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COGS and Ad Spend – Return on Podcast Ep. 35

COGS and Ad Spend - Return on Podcast Ep. 35

The following is a transcript of Episode 35 of Return on Podcast, the show where we help e-commerce sellers improve their ROI in business and in life. For more episodes, subscribe to our YouTube channel or listen on Podbean, Apple Podcasts, Spotify, and Amazon/Audible.

Tyler Jefcoat:
All right. Hey guys. I’m Tyler Jefcoat with Seller Accountant and with Return on Podcast, and I’m gonna welcome you back to this mini-series that we’re doing called From Pain to Profit in 2023. Again, a quick reminder, normally we have the long form interviews as we’ll start again in January, like they always are, where we’re gonna look at investing in the intersection of investments and e-commerce.

But for this end of Q4 2022, this is an important moment for us as CEOs to reorient and refocus our vision. That was video one, or session one, if you’re listening to this. Our books, which was session two. Our profitability as defined by PAG, that was session three. That was last week’s session. And then today I want to dive into a discussion that we’re not having enough.

We are starting to define profit as being post advertising gross profit, where we really understand the validity of each of our products and of our entire portfolio. But what we’re forgetting is that there are two elements of that equation that are much more controllable and much more important than the other ones.

So again, if you’re listening to this hang with me if it gets confusing. There are some examples on the screen that you can get in the Seller Accountant YouTube page. But let’s look at PAG again, as a quick reminder, is that kind of sales minus our product Cost of Goods Sold minus these Amazon fees and then minus advertising ’cause it’s post advertising gross profit.

The example we talked about last week and actually the example that’s on the screen right now both happen to have a PAG of 25%, which is pretty good. Something I wanna remind you of though is that the two categories within this, you know, basically this formula that are the most important and the most controllable are your landed Cost of Goods Sold and your advertising, your TACOS.

And I want to help you rethink the way you manage your products because we, normally, if you think about this, think about a large Fortune 500 company. If you’re looking at a consumer product brand, you’re gonna have totally different departments that are doing your sourcing versus your advertising, right?

You’ve got marketing guys, you’ve got sourcing guys, you’ve got inventory guys, you’ve got your PPC guys. They’re never the same guy. But because we are e-commerce brands, we don’t have the luxury of having a siloed approach, and we need to start looking at these two crucial metrics. The first one being landed Cost of Goods Sold, the second one being TACOS or total advertising. We have to look at those in concert.

So I’m gonna show you something on the screen. I’ll walk you through it for those of you guys that are listening, and this is how I want you to start viewing each of your products or your entire portfolio. So first of all, just think about this theoretically. If my Cost of Goods Sold total, plus my advertising total is a lower percentage of my sales, that’s a good thing, right? That means I have more profit margin left, I’m gonna be happier.

And again, on the middle of the screen here, if our total COGS plus TACOS is 40%, let’s just say in a crazy amazing world, we only have 20% of our sales that are Cost of Goods Sold. We have great margins on the product, and we can keep our TACOS at 20%. 20% Cost of Goods Sold plus 20% TACOS would give me 40% total load in those two metrics. I would consider that to be an extremely premium product.

But we can get there more than one way. What if I had 25% landed Cost of Goods Sold, but I was able to keep my advertising budget under 15%? 25% Cost of Goods Sold plus the 15% still gives me 40%. That is a premium product. You can imagine, keep going. By the way, the average success story that I see here is actually 30% landed Cost of Goods Sold.

So imagine this: I have about a third of my entire sale price in the COGS, and then I’m able to keep that advertising budget below 10%, right? 30 points in product, 10 points in ads gives me that 40. And I’m just, I’m, I keep hammering this number, 40, 40, 40. Because if you can look at your P&L over some meaningful amount of time and the total percentage of your landed Cost of Goods Sold, plus the total percentage of your total advertising is 40% or less, then you have a very scalable, a very premium portfolio of products, and you are a very investible business. You’re gonna be able to get better returns on capital, you’re gonna be able to get better private equity investment or venture investment. And so just know that’s aspirational. Not all products are like that.

If your TACOS plus COGS is 45%, you have a solid, sustainable product. You have the ability to, to be profitable with some scale, not as scalable as those premium products, but you’re in pretty good shape. But you have to be careful not to overspend on TACOS if this is you.

And then you have products that are borderline because you have really high COGS, right? And as a result, you don’t have a lot of wiggle room for advertising. And then you have products where you have 50 – if you think about like the wholesale arbitrage guys out there, their Cost of Goods Sold might actually be 50 or 55% of their total budget, literally just the product. And those guys have zero budget for advertising. And the point of mentioning this way, guys, is I just want you to rethink the way you’re thinking about your products.

If you happen to be watching this on YouTube, the way the formula actually works in my mind is you start with your landed Cost of Goods Sold, you come up with a market target for what your profitability should be and the way you’re gonna do that now is just what can I afford to have my total COGS plus total advertising together, and then that’s gonna leave me with what I can afford to budget for advertising.

I’m not gonna let my advertising get outta control because the definition of insanity, especially in a bear market right now, is to overspend on ads, to stock out, to have to rush ship new product, paying still higher than normal container rates. It doesn’t make sense. We are in a bear market. We need to prioritize having our best products actually generate profitability. Yes, we may not grow as quickly as we were growing last year. But we gotta stop the madness of needing more capital to grow quickly, to make no money.

And as capital markets tighten up and as interest rates go up, this is even more important than it has ever been for an e-commerce seller. And so, again, I wanna know what is the reality of the profit margin that I have in my product. And given that Cost of Goods Sold profit margin, I’m gonna let that dictate how much I can afford to spend on my advertising.

I’m not gonna just go to the market and say what can I afford to spend on advertising? It doesn’t work that way. I’ve gotta understand what my budget is based on how much room I have. And I may use this in my product decision. So let’s say for instance that you and I were looking at potentially investing in a couple of different products. And product A was going to have a 25% Cost of Goods Sold. In other words, just to keep this simple, I can sell the product for a hundred bucks. I only have to pay $25 landed to get the product right. And I’m comparing that to an option where I have to pay 35% to secure that, that similar product.

I’m gonna always, almost always choose the product with the lower Cost of Goods Sold, in other words, the higher profit margins, because I wanna have more room left in the tank to mess up my advertising occasionally and to out-compete my competitors to earn the right to be seen on Amazon or my other marketplaces or my direct consumer channels.

And so just to kinda wrap this video up, guys, I know this is a little bit technical. This is the kinda thing that you and I could probably talk about in more of a detailed call if you have questions about it. But here’s the thing. I can’t let advertising happen to me. I have to let the margin of my products drive how much I can afford to spend on advertising. And I may accept a low margin initially while I’m launching a product, but once a product has settled in through a launch cycle, I have gotta hold it accountable to have a high profit margin, which is what we talked about last week.

And the two most controllable elements of this are my landed Cost of Goods Sold. I don’t have to select that product. I can go pick another product or I can renegotiate my supply chain. And then the second one, and then maybe the one that’s most immediately controllable is my TACOS. What kind of leash am I giving my marketing team to spend on PPC? If I’ve got a lower margin product, I’ve gotta really reign in that advertising budget so that it doesn’t crush me.

So, again, Tyler, this is a Seller Accountant and Return on Podcast kind of mini-series. We’re gonna continue next week. We’re getting into the deep end of the pool, baby. We’re gonna start talking about a concept called Return on Inventory Investment next time. And then we are gonna get into the absolute thick of this thing with a metric called Return on Working Capital to help you understand exactly how effective you are at managing your finances.Hang with me. Really enjoy this series ’cause I’m a nerd. I hope you do too, and I will see you next time. Take care.

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