Vital Signs: A Blueprint for DTC E-commerce Health #37

Vital Signs: A Blueprint for DTC E-commerce Health 🩻

Direct-to-consumer (DTC) e-commerce success hinges on more than just having a great product and a beautiful website on Shopify and a lot of FB & Google Ads.

Key financial metrics become the guiding stars of profitability and sustainable growth.

Today, we'll dive into three critical metrics that every DTC e-commerce brand should watch:

1. Contribution Margin

2. MER (Marketing Efficiency Ratio)

3. Payback Period

Contribution Margin: The North Star of Profitability

Contributing to the bottom line is the Contribution Margin, a fundamental metric for DTC e-commerce brands. It's the litmus test for assessing the profitability of individual products or campaigns, allowing you to make informed decisions on resource allocation.

If you don’t monitor the health of each transaction, your business could flatline.

And I am not talking about health flat retention curves.

How to Calculate Contribution Margin:

Contribution Margin = (Total Revenue - Variable Costs) / Total Revenue

Variable costs include costs directly tied to product production, such as manufacturing, shipping, and packaging. A healthy Contribution Margin is essential because it helps you answer questions like: "Is this product profitable?" or "Can we afford to run this marketing campaign?" By understanding your Contribution Margin, you can allocate your resources strategically to maximize profitability.

A deeper dive on Contribution Margin…

In the heady days of 2017-2021, DTC Brands were chasing revenue growth by any means necessary. As money has become less available, brands have had to focus on efficiency and profitability. Enter Contribution Margin.

By focusing on contribution margin, DTC EComm brands can make better pricing, marketing, and product development decisions. They can also identify areas where they can improve their efficiency and profitability.

Here are some specific examples of how DTC EComm brands are using Contribution Margin to improve their businesses:

• Pricing: DTC EComm brands can use contribution margin to set profitable and competitive prices. For example, if a brand has a contribution margin of 30%, they know they can afford to sell a product for less than 30% of the cost of goods sold and still be profitable.

• Marketing: DTC EComm brands can use contribution margin to determine which marketing channels are most profitable. For example, if a brand has a higher contribution margin on sales from their website than from Amazon, they may want to focus more on marketing their website.

• Product development: DTC EComm brands can use contribution margin to decide which products to develop and sell. For example, if a brand has a higher contribution margin on one product than another, it may want to focus on developing and marketing the first product.

MER (Marketing Efficiency Ratio): Turning Ad Spend into Gold

In the world of DTC e-commerce, marketing is the lifeblood of growth. But how do you know if your marketing efforts are paying off? Enter MER, or Marketing Efficiency Ratio, a metric that reveals how effectively your marketing dollars are transformed into revenue.

How to calculate MER:

MER = (Revenue Generated from Marketing Efforts) / (Total Marketing Spend)

A MER greater than 1 indicates that your marketing investments generate more revenue than you spent. A MER less than 1 suggests that your marketing efforts may not yield the desired returns. By constantly optimizing your marketing strategies based on MER, you can fine-tune your campaigns to achieve maximum ROI.

What is the difference between MER and ROAS?

ROAS stands for Return on Ad Spend. It measures how much profit a business generates for every dollar spent on advertising. ROAS is calculated by dividing total profit by total ad spend.

The critical difference between MER and ROAS is that MER considers all marketing spending, while ROAS only considers ad spend. This means that MER can be a more holistic measure of marketing performance, as it takes into account all of the different channels that a business is using to market its products or services.

Another key difference is that MER is calculated after accounting for all marketing costs, including fixed costs such as salaries and rent. ROAS, conversely, is calculated after accounting for variable costs such as ad spend and cost of goods sold. This means that MER can be a better measure of profitability, as it considers all of the costs associated with marketing.

Here is a table that summarizes the key differences between MER and ROAS:

When to use MER and ROAS:

• MER is an excellent metric to use when comparing the overall efficiency of your marketing campaigns across different channels. It can also be used to track the long-term performance of your marketing efforts.

• ROAS is an excellent metric to use when comparing the performance of specific advertising campaigns. It can also be used to set goals for your advertising campaigns and to track your progress toward those goals.

Choose your financial metric weapon of choice…

Overall, MER and ROAS are both important metrics for marketers to track. MER can provide a more holistic view of marketing performance, while ROAS can provide more granular insights into the performance of specific advertising campaigns.

Payback Period: Making Smarter Investments

In the DTC e-commerce universe, speed is of the essence. You want your investments to pay off quickly. The Payback Period is the metric that helps you gauge how long your initial investment in customer acquisition can be recouped through their purchases.

How to calculate Payback Period:

Payback Period = Cost of Acquisition / Monthly Gross Margin Per Customer

How do you apply this to performance marketing?

1. Measure the profitability of their campaigns

By tracking contribution margin, marketers can see how much money they make on each sale after accounting for the cost of their paid marketing campaigns. This information can be used to optimize campaigns, allocate budgets more effectively, and make better decisions about which channels and strategies to invest in.

2. Identify which campaigns are driving the most profitable sales

Not all paid marketing campaigns are created equal. Some campaigns may drive more sales than others, but they may also be less profitable. By tracking contribution margin, marketers can identify which campaigns generate the most profitable sales and focus their resources on those campaigns.

3. Set realistic budgets for paid marketing campaigns

When setting budgets for paid marketing campaigns, it is essential to consider the desired contribution margin. For example, suppose a marketer has a target contribution margin of 30%. In that case, they will need to spend less than 30% of the revenue generated from their campaigns on paid advertising costs to be profitable.

TAKE ACTION: Equipped with this information, you can adjust your Google Meta, TikTok, Snap, Affiliate, & Influencer bids, placements, and corresponding CPM, CPC, and CPA.

The Holistic Approach to DTC EComm Financial Health

While these three metrics—1) Contribution Margin, 2) MER, and 3) Payback Period—provide valuable health insights individually, they are most potent when considered together. By examining them in tandem, DTC e-commerce brands can gain a 360-degree view of their financial health and marketing efficiency.

Being data-driven and results-oriented isn't just double talk —it's the backbone of health and success in the modern e-commerce landscape. Regularly monitoring and optimizing these vital financial health metrics will enhance your decision-making and help your brand thrive in a competitive market.

In conclusion, the road to DTC e-commerce success is paved with metrics, and these three—Contribution Margin, MER, and Payback Period—are your VITAL SIGNS.

Keep them close, make them part of your daily routine, and watch as your brand becomes more profitable, efficient, and resilient in the face of market challenges.

Bonus track from Rush, a deep-cut of early 80’s rock in your life.