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Losing money on Amazon FBA products is a real and serious consequence. Most beginners simply don’t understand the numbers such as revenue and profits.
Essentially, this all starts with understanding unit economics.
Imagine that, after hours of searching, you found a great product and a niche where the numbers work well. You paid for the inventory, set up your Seller Central account and are soon making good revenue from your new business.
“What can possibly go wrong?“
🙄 Well…a lot…
It’s absolutely possible to make tens and hundreds of thousands of dollars in revenue, yet still break even or lose money due to poor understanding of your financials metrics.
The key here is to understand your unit economics, i.e., average profitability on a per-unit-basis.
Understanding ‘Unit Economics’
Would you rather generate $10,000 selling 10 products which retail for $1000 each, or selling 100 products $100 each? While I’m slightly biased as I prefer the later, tt’s hard to give the answer without diving deeper into the financial structure of the business.
Unit economics is a fundamental business concept. It’s like building blocks of a business. Using unit economics, you can model out specific business scenarios and see how they affect profitability.
The definition of unit economics is to ultimately answer the question, “How much actual profit am I making per unit sold?” and “How much do I need to spend to make that profit?” which is an important consideration given the rise of PPC costs on Amazon.
From here you can determine whether your business is genuine. In my opinion, if it’s not saleable then it isn’t profitable…unless you’re running a SaaS business.
The simplest way to look at it is this: you take all the revenue you’ve made over a period of time, and you divide it by the number of orders you’ve got over that period. That would show you AOV (Average Order Value). From here you’ll know how much each order is bringing in revenue.
Another important metric for Amazon sellers is ACoS (advertising cost of sales). For the beginners here on my blog, this reflects your expected advertising efficiency level. Let’s say you were to spend 30¢ to generate $1 of PPC sales, your ACoS is 30%.
Why Is Unit Economics Important For Amazon Sellers?
Any Amazon business is a cash generation machine, where you put money in to purchase
inventory, and then get that money back with a profit to purchase even more inventory. But in order to sell on Amazon, you also have to spend money on advertising, keep track of Amazon FBA fees, shipping and storage costs.
And because the Amazon payouts are bi-weekly (i.e, twice per month), it may be hard to tie them down to specific SKUs and make sense of them after a certain period of time.
There is a huge difference between making top-line revenue and actual profit. From there, there’s profit before tax and profit after tax.. If you don’t properly analyze your unit economics from the early days, you might end up with a product that has high costs paired with low pricing power. You’ll end up actually losing money and might actually go out of business.
Losing Money on Amazon FBA is Real
A guy I know was managing an account for a client that was making $40,000 per month in revenue. They thought the business was doing fine, and the financials were solid. Yet, when he plugged in the numbers, he saw that the business was not just unprofitable, but actually losing money to hidden Amazon fees. This is why external auditors are used by some of the world’s biggest companies.
Another interesting story happened to Sellerscale’s founder, Paul Faguet. When he launched his first product on Amazon (a meditation pillow), he estimated the demand, but didn’t dig in the numbers. Eventually, he ended up losing money on the product due to high storage costs and complex fulfillment fees. Paul had to close that business eventually, but learned a valuable lesson on top of which Sellerscale was built: “it’s much cheaper to do due diligence ahead of time.”
To avoid losing money, you’ve got to know your numbers – of existing products, as well as potential ones.
If you view your business as a cash generation machine, then you might want to know whether putting more money into purchasing more inventory or simply more PPC advertising might generate more revenue. And if so, by how much.
Below we talk about the key unit economics metrics you need to keep track of and the questions to explore that to ensure your business is healthy.
Key Metrics To Keep Track Of In Your Amazon Business
- Daily Unit Sales – this is the number of units you sell per day, on average.
- Average order value (AOV) – this metric is calculated by dividing your total revenue by Daily Unit Sales.
- ACoS – Advertising cost of sales. This represents how much you need to spend on PPC ads in order to generate $1 in ad sales. Say, if my business put $100 in PPC ads and I made $200, my ACoS is 50% which is rather high. The more this metric is, the more heavily I rely on PPC advertising as my revenue stream. Personally, I’m pushing hard into an SEO strategy which very few people are doing given the rise of unprofitable Amazon PPC campaigns. Vice versa: the more organic sales I can acquire (where customers find me with keywords), the less I’ll be spending on advertising they will be, and thus, more profit.
- FBA Fee – this is the fee that Amazon charges all its professional sellers like me to fulfil a single unit of any product to their customers, including handling returns and shipping. You can estimate the fees using Amazon built-in revenue calculator.
- Unit Landed Cost – quite simply this is your total cost of making, packaging and sending your batch of products to any of the Amazon fulfilment centres in the United States. If the factory quoted you a total of $2.5k to produce 1k units of product (which includes all packaging, bubble wrap, marketing brochures, etc), and your freight forwarder quoted you another $500 to sea freight or airfreight this batch from the supplier all the way to an Amazon FBA warehouse, then your specific unit landed cost will be $3.
- Profit Per Unit – once you get a solid understanding of your initial costs, including Unit Landed Cost, Amazon FBA fees and advertising, you can subtract it all from AOV and calculate the profit you receive per unit sold.
It’s important to perform this analysis before you start selling on Amazon. In many cases, doing due diligence before you start selling is cheaper than making mistakes and losing thousands of dollars due to poor business decisions.
Questions To Explore In Your FBA Business
Once you understand your unit economics and have them under control, you can start playing with assumptions.
Before starting, ask yourself:
- How much will I need to rely on Amazon PPC to generate an acceptable ROI?
- What is my breakeven ACoS?
- What will my ROI and payback period (otherwise known as a Cash Conversion Cycle) be at different price points (such as catering to premium customers), ACoS levels, and sales velocities?
- Will I be able to breakeven on price and ACoS during different times of the year?
- How does (potentially) a $1 reduction in unit landed cost impact my business and product ROI, as well as other KPIs?
- What would happen to my profit margins if I made a 50% discount for 2 days?
As we said, you can use unit economics to establish per-unit profitability of your current products, as well as your potential ones. Ideally, you should have a pipeline of products and understand not just the demand – but the underlying costs and fees, which will be unique to every product.
Feel free to use this free Chrome Extension from Sellerscale to help you assess the profitability of products in your research.
Also, I found an offer from www.sellerscale.com (non-affiliate link) where you can get a 50% off the first two months of Sellerscale using the promo code SCALE250.
As always, look at Amazon like a marathon and not a sprint. I’m 4 years in and I’ll be here for another 10 years. I like to say that this is the worst get-rich-quick scheme around…but for scalability….it’s hard to find better.