13:26] or they can conceptualize how it applies into campaigns and that's 279
[00:13:29] what I really don't like about it. 280
[00:13:31] I made a LinkedIn post about this a couple of weeks ago and it's because 281
[00:13:34] everyone comments this on all my posts I put up which is I'll put up a 282
[00:13:38] post about something technical about contribution margin, on first order 283
[00:13:42] or the importance of first order profitability and someone will come in 284
[00:13:45] with Yeah, but what about the LTV and I'm like that's it's so the reason why 285
[00:13:51] I have an issue with it is to number one There's a time decay associated with LTV. 286
[00:13:56] And so when we're talking about LTV, what are we talking about? 287
[00:13:59] We're talking about 30 day. 288
[00:14:00] We're talking about 90 day. 289
[00:14:01] Are we talking about lifetime LTV? 290
[00:14:03] So since the inception of the company What is the lifetime value being since then? 291
[00:14:07] Because as you start to go out in time you start to increase number one 292
[00:14:11] your risk and number two your cost of capital You Because if you're going 293
[00:14:15] to be acquiring customers and hoping for profits to unlock over a very long 294
[00:14:18] time period, there's a huge cost of capital in just pulling that forward. 295
[00:14:21] and then the second reason I don't like it is because it's revenue based. 296
[00:14:25] It's telling you how much revenue you're getting from a customer over 297
[00:14:28] its lifetime, but if you look at the unit economics of any brand, and you 298
[00:14:31] break down first time versus returning customers, and once again, you can do 299
[00:14:35] this in Excel sheets just out of the back end of Shopify, you'll almost always 300
[00:14:38] see returning customers are getting like average of 30 percent discounts. 301
[00:14:42] And the reason being is that the brand is just sending emails with 20 percent off 302
[00:14:46] codes, 30 percent off codes, 40 percent off codes to try to get people back. 303
[00:14:49] And so these customers profit contribution is so minimal. 304
[00:14:53] And then factor it on top of all of that is that most advertisers are spending 305
[00:14:58] 20 percent of their budget on existing customers and they don't even know it 306
[00:15:01] because they're running Pmax and Advantage And so now you also have a CAC associated 307
[00:15:05] with getting these customers back. 308
[00:15:06] And so you run all the math and it's easy math to run. 309
[00:15:08] You can go a hundred dollar average order value, LTV is 200. 310
[00:15:12] we've doubled the profitability of the customer, but really let's say that 311
[00:15:15] we're taking 30 percent discounts. 312
[00:15:17] Okay. 313
[00:15:17] So now it's really only like 70, 170 in revenue, maybe 160 in revenue. 314
[00:15:22] and then you take into consideration that there's maybe a 10 CAC there and 315
[00:15:25] you're like, okay, it's only like 150 and now it's a completely different story. 316
[00:15:28] Because if you were looking at, okay, we double the profit of a customer over 317
[00:15:31] time, and you were using that to KPI and benchmark the entire business, but you 318
[00:15:36] look into the details and you actually, these returning customers aren't driving 319
[00:15:39] any profit or very minimal profit. 320
[00:15:42] We're in a very different position. 321
[00:15:43] We shouldn't be scaling acquisition. 322
[00:15:44] We should be fixing acquisition first and potentially we should be 323
[00:15:47] changing our retention strategy. 324
[00:15:48] So we're not discounting. 325
[00:15:49] So heavily as well. 326
[00:15:51] it makes sense. 327
[00:15:51] I think the idea of in that graph you showed earlier, it was a really good 328
[00:15:54] representation of that is start with a very small discount, see who bites, 329
[00:15:58] take them out of the list, your email list, wherever the case may be, and 330
[00:16:01] then go to the next process and see how far you can push it until you hit that 331
[00:16:04] actual point of diminishing returns. 332
[00:16:06] Whether it's 10%, 20%, 30%, 50%, who knows, based on your business. 333
[00:16:10] that's where you'll find the most profit from it. 334
[00:16:11] And I've actually, talked to clients in the past about that and it saved them 335
[00:16:14] a lot of money and actually allowed us to increase our volume on just going 336
[00:16:18] after new customers because they didn't realize that their LTV was actually 337
[00:16:21] eating into their net profits like crazy. 338
[00:16:23] so something just like that can really change a business from. 339
[00:16:27] Both the financial side and the marketing side. 340
[00:16:28] whenever, we hear CFOs, it's okay, like I got to try to 341
[00:16:32] explain to them what's going on. 342
[00:16:33] But then they're also coming at it from their angle. 343
[00:16:35] It's yes, I know what you're saying, but I'm also trying to explain to you, 344
[00:16:37] what's going to actually make us money. 345
[00:16:38] And so it's up to both sides to understand like what the algorithm, but also, 346
[00:16:42] okay, from the, actual acquisition side of it, is it actual benefit or not? 347
[00:16:46] It might look better for us, but we don't know if that's actually true. 348
[00:16:48] I think that gives a really good understanding of 349
[00:16:50] contribution margin though. 350
[00:16:51] we went through contribution margin went through a few different ways that you can. 351
[00:16:55] look for inefficiencies, order, product level, and then LTV. 352
[00:16:58] it's not what you, not what it seems on the front end. 353
[00:17:01] So making sure that you are also tracking contribution margin 354
[00:17:04] across the lifetime of customers. 355
[00:17:06] Perfect. 356
[00:17:06] I love the insight. 357
[00:17:07] we don't really get much of this from just the space in general. 358
[00:17:10] It's too focused on in app and what's going on. 359
[00:17:13] if people want to learn more about you and, get more insights, 360
[00:17:15] where can they find you? 361
[00:17:16] the first thing is the YouTube channel, so I'll give the link to you, you can scroll, 362
[00:17:20] look at the below, it's Bluesense Digital. 363
[00:17:23] The second is the podcast, it's more longer format if you want to hear 364
[00:17:25] me talking for an hour and a half straight to some people in Australia. 365
[00:17:29] it's Blues Brothers Podcast. 366
[00:17:30] And then LinkedIn is the easiest way to message me. 367
[00:17:33] If you want to ask any questions about any of this CFO jargon 368
[00:17:37] that I like to talk about. 369
[00:17:38] That would definitely be me as well, but awesome. 370
[00:17:41] thanks for coming on. 371
[00:17:41] And like I said, we'll probably, have you on more just to give some 372
[00:17:44] more insight for us all and I guess demystified the CFO side of things. 373
[00:17:48] Thanks again, Nathan
