In this episode, Nathan and Val discuss the importance of first-order profitability in e-commerce businesses. The podcast is structured into three sections, firstly setting the scene, secondly how to become first order profitable, and finally how to operate a repeat purchase model.
Takeaways
Chapters
00:00 Introduction and Setting the Scene
03:36 The Importance of First Order Profitability
08:10 Accurate Gross Margin Calculations
20:28 The Role of Pricing Strategies and Shipping Costs
26:51 The Power of Upsells and Cross-sells
28:33 Importance of Tracking First Order Unit Economics
39:13 Becoming First Order Profitable
48:39 The Role of Markups and Pricing Strategies
53:47 Testing Pricing Changes and Elasticity of Demand
In this episode, Nathan and Val discuss the importance of first-order profitability in e-commerce businesses. The podcast is structured into three sections, firstly setting the scene, secondly how to become first order profitable, and finally how to operate a repeat purchase model.
Takeaways
Chapters
00:00 Introduction and Setting the Scene
03:36 The Importance of First Order Profitability
08:10 Accurate Gross Margin Calculations
20:28 The Role of Pricing Strategies and Shipping Costs
26:51 The Power of Upsells and Cross-sells
28:33 Importance of Tracking First Order Unit Economics
39:13 Becoming First Order Profitable
48:39 The Role of Markups and Pricing Strategies
53:47 Testing Pricing Changes and Elasticity of Demand
Welcome back to the Blues Brothers podcast, the podcast in where we share the challenges, insights and triumphs of scaling seven figure brands to eight figures and beyond. In this episode, I'm joined with the first repeat guest on the podcast, Val. And the topic for this pod is becoming first order profitable. So I've been having a lot of conversations with Val over the course of the last few weeks about first order profitability versus returning order profitability. And on the back end, we've been building some unit economic models to determine the state of brands and how healthy they are. So I wanted to structure this podcast by number one, setting the same. So why are we even talking about first order profitability? Why is it an important podcast that we should be recording? Number two is then moving into how to actually be and become first order profitable. And then lastly, I want to touch on that you can play the repeat purchase game. and that you don't necessarily have to be first order profitable, but you have to be incredibly sophisticated and incredibly sophisticated Ecom operator. And so we'll briefly talk about how you can actually do that correctly and how you can probably identify if you shouldn't be going down that route. And if you should be building a business model around generating profits on first purchase. With that being said, I might pass the veil to kick us off in regards to the importance of self liquidating. customer acquisition by being profitable on first purchase. Yeah, I appreciate the intro Nathan and good to be back. I got the trophy of the first repeat guest, so that's incredible. Yes, and I think that's an incredibly important topic and we'll talk more about it in more detail. But I think to set the scene, the reason why you want to be first order profitable or first time customer. to reach that profitability with your first time customers at purchase one is because if you don't turn profit on that first order, someone has to finance the loss. And who does that? Right? There's essentially three ways you can finance the loss. It's either repeat customers who basically help you fill in the profitability leakage with their profits. It's either raised capital from investors, so investors come in and actually pay money for that loss, or it's creditors who come in and give you capital to finance that acquisition at a loss. And most brands don't actually understand that, and they fail to conceptualize and contextualize the loss and think, okay, how exactly are we financing the loss? And... If you continue with the losses for a series of months, that will accumulate into a sort of cash deficit that no longer can be financed because now you're... sort of blowing that out of proportion. Repeat customers are not enough to finance it. Investors are not happy with your performance and they are not really willing to extend more capital. And creditors look at your business and they see a lot of risk across the board, a lot of red on the P &L and they're not as open to... extending line of credit or better terms for you to continue financing that first purchase loss. And at that point, that's the sort of turning point for a lot of brands and they have to figure out a way to turn profitable in the first purchase. Otherwise they will basically derail into bankruptcy. I probably couldn't have said it any better. The only thing that I'll add there is if you're in this assumption, you can't really be bootstrapped unless you're providing your own capital. But let's say you are providing your own capital and you're going in with a few hundred grand. If you aren't profitable on first purchase, it's going to be very difficult to scale at any degree of high growth rate. Because if you're unlocking breakeven caq at the four to five month mark, then you can pretty quickly model that out and do the math, but you'll only be able to grow at five to 10 % per month maximum. That's an absolute maximum case. And so if you wanna be growing rapidly, which most business owners do, most business owners do wanna grow their business quite quickly and achieve their goals faster, it makes sense to be self liquidating customer acquisition by... having first purchase profitability and then you can just take that free cashflow and put it straight into acquiring new customers rather than having to wait through this cycle for cash to be unlocked. Yeah, that's exactly right. And it's all about cash conversion cycle. What most brands forget is that cash conversion doesn't start when you acquire the customer. It actually starts when you buy inventory because you've invested capital before you even start advertising and marketing that product to the customer. So once you've invested capital, it will take a certain number of days and the sell through rate will tell you how long it typically takes for you to flip inventory. Or let's say it takes you 30 days on average for top sellers to sell through. So it means some of that will sell within 0 to 10 days. Some of it will sell within 50, 60 days, so on average 30 days. So you have to price that into your cash conversion cycle. Otherwise you will not really, because you have to finance that 30 days before you even start selling to your customer. Right. And without understanding that pre cash or pre investment of cash into the customer journey, you will basically double down on the loss at acquisition on top of the investment and product line before advertising. Yeah, I think the key there in terms of the financial ops at most DCOM operators miss is they maybe they're competent enough to look at the P &L and get an understanding for how the P &L works, but they don't have that extra nuanced understanding of how cash moves across the P &L month on month and how that's impacted by inventory. So they're not actually projecting cash or inventory purchases. and they're just looking at their P &L and then trying to run their business. But then when they look at their bank account, it doesn't line up whatsoever. So there's a bit of a disconnect there. And that's like another topic which is outside of this webinar, but it's the difference between a cruel and cash basis for accounting. A lot of brands follow... kind of a hybrid model. So they, you know, sometimes they don't treat their revenue properly and they look at deposits, cash deposits as revenue and inventory purchases as cogs, which is not. And that's the major difference between accrual and cash is that you want to look at your actual revenue reported in Shopify rather than deposits deposited because that has implications in terms of time when you actually get those deposits and you want to look at cogs versus inventory payments. because COGS is what you actually sell within a month, for example, and the cash payments for inventory is when you actually pay for inventory. So that's important for cash flow, not so much for profitability. So when you combine both, you're missing the picture altogether in terms of profitability and liquidity. So never combine both approaches. If you want to have a read on profitability, liquidity, always treat them separately. Look at COGS for profitability. Look at cash payments for liquidity. Yeah. The other part of the scene that I also want to paint here is why are a lot of brands currently not profitable on first purchase? And I'm auditing a lot of brands these days who are self liquidating on first purchase, which is a tricky situation to be in. and there's a few reasons why I'll touch on one on them. I'll move over to you, but the first one is inaccurate gross margin calculations a lot of the time. And that's one that I've talked about a lot. So I probably won't. spend much time here, but it's just not getting under an understanding that your gross margin is not the cost of goods sold that's provided to you by the supplier in your moq PDF. It's not our we're paying $2 a unit. So that's our unit cost. It's that laid in with the cost of delivery into the location that you're shipping from alongside all associated variable costs, whether that's three PL shipping costs, as well as am I missing something here? Yeah, transaction fees. Yeah. as well. Yeah. And so they end up stacking up very, very quickly. It's most brands think they're running at 70 % gross, but you start to layer in all the other variable costs. And pretty quickly you said that they're closer to 45, 50, which completely changes their calculations when they believe their first purchase profitable. But then we come in, drop their data into a model, have a look at their normalized P and L and we go. you're not profitable on first purchase because all of your assumptions are wrong. Yep. Yeah, that's a big one. And I think I made a post about it in a detailed video going through a D2C PNL and how I see it. And I think the biggest... There's a lot of terms being thrown around and I wanted to consolidate them all in one video and make sure that people understand that there's three levels of variable costs. First level is the creation level where you take your product cost and some people call it gross margin, but it really isn't, right? It's just product margin. How much profit do you make on top of the product cost? basically your markup, right? So you mark it up, that's how much product margin you get to keep at the creation level. Then there's a delivery level, which is how much do you incur in shipping fulfillment and transaction fees to deliver the product to the end consumer, to the customer? And that's your second level. And after those two levels of creation and delivery, you get your gross margin. That's what the gross margin really is. Or it's also called as contribution margin two. So after creation, it's contribution margin one. That's how much profit you keep after selling or after product costs. After delivery costs, that's your contribution margin two. And then the contribution margin three or profit contribution, that's what they call it. comes after you deduct your advertising, direct advertising and direct marketing costs. And that's your... basically contribution margin three or whatever the final contribution margin because marketing is kind of a hybrid cost. It's sort of variable but it's also fixed because you have to set the budget beforehand before it even delivers any ROI for you. And that's why it's not entirely variable because you still have to incur it before you get revenue. Whereas other variable costs you don't incur them unless you have revenue. So that's why it's kind of like a variable fixed hybrid cost. Yeah. On top of inaccurate, gross margin calcs, the other one is inefficient marketing. So just an inability to decrease CAC at the end of the day, if you're not profitable on first purchase, it's either because you're not generating enough, Contribution margin too, on first purchase or your CAC isn't low enough. So it's, they're one of the two issues. And so it ultimately comes down to a misunderstanding and pricing. and your ability to drive margin on a product or your ability to drive down marketing costs by being more efficient through your marketing. And so you could pretty much simplify the entire re -commerce down just to that, which is you should be, you know, maximize margin on products who are having strong pricing power and then decrease blended cac as much as possible. Yeah, and I think there's two methods to do that. One method is look at your pricing strategy. Are you taking into account discount and returns allowances? Because what happens is when you buy a product at a certain cost, let's say $1 and you mark it up 10x, so you sell it at retail price of $10, you basically assume that your product margin or contribution margin one will be $9, but it typically is not the case because then you have to discount and then you have to accept refunds from your customers. And if you discount 10 to 20%, that's another one to two dollars that just goes out the window. which you didn't really capture in that markup originally, because you thought, okay, let's just 10X mark it up, but it's based on, you know, our feeling, not so much mathematical evidence. And you didn't know how much, you know, it would cost you to push the product into the market and how much you would have to discount. And then the refunds as well, you couldn't have anticipated that beforehand. So what happens is you then, if you're... market analysis tells you that you can actually market up a bit more to capture those discounts and refunds into the price, then you should go ahead and do that. That's method number one. And method number two is actually using incremental unit discounting, right? If you see that you're not as profitable in the first purchase as you would like to be, create incentives for customers to basically add more units to their cart. driving that contribution margin dollars up. So maybe your margin shrinks a bit percentage wise, but in dollar terms, it's much more and that's what matters. And of course you can include the links in the podcast. People can see a detailed breakdown of me going through incremental unit discounts and sign up offer discounts and they will see how exactly they can approach it. Yeah, I actually made a calculator on this the other day. I might quickly screen share it so that anyone watching on YouTube can say it, but I wanted to visually demonstrate this point, which is the fact that if most people keystone markup, so they take their cost of delivery or their cogs and they just times it by two, they would price it$50. But without consideration of discount allowances, shrink allowance, shipping costs, that's going to be incurred. And then ultimately hack as well. There's going to be a cost to acquire a customer. then you come out to a pricing of $86 and 50 cents, which is wildly different from a$50 pricing. And so where an unsophisticated Ecom operator would have came in and just gone, okay, let's Keystone price to X and then try to run ads. I would never have been able to get the business off of the ground. If they did the analysis of allowing for shrink allowance, allowing for discount allowance, understanding what they cack probably is going to be within the context of their pricing and their. our individual niche and building all of this in, then they can sit at a contribution profit that they already know and understand and can predict moving forward. And then from that, they can also understand where they should sit OPEX. Because if you know that your contribution profits going to sit at about 35 % and you want to do 20 % net as a company, you know, let's just keep OPEX at 15%. And then you've also got an acquisition mode target out of that. So I think most brands don't price anyway, anywhere near. what this looks like, but it's an easy adjustment to make to start to become profitable on first purchase. Yeah, exactly. And like we mentioned, they just look at the first one, the cogs, right? Just mark it up and done. But it's so much more complex and... detailed than most brands think. And that's why unit economics is so essential and you have to keep it in real time, know your variable costs, how they change month to month so that you can capture that into your offer, into your unit economics and communicate that to your marketing team so that they can execute and deliver results. And that's one of the things, and you've experienced that firsthand for sure, is when brands are not happy with results and most of the time they with... hold some information from marketers, right? And they don't communicate the unit economics clearly. Of course, marketers are expected to ask for that information, but if there is no sync between founders and marketers, of course the results are not gonna be satisfactory. Yeah, yeah, absolutely. Is there anything else that you would add to setting the same why a lot of brands currently aren't profitable on first purchase? I would say that... There's not much else to be honest. It's really just economics and building out a customer journey that fits the economics perfectly. So I don't think there is anything else to add that would make up for the majority of brands. Of course, there is certain exceptions and special cases with brands of why they are not hitting those targets and first purchase profitability, but... For the sake of sort of general discussion, I think we've covered it. Perfect. The next thing that I wanted to touch on was some unit economic requirements for first order profitability, because I think we could start to map out of the next 10 to 15 minutes, actual concrete numbers that you really have to be hitting at a baseline for you to even be first order profitable. If your main acquisition channel is going to be paid ads, which let's be real 90 % of econ brands, their main acquisition channel is paid ads. I think we can talk about average order value. I think we can talk about more specifically contribution margin on first order, which is probably the more specific metric to look at. Could then talk about gross margin and then also CAC as well. When it, when it comes to average order value, why I say I think it's more important to look at contribution margin too, on first purchase is because at the end of the day, average order value doesn't mean anything. What matters is the margin made on the order. If we're looking at becoming profitable on first purchase. And so yes, we can maximize average order value and get your average order value up to X. But if there's no incremental increase in margin on the order, there's no point unless. There's some really long tail strategy that you have in the backend where you're trying to move more units to therefore have your product in more houses or something like that. But it starts to get away from just the core of unit economics and building a brand using concrete numbers. So if you're looking at first order profit contribution, I think that you really need to be operating with at least 50 to $60. of profit contribution and that's AUD. So you can convert that to USD and it'd be about 35 to 40 on first purchase or else it's going to be very difficult to self liquidate right out of the gates if you're about to launch into ads. And the reason for that is it's very difficult to achieve a CAC below 35 to $40 when you have no pre -existing customer database, when you have no product in anyone's houses, you're getting no word of mouth purchases. That's going to artificially deflate your blended cac number. And it's all coming through direct paid channels. And the reason for that is a really, really basic calc. And it depends whether you're going to use Google or Facebook as your primary acquisition channel. That's going to change the calculation. Let's say you're using Facebook. Your cac on Facebook. Simply is your conversion rate divided by your CPC. And so you need to drive conversion rates up or CPCs down. one or the other and your blended cac and pruse. Realistically, a CPC out of the gate is probably going to sit at about a dollar. Once again, this is Australian, USD is about 70 cents. And conversion rates out of the gates, depending on your average order value, you're probably going to sit at about two to 3%. And so that's going to land your blended CAC at about 40 to $50. And so if you don't have 40 to $50 of margin built in to first order, it's going to be very difficult to be first order profitable in the early days. until you start to achieve escape velocity where you can drive blended CAC down to a more sustainable number at about 25 to$30. And you could build that into your modeling. So you could have an understanding that, hey, out of the gates, we're not going to be profitable, but we're going to assume that blended CAC is going to gain efficiency as we get product out into market. But there's some baseline numbers that I'll throw out there. Yeah, I think that's a good starting point. And then when you base your economics on that blended cap of let's say 40 to 50 Australian dollars, then you got to go towards shipping and say, okay, so shipping costs us this much to fulfill one unit, for example, in an order. Doesn't make sense for us to pay that much if we can try and push customers with an incentive. to add one more unit because the change in CAC is non -existent, right? The customer is still the same. You're still acquiring the customer. And shipping is just an incremental or marginal increase in shipping cost of, let's say, 50 cents to one dollar, depending on whether you work with a three PL or in -house warehousing for in -house where operations, there is no increase on the on the shipping side. There's might be slight increase because of weight changes, but it's probably marginal as well. So once you price, you know, you price marketing, then you price shipping into that. Then you make a decision on how you want to approach your offer. to first -time customers and should you incentivize them to buy more units in that order so that you generate more profit contribution dollars without impact on customer acquisition costs and shipping fees because again there's so little there. The only truly variable costs in that case when you add more units are your cogs because you're selling more units, more products and your transaction fees because your AOV goes up. But the shipping, it is variable because you won't incur it unless you sell a product. But it's a marginal increase per unit that customers add to their cart. So you keep that in mind because I see a lot of brands make that mistake. They say that the variable cost is a percentage of their AOV, which is not. It is a percentage when you only add one unit per order. But once you add more units per order, the... the relationship to or the percentage of AOV goes down as each unit gets added to the cart. Yeah, that well, I say that all the time, which is people just use averages. I feel like the rule should be you should never use an average in any econ. Like it should always be understanding the data that is informing the metric rather than just pulling a metric and then just applying it to the whole business. Because if you take, we have 40 % gross margin, because that's what it was the last financial year. It's like, okay, but how have the skews changed because gross margin differs at not only a skew level, but at a units per transaction level. And so you have a cohort of customers that are actually sitting at 70 % gross margin. And because you're not splitting out the data, you can't get the understanding of why don't we just optimize to this kind of customer rather than just averaging out and being happy with 40 % gross at the end of the year. That's exactly right. I have an interesting example of this, which is, so you said units per transaction, increasing incremental units in a transaction. So you get economies of scale and shipping fees and all other associated variable costs. There's also immediate cross sells and upsells in cart post purchase and through post purchase email flows. And the interesting example, which ties directly into this, I think I made a LinkedIn post about it. three months ago, maybe you saw it, maybe you didn't, which was back about two and a half years ago, I was selling patio heaters and I was selling patio heaters because I identified during COVID that all US restaurants could continue to operate as long as everyone was outdoors. And if you're outdoors, you sort of want a patio heater, you don't want to be in the cold. And so there was a shortage of patio heaters in the US and pretty much the whole of the US sold out. And so I imported about 500 of them. and sold out in a week, two weeks at a blended cac of maybe $10. And these are thousand dollar A of A products. The funny thing was that my margin was nothing like it was absolutely nothing because of the moq and importing into the country, I had no idea what I was doing. So I incurred all of these costs, where my gross margin ended up being probably about 10 to 15%. And so on a thousand dollar product, I was making a hundred to $150. Also because the shipping costs were so expensive, shipping these things around the country. And I had no idea of how to restrict state targeting so that I minimized shipping costs. I was just shipping anywhere across the country. I didn't care. And so what ended up happening was I was only really making in contribution profit when we minus off CAC about a hundred dollars. And so after I sold about 10, I got two emails which said, do you sell patio covers as well? Cause it's going to be outdoors. And I thought, let me go source one of these. So I went and saw some patio covers on AliExpress for $7 a unit landed cost to the customer, drop ship directly with five day shipping times. And I laid that in as an immediate cross sell in a post purchase email flow, which said, Hey, I noticed that you didn't put a patio cover in your order, but all of our customers do. Maybe you made a mistake. Here's the link. I'll give you 40 % off. And I priced it at 150 and I discounted to 99. And so I was making the same profit on the cover upsell than I was on the $1 ,000 patio heater. Just by building in an assumption that, Hey, everyone orders this. You should have it in your cart. And because they were price anchored at a thousand, a hundred dollar addition wasn't that bad. The incentive was there with the 40 % off and I doubled the profitability overnight with really not much change to revenue. Revenue went up like 10%, but profitability doubled. And so it sort of goes to show the importance of having those cross sells immediately after first purchase. Because even if you have a 20 % take rate or a 10 % take rate, it's a hundred percent margin because there's no cost. on getting that upsell because you've already bought the customer. And so if you end up dividing that contribution margin across the, let's say 10 % take it to 10 orders, you end up becoming so much more incrementally profitable across the entire cohort. Yeah, that's the power of economics, right? And that's why I always, I see such a missed opportunity when brands don't have in -cart upsells and cross -sells. That just hurts my eyes. And I think, you know, we've gone so far in the e -commerce space that this is a necessity for every brand. It's no longer just an optional add -on, right? Because you're making money on repeat customers and upsells and cross -sells. Now it... It's really difficult. Again, we've gone over why, because again, you got to be very competitive in the space. And even if you do all these adjustments to your offer and economics for first purchase profitability, you will likely still not make as much profit. So you have to play with cross -sells, up-sells. And if you don't just miss an opportunity for profit generation at that level. Yeah. What's the importance of tracking first order unit economic separator repeat orders? I know it's obviously something you do is something that we do internally. But why do you deem it important? track first time profitability. First time audit unit, first time unit economics versus recurring customer unit economics. yes. Yes, okay. That's a good question. And I think there's a few reasons. First reason is repeat customers tend to spend differently than first time customers for many different reasons, especially if you have an extended catalog of products, a lot of options. customers may not buy the same product they bought in the first order and come back for something else. So that will make a difference for the average order value. If you don't split that out, you will skew your data and not really understand the economics that you play with for different types of customers. The second thing is there is different marketing spend for... first time and repeat customers. As you know, for first time customers, we can assume $40 to $50 in acquisition. For repeat customers, if you have to retarget them with spend, you will still allocate some direct marketing for repeat orders and you have to know how much you spend to bring those customers back. Although, most likely, you will still generate more profit contribution just because it's not as challenging to repeat. in terms of cost, it's not as costly to bring customers back than acquire new ones. So that price or cost difference will make up for profit contribution. And when you do those distinctions and you know exactly how much your first time customers make and how much your repeat customers make, you can then make strategic decisions about. You know, allocating budgets and understanding, okay, should we spend a little bit more money to retarget existing customers and bring them back in because we're making that much profit contribution. And it's actually more valuable for us to invest more in retargeting versus first time customers based on the output, because we know that let's say a repeat customer is five X more valuable. And contribution margin dollars than the first time customer. So should we, you know, make changes in our strategy and bring those customers back? And again, you go back to the. customer portfolio analysis and you segment customers based on their purchasing behavior and how they, you know, quantitatively and qualitatively, how different are they from each other and then you look at each segment separately and you see even further differences between, you know, repeat customer economics. Because again, based on the segment, you will see those staggering differences in terms of LTV and order economics. And once you've gone through all those calculations, you now know how much we can offer in terms of discounts and coupons to repeat customers. Because again, something that you might discover as well is that maybe retargeting doesn't make sense in terms of ads. We should probably send them a coupon for an X amount because that will be cheaper than us going to Facebook and advertising that. So based on those calculations, you will know exactly how to proceed and what kind of strategy to implement. Yeah. Funny enough, I see a lot of clients that sort of give me an Excel with the math that they've ran. And they've run, and I could say this for every single metric, and I know you could as well, but it's that they do some form of math to prove that they're either profitable or that they're going to be profitable on second purchase, but they're using average order value just as a blanket number. And they're not delineating to first purchase average order value or to repeat purchase average order value. And in most brands, there was an enormous difference between those two numbers. some there isn't like I've, I've seen a lot that, yeah, it's about the same because there's not a big skew range. And so they can't really have much increased purchasing power through that repeat purchase. But in most it's the difference between like $250 and 350 or 400. And so when you're taking an average there and you're going, yeah, we're acquiring customers profitably because our average order value is 350. But it's not, it's 250. So you're actually not acquiring customers profitably. and you're making money on fourth purchase. And so your P &L looks good, but it's only because you've been operating for five years and you've got all these customers backed up and you have an increased spend marginally recently. And so you're sort of in that pipeline. But the second you go and start increasing spend, you're going to start negative cash flowing because you increase the proportion of new customer acquisition, which is negative at a unit level in comparison to your current customers. Yep, that's exactly right. With that, I built a calculator. I built two calculators actually to health check brands. I could probably pull it up as well in this podcast. The first one is to assess projected revenue decreases to get an understanding for how profitable a brand is. And so a really healthy brand theoretically should be able to take a 50 to 60 % revenue cut tomorrow and not go under. Their variable costs should change as a consequence. Their OPEX. can stay the same and they should be able to be driving enough EBITDA to be above zero. And so that's exactly what I built here, which is that you input all of your numbers and then it projects revenue decreases. And then you can specify whether you want to project a decrease in OPEX. So, okay, if we did experience 60 % shrink, do we want our OPEX to shrink by 60 %? Well, our marketing is probably going to shrink by 60%. And so you can project that in and say, okay, this brand with this unit economics, which is a real brand, can take a 60 % decrease in revenue and still be profitable at an EBITDA level, which is an incredibly strong position to band because most brands would input their numbers in here. They wouldn't be able to take a 10 % loss or even a 20 % loss. I made a second health check, which the numbers are working in here right now. We can put an assumption in, which. I don't think you're a fan of, which is a healthy brand who wants to go and negative, be not generating profit on first purchase. If we're looking at the P and L structure, what that means is that their contribution margin on returning customers has to be greater than OPEX. So it has to cover OPEX at least. Or else, if we go and start acquiring customers at a negative amount, maybe it's negative five, negative $10, the P &L will just go immediately to negative because there's not enough contribution margin from those returning customers to cover the OPEX cost. And so this is a really easy way to get an assumption of, is this a healthy brand that could go into the negative on customer acquisition or could they not? Right. Yep. Okay. Here's two things that I don't like about this, this particular one, the repeat customer. In general, it makes sense. In theory, it makes sense. In practice, there's two challenges. One is the moment you shut down acquisition, your retention also suffers, right? So when you say that repeat contribution margin is above all packs, we're good to shut down acquisition. Not a good call, right? Because the moment you shut down acquisition, there is windows, retention windows, right? 30 days, 60 days, 90 days. You will have that lag effect. After you shut down acquisition, you will experience shrinkage in repeat customer contribution margin within the next 90 to 180 days. And once that happens, most likely, your repeat contribution margin will go. below OPEX. So even if you have currently repeat contribution margin above OPEX, once you shut down acquisition, that will certainly change. So if you do decide to shut down acquisition, make sure you don't extend it for over 90 days because then the... drop in acquisition will catch up with retention and that will cause the repeat contribution margin to go down. And the second thing I don't like it, the second reason why I don't like that approach is because when you exclude first time contribution margin and only look at repeat contribution margin above OPEX, you expose your understanding of the situation to the fact that you're not taking... first time contribution margin into your account. Because if you're losing money at first purchase, contribution margin is negative at first purchase at acquisition. So it actually will cancel out some of the repeat contribution margin, right? So by looking at repeat contribution margin alone and saying it's above OPEX, that may not be the case because you have... losses on the first time contribution margin, which also have to be priced into or taken into account to make sure that the repeat contribution margin also makes up for the loss at first time contribution margin. So I like the repeat contribution margin, but it has two very big weaknesses and exposures. So make sure that you also look at first time contribution margin as a health check to make sure that Repeat contribution margin can cover both the loss on the first time contribution margin OPEX and also evaluate the extent of recent acquisitions on the repeat contribution margin. Because once you shut down acquisition, your repeat will suffer as a result too. So again, I know I'm overcomplicating this, but make sure that you pay attention to those two areas as well. Yeah. I still want to touch on that, but I'll factor this into part three, which is if you're going to not be profitable on first order, let's dive into our recommendations, but my recommendation number one is still going to be that calculator, which is if your returning customer contribution margin is greater than OPEX, it means you can afford to take losses on first order and your P and L will still ideally be above zero as long as your losses on first purchase is less than your profits on returning customer minus offbacks. Yes, exactly. Yeah. So just measure the extent of the loss in relation to how much repeat contribution margin profit is. Yeah. And so you could use that as a health check under the assumption that do not turn off acquisition. And number two, note that the difference between OPEX and contribution margin on returning customers is the margin that you have to go play with if you want to start negative cash flowing on first purchase. Yeah. good summary. Yeah. So as long as people don't just pay attention to repeat contribution margin, I'm totally fine with the calculator. Fair enough. So for brands that aren't profitable on first order, and I know you work with a couple that actually some brands do an incredible job at it. The reason why I don't recommend that your average DTC owner goes and starts a brand that's reliant on second purchase or third purchase profitability. And I was actually talking to someone about this on a consulting call today. And they just took on a client who's in this exact instance. So they sell a $60 consumable product that's reliant on repeat purchases because they have a CM2 of $20 on that order. So they need a CAC below $20 to be profitable, which just is not happening on a startup new brand unless everything is absolutely dialed in, which it simply won't be. And so... Unless you have everything absolutely dialed in and you're really, really sophisticated within ACOM and you have the ability to raise capital as well to fuel initial customer acquisition, it doesn't make sense to play such a risky game when you can build a foundational business that makes the cash flows upfront. And then later down the line, you can look into a business that's reliant on repeat purchase ability. The reason why I even want to talk about not being profitable on first purchase and talk about this kind of businesses is because there's a huge opportunity in them. And there's a huge opportunity because 99% of people aren't able to do it. They don't have the sophistication to be able to pull off a business that's reliant on second or third purchases. And so because everyone fails at it so much, if you have someone that's a really strong operator and knows exactly what they're doing, they can come in and just crush. But it's reliant on a bunch of things, which is what I want to talk about. The first one being really knowing your numbers, but more importantly, cause everyone says, know your numbers and what does that even mean? It's more so understand the data that informs the metrics that you're going to baseline everything against. And so rather than looking at average order value or returning customer rates or even total sales in Shopify. Getting an understanding for average order value can actually be delineated into returning and first order. Average order value is also a function of average unit retail, UPT, discounts, return rates. Returning customer rate, it's really not an informative metric to make strategical decisions. And so breaking that out into a cohort analysis that goes down to the contribution margin level to get an understanding of how cohorts are changing and when you're getting drop off and how you can curate a strategy around that. It's getting the deeper understanding on every single baseline metric and the data that's aggregated to give you those metrics. That's the level that you need to be operating at to be able to be scaling a company that's not profitable on first order. And that you need to be ensuring second or third order profitability because you're taking a huge risk with not being profitable on first order. If there was an economic swing or a macro change. that suddenly caused your entire cohort to not buy in the next 30 to 60 days, you've just taken an enormous loss on acquiring that cohort that then doesn't go through and actually become profitable. Yep. That's a, that's a perfect summary. Honestly, nothing really to add to that. Yeah. And yeah, the only thing I would add to that is got to understand the inputs to evoke change on the output side. And lots of brands are not really following that thinking. Like you mentioned AOV is an output and the inputs are. units per transactions, retail price, discount given. Once you understand that it's all about the inputs because you have control over inputs, then you can measure outputs. But lots of brands only measure outputs without understanding the inputs. And that's where they fail. And that's why they are unable to play with the economics and grow as quickly as they want. And... hit the desired profitability and liquidity targets. And I think that's the reason why so many businesses fail within five years, because they just don't understand the game and how to play it. Yep. If you had an income operator approach you and they said, I'm about to start a business, which is a $60 AOV. It's a consumable product. It's going to be reliant on subscriptions and repeat purchases. What core metrics would you be telling them that they should be tracking on a week to week, month to month basis? Yeah, the first one is, of course, the lifetime contribution margin to customer acquisition cost within 30 days. So how much do you actually lose in that 30 days? That's number one metric. If, let's say, if it's below one lifetime contribution margin to CAC within 30 days, it means you're losing money on the first purchase. You've got to understand how much exactly you're losing. Then I look at churn rate, right? How many customers are actually churning out of your product? If it's above 90 % after that 30 days, that's a huge concern, right? So you probably have a product quality issue. And you gotta dive into that before you start scaling the spend, because otherwise you're gonna lose money on that spend at acquisition. And then you... are not really repeating customers back, they're churning. So you're losing money even at repeat level, right? And that's not really good for the business. And then of course, if the churn rate is not as high as 90%, if it's way below that, you're looking at 50%, for example, then of course I would look at ways to optimize, go back and optimize the first 30 days. And how can we do that? So we'll look at the gross margin, contribution margin. Can we add another product? Collect some data from customers, see what else they need and what can we cross sell within that 30 days to push their contribution, 30 -day contribution margin up. and basically boost that LTCM to CAC, 30-day LTCM to CAC above one so that we turn profitable on that first purchase. So I would say that these would be the core three. The first one is LTCM to CAC within 30 days, churn rate within 30, 60, 90 days, 180 days. So track the... the windows and understand how many customers you're churning over months. And then gross margin within that 30 days, of course. Repeat is not as important. 30 day gross margin would be the most important. I'm doing a analysis at the moment across our entire client portfolio to try to determine what the common characteristics are of success in the highest cash flowing businesses that we have in our portfolio. And then I want to make a YouTube video on it and then have it at the start of our onboarding, which is, Hey, here's our 10 most successful clients. Here's the three, four common characteristics between all of them. I haven't finished it yet. I don't have three to four characteristics yet, but the first one, which I found was interesting, which is absolutely the case for these five to 10 brands so far is they all have really strong maintained markups. And so I think that that's probably we've talked about it a few times in this podcast, but that's probably not talked about a lot when it comes to. content on LinkedIn, content on YouTube, starting a con brands, trying to go down the course route, being in communities. I don't think many people talk about the maintained market required on a product, but the clients where we have a 10 maintained markup, a four, a five, a six, they have so much profitability because they have so much room to acquire customers on first purchase. Like the... don't even don't even regard second purchase. If a customer comes back and buys on second purchase with a 10 MMU, it's ridiculous levels of profit. And so it's these are the brands that we work with that have EBITDA of 40 % 38 37%. It's because they have really strong pricing power and they mark up their products as much as humanly possible. And so I'm thinking about making a video or a LinkedIn post about just raise prices. as test raising prices and and on that, how would you how would you suggest test raising prices? Because I used to do this when I owned my own a comm stores. And it was the scariest thing ever. Which is you have your products, they're selling you're selling 20 30 100 units a day. And then someone comes in and says, Yeah, but you could be making an extra $5 ,000 a day if you just up your prices $10. And you sit there and you go, really? But what's gonna All my sales will stop though. No one wants to buy it at $100 rather than 90. How would you approach incrementally testing pricing changes and how that impacts elasticity of demand? I mean, it's a whole other topic. And there's actually people who specialize in pricing strategy. So there is a whole direction of pricing strategy. So it's not as simple as many people suggest. But of course, it has to be rooted in your research and data. So I would start by surveying your existing customers and saying, look, how much? more likely are you to buy this product at this price point? So if we were to increase it by five to ten dollars or fifteen dollars or twenty dollars, are you still likely to purchase this? And I think there is actually a methodology behind it. I think it's called Venn pricing strategy. I'll look it up exactly. Van Westendorp pricing model and it actually addresses that whole point based on the customer research and I'll pull it up. Do I have permission to share a screen? You should be able to, yeah. sure. So for anyone interested, this is how it looks. So basically you reach out to your customers and you say, look, if it was priced, you know, by another price, stop by another hundred, $200, $300 was, would it be too cheap, cheap, not expensive, not cheap, expensive, too expensive. And at some point you can collect enough data and enough. customers respond to you and you can build out this kind of chart and then you will know the point of indifference and that's your optimal price point for the product. And again, I wouldn't recommend doing that for all your products. Of course, it has to be done on a flagship or core product. But what I typically recommend as well is perform this basic ABC analysis to understand how much value certain products contribute. to your brand and then classify them into winners, complementary products and toxic products. Toxic products are the products that you don't really care about and you should push them out of your business as soon as possible. So cash is more important than contribution margin with those guys. Just push them out of the business, convert them to cash and then invest that cash into initiatives that generate high ROI and buy new products or invest in acquisition. Complimentary products are typically the products that you have for cross -sells, up -sells, and are the ones that actually have that potential for price hikes, huge potential. Like you said, for example, with the cover for the patio heater, you could have priced it at $200, most likely, and still given them a discount of 50%, and you would have made a huge margin nonetheless. So that's something that you could have used. That was your complimentary product that you could have hiked the price of. And for winners, you got to be very careful because that's something that is doing extremely well. So, you know, testing price with those guys could break your profitability, break your, break your sales. So you got to be very cautious about testing price there. Go with data collection for winners. So. ask your customers how comfortable are they paying higher prices, especially if there's a lot of repeat customers coming back to buy the same product. Ask them if they're comfortable paying more money for it. And if not, then it's probably not a good idea because again, you would lose more contribution margin dollars if the conversion drops, even though you're collecting more money at retail price level. Do you think customers would be biased towards the cheap end because they've already been price anchored to their existing purchase? They could be, yeah, they could very well be, but... It still depends because you... It's kind of like this brand perception, product perception. And if they say that it's not too expensive, that's a good sign. It means that they're not against it. And if they say it's too expensive, then of course. So you look at the extremes. Don't look in the middle, because that's where the lines are blurred. But look at the extremes and think, OK, if they're saying it's not too expensive or it's OK, then you can probably go ahead and test the price in there. But if everyone's saying, no, it's too expensive already, like I wouldn't be happy to pay more, then you're probably at the absolute limit. And maybe you should consider dropping the price, right? And saying, okay, maybe we'll generate more profit contribution because all of our existing customers are saying it's too expensive already as is. So maybe we drop the price and see what it does and we generate more profit contribution dollars that way because the conversion now goes up and more people are buying the product. Yeah, yeah, perfect. Anything else to add on this podcast of becoming first order profitable? I think we're good. I think we've covered it in a lot of detail. There's still a lot to unpack. So if people have comments or questions, drop them under the podcast, wherever it's shared, and we'll follow up and maybe make another podcast, podcast number three, three -peat guest. for sure. Yeah, I think we could make a podcast every day with the conversations you and me have offline. So yeah, I appreciate it. I appreciate you taking an hour out of your day, Val, to hop on. I thought this one was valuable. for the pleasure. Alright guys.