Analysing the Profitability of Shopify Stores

Introduction

If you’re considering setting up a Shopify store, or expanding your existing portfolio, it’s very important to have a robust mechanism for evaluating the feasibility of any potential products.

Having worked with many Shopify store owners over the years, and managed several of our own stores, we have developed a robust business case development methodology which solves this problem.

It’s tried and tested so in this article, we’d like to share our approach to help you evaluate whether potential products are right for your store.

Where to start?

Given that most Shopify and Amazon store owners are sourcing products from abroad, we’ll be describing our model for analysing international products; however, this approach applies equally well to products being produced or sourced locally.

The most important place to start is by analysing the market to find product opportunities. The best approach is to try to identify low competition niches but given how competitive the e-commerce space is, a good second prize is to find high margin, high volume products.

We won’t be going into the details of how to do this as it has been covered extensively through platforms such as Helium10 and Jungle Scout. Although these are geared towards Amazon products, the data you’ll derive from these platforms carries over nicely to DTC Shopify stores.

Assuming you’ve already identified a potential product, here’s exactly what you should do next, step by step:

Step 1 - Find Potential Suppliers

This part is super easy as all you need to do is search for similar products on Alibaba as in all likelihood there will be something already available from China or South Asia. Most suppliers are very professional and will be able to provide details on their portfolios very quickly.

We recommend starting by asking for information on their Minimum Order Quantities (MOQs) to determine whether your supplier is the right fit for your budget, and check that they are able to send samples so you can check the product quality before placing a larger order.

Step 2 - Obtain Product Data

Pricing is obviously a major factor, but there are other important data points which you’ll need, mainly pertaining to shipping. The best thing to do here is to send a Google Sheets template and ask them to fill it up.

Step 3 - Calculate Landed Cost

Landed Cost is a very simple shipping term which surprisingly even some accountants get wrong.

Essentially, it’s the fully loaded cost of the product once it arrives in your warehouse for sale. It can be calculated by adding the First Cost (the price paid to the manufacturer for the products) and all other shipping costs involved in door to door transport:

First Cost + Shipping + Customs = Landed Cost

Getting the total cost of your order is pretty simple, and it’s possible to accurately estimate this once you have a few orders under your belt. But how you apply this to your products can be quite tricky.

In our model, we do this in one of two ways depending on how much product we are shipping and by which method:

Method 1 - By value

If you’re shipping by sea then the weight of the consignment is not relevant as you’ll either be booking a full container load (FCL) or space within a container for a few pallets (LCL, Less Than Container Load).

All you need to do here is apply a factor to your products to determine each product’s share of the shipping costs. We’ll demonstrate how to do this below.

Method 2 - By weight

If you’re shipping by air, the cost will be driven by weight, so instead of factoring the relative value of your products, you’d need to work this out considering the weight of your products.

Landed Cost Calculation Example

In this example, we are shipping 11,000 units at First Cost of $2.4 per unit. The additional cost per unit, attributed evenly across all products, is $0.93 leaving us with a landed cost of $3.4.

Obviously, most shipments will include many different SKUs with different weights and values so it gets much more complicated than this. But, this illustrates the approach very well and leads us on to gross margin.

Step 4 - Calculate Gross Margin

Gross margin represents the difference between Sales Revenue and the Cost of Goods Sold (COGS) and is critical in analysing whether products are “interesting” enough to include in our Shopify portfolios.

In our opinion, a gross margin of less than 75% is high risk as it would leave very little for advertising. Pushing for products with a gross margin upwards of 75%, even into the 90% range, is much more viable profitability-wise.

How gross margin is calculated

• Gross profit = Revenue - COGS
• Gross margin = Gross Profit / Revenue

What is included in Cost of Goods Sold (COGS)

COGS includes all Direct Costs related to the preparation of goods sold by a company.

For companies manufacturing products locally, COGS includes all raw materials, labor, manufacturing overheads and local shipping costs.

For companies importing products, as in our example above, this includes all of the fees associated with shipping including packaging, freight, haulage, duty and repaletisation.

This is essentially the Landed Cost.

In both cases, COGS includes all costs associated with preparing products for sale in the local market. It does not include advertising, salaries or anything attributed to Cost of Sale (CoS) which contributes to net margin.

Gross margin example

In our example, the only additional data point we’d need to calculate Gross Margin would be the RRP of the product. Let’s assume that the product retails at $14.99. If you break down the calculation, you need to find the ex VAT RRP, and then the gross profit.

The calculations would look like this:

• Ex. VAT revenue = $14.99/1.2 = $12.49
• Gross profit = $12.49 - $3.4 = $9.13
• Gross margin = $9.13 / $12.49 = 61%

Spreadsheet example

Gross margin is super important to get a handle on for Shopify store owners. At first glance, a GM of 50% might sound exciting as essentially you’re doubling your money; however, when you consider operational costs and advertising, this is too low and would put your balance sheet at risk.

In our opinion, gross margin should be at least 75% and ideally pushing towards 90% to make a product viable.

A note on VAT

Whether you’re VAT registered or not, all of your calculations should be done excluding VAT. This ensures accurate financial analysis, as VAT is a “pass-through tax” which does not affect actual profitability. If you include VAT in your calculations, you will essentially be inflating your profitability.

What next?

We’re really keen to understand whether you agree with our approach and whether anyone has any suggestions on how we might improve things. Even though we’ve been doing this for years, we consider ourselves students of the game and are always looking to improve and learn.

In addition, we have packaged all of this up into a nice, clean Google Sheets template so if you’d like to receive a copy, let us know. Lastly, we have some content in the pipeline to take this further, specifically on how we calculate net profit so if you’re interested in this please let us know; a tweet on X or a comment on Linked In would be very well received.