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Understanding Variable Traffic Spend

Traffic is the highly variable cost that determines merchant profitability

Highly variable traffic spend determines merchant profitability

Ecommerce profits are achieved by maintaining product margin, controlling Traffic Spend as the highly variable part of the Cost of Revenue and managing overheads.
Understanding how to assess ecommerce costs correctly is fundamental to the success of profitable ecommerce businesses.
The variable Traffic Spend, which is a significant fluctuating element of the Cost of Revenue, presents a real problem to finance department thinking.

Traffic is never free - It is a dangerous highly variable cost

This is self-evident for companies selling on marketplaces like Amazon. Merchants accept a 20% cost from Amazon to get an order. In online sales orders come from buying traffic that equivalent cost varies as Traffic Spend.
*Traffic Spend is the total costs paid to Google, Facebook, Bing, Affiliates, Email and all paid traffic sources. This Traffic Spend in ecommerce is measured as CPA%. This is an unavoidable, highly variable cost incurred by selling on your website.

The Ecommerce Manager is responsible for “Ecommerce Gross Profit”

The largest cost in the Cost of Selling is the variable Traffic Spend. This variable spend is a threat to profit and the eCommerce Manager and Financial Department need to set an acceptable Traffic Spend%.
Revenue - Cost of Goods - Traffic Spend = eCommerce Gross Profit
Traffic Spend% is also known as Target CPA% and ensures an acceptable Gross Profit Margin.
The key objective for the ecommerce manager is to maintain sales growth at the agreed Traffic Spend % to maximise this “eCommerce Gross Profit” construct.
While there are other costs of revenue such as credit card charges, postage costs etc., these are not highly variable and can continue to be accounted for as overheads.
Financial Departments must budget, monitor & reforecast the variable Traffic Spend regularly.

Ecommerce Gross to Net Waterfall to Ensure Profitability

Below “Ecommerce Gross Profit” other costs of revenue can be treated as overheads and deducted as usual.
eCommerce Gross Profit - Overheads = Net Profit

The costs of online sales need to be assessed in a different way to standard retail

Retail Accounting
In standard retail / B2B it could be viewed as essentially sales and overheads. Standard retail offers a simpler model of profit and loss. Footfall (Shop Traffic) is effectively a fixed overhead cost based on location.
Sales £1,000,000
Product margin 40%
Gross Profit £400,000
Overheads (£200,000)
Net Profit £200,000
Online Accounting
Online accounts have the additional variable Traffic Spend that is the necessary payment for footfall (Online Traffic) an unavoidable variable cost and key difference between online and offline selling.
Sales £1,000,000 Sales @ 5% Traffic Spend £1,000,000 Sales @ 10% Traffic Spend £1,000,000 Sales @ 20% Traffic Spend
Online Sales £1,000,000 £1,000,000 £1,000,000
Product Margin 40% 40% 40%
Gross Profit £400,000 £400,000 £400,000
Variable Traffic Spend (£50,000) (£100,000) (£200,000)
eCommerce Gross Profit £350,000 £300,000 £200,000
Overheads (£250,000) (£250,000) (£250,000)
Net Profit £100,000 £50,000 (£50,000)
*The above example is a very common example where the Merchants profit changes as Traffic Spend is not controlled by the Ecommerce Manager.
The variable Traffic Spend is the lever that impacts profitability. Spend too little and traffic decreases, spend too much and profit is negatively impacted. It is important not to cap the traffic budget as this will restrict potential revenues and profit.
Traffic x Conversion Rate x Average Order Value = Ecommerce Sales
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How the Variable Traffic Spend is Managed
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8% is an industry average Traffic Spend
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How does IRP control costs?
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