As an ecommerce seller, price competition is often intense and profit margins are slim. As well as your pricing strategy for the products themselves, keeping your costs as low as possible is vital to your success.
Despite the increase in online shopping, almost a quarter of ecommerce businesses fail every year, so understanding the financials is key to your success.
But which costs can you bring down whilst ensuring customers remain happy and the business continues to grow?
Whether you are run a small-scale Amazon dropshipping business or larger ecommerce operation, understanding the difference between fixed and variable costs in ecommerce can help you run your business more profitably.
What are Fixed Costs?
Fixed costs are your overheads – the price you pay to keep your business up and running. They’re the bills you pay every month that aren’t affected by your production or sales volume.
Even if you’re not selling, you still need to pay your fixed costs. No matter how many products you sell, you still need to cover your rent, utility bills and staffing costs whether you run a factory or work from home.
Fixed costs tend to stay roughly the same from month-to-month.
That makes them easier to predict, so you know how much you need to stay in business per month or year. But that predictability can also make those costs difficult to change.
You can shop around for cheaper rent, utilities and insurance but these are all costs that are likely to increase over time.
Due to rising energy and shipping costs including disruption caused by the Covid-19 pandemic, many ecommerce business owners have seen these fixed costs rise substantially in the last few years.
Your fixed costs can be found on your balance sheet and in your income statement, and are made up of expenses including:
- Web hosting fees
- Rent for office (or virtual office)
- Internet access
- Subscription fees for ecommerce platforms
It’s important to be savvy with your fixed business costs, shopping around for the best pricing as well as flexible cancellation options if trouble should hit your business.
As seen in the Covid-19 pandemic, unexpected events can hit at any time and having flexible agreements (such as rolling monthly rental costs), as well as insurances, can really help when disaster strikes.
What are Variable Costs?
Any costs or expenses that change from month-to-month are counted as variable costs. These are the costs involved in producing and selling your products or services and come under the COGS (Cost Of Goods Sold) category.
Put simply, if you need to cut costs, you should look at your overall variable expenses first. The lower these costs are, the cheaper your production costs and the bigger your profits.
Variable costs are linked to the number of products you sell; put simply, they increase when your sales volumes increase. These costs include labour, energy costs for production and raw materials.
For example if you sell hats your revenue is likely to increase during the holidays, but so will your variable costs including the wholesale price of your products.
Depending on your business, you can increase your profit margins by reducing your variable costs per unit.
Let’s say you run a business selling stitched wallets. You could train your employees to work faster or use less expensive materials. The more ways you can find to reduce variable costs, the more significant the impact on your profit margins and cashflow.
However, it’s worth remembering that you shouldn’t sacrifice quality to reduce costs. If your wallets start to break easily and you get start to get negative reviews, you could end up losing business by making your customers unhappy.
Variable costs for ecommerce include:
- Raw materials
- Storage Costs
- Shipping Costs
- Payments for suppliers
- Contractors for graphic design, social media campaigns etc
- Marketing costs
Variable costs can cause major cashflow issues for ecommerce business looking to grow rapidly.
This is because business owners don’t anticipate the much higher costs for doing business on a larger scale, undermining the profit margins (COGS) for the products themselves.
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What are Semi-Variable Costs?
Semi-variable costs can vary depending on the revenue you earn.
In general, they’re costs where you pay a fixed monthly fee for a service, then a semi-variable cost on top depending on how much you use that service.
For example, if you employ a digital marketing agency to drive more traffic to your website, you could pay a monthly fixed costs for the service, plus the costs to Google/Facebook etc. for the ads themselves.
Because the amount of money for the ads can vary from month to month, it’s counted as a semi-variable cost.
Some of these costs can be difficult to predict such as needing a new website; unexpected staff/HR costs; legal fees; business interruption caused by staff illness; and many more.
It’s best to keep some cash in reserve to account for these semi-variable costs.
Boost your Ecommerce Business by Understanding Fixed vs Variable Costings
Both fixed and variable costs are associated with running your ecommerce business and you’ll need to make enough profit to cover them.
Aiming to keep your costs low across the board will strengthen your profit margin. But remember never to compromise on the quality of your goods and services, or you may drive away customers.
Running a successful ecommerce business lets you connect to an audience worldwide, so focus on areas where you can streamline your costs to maximise profit and best serve your customers.
The first step to improving your e-commerce business’s profitability is having an accurate picture of your finances, which is where an experienced e-commerce accountant can help.