Maximize Your Margins as an Ecommerce Founder

0:00What is it in your business that is the place where you can uniquely generate outsized value because of the way your business is structured. Hey everyone, welcome to Shopify Masters, your companion for starting and building a business. I'm your host, Shuang Esther Shan. E-commerce can be a powerful sales channel, but only if you can get the finances of your business right. Our guest today has spent 10 years growing e-commerce brands and he's now using that knowledge to launch his own immense personal care brand. Andrew Ferris is the founder of the agency AJF Growth and the host of his own podcast.

0:39And he's here to share how to maximize your margins in a direct-to-consumer business. Thank you so much for being here, Andrew. Thank you, Shuang. I know that you've had a long career in e-commerce at different agencies, helping brands grow and scale profitably. You're also the owner of your own agency, and you're in the process of building your own CPG company. So what made you want to also try your hands at starting your own brand? Well, I've run brands before. So in my background, I started on brand side as a media buyer, went over to an agency as like a strategist and then an executive there.

1:15And then that agency spun off some brands. And that was that common thread collective. We spun off an aggregator called four by 400, which I ended up being the CEO of mostly did a terrible job in that job. I learned a lot through failure and through mistakes. We ended up selling off all those brands, but one as a lot of aggregators discover there ends up being outsized impact, outsized upside in one brand versus some of the other ones in their portfolio. So we sold all of them, but one. So I sort of been around all those things and have had my own boutique agency for a little bit. You know, I just a couple things there.

1:47I really like being in the work itself. You know, some people want to build an agency where they sort of lead a large team and all those things. But I have found that I really enjoy being the work and I just kind of love brands. It's fun. But I think the really core thing for me was that I have come to some conclusions in my experience on sort of every side of this thing about what makes a really good e-commerce brand, how you maximize that channel and that sort of business model of e-commerce as effectively as possible. And because I have come to those conclusions, I've been kind of keeping my eye out for a while on products that I think would make sense according to those things.

2:25And I sort of landed on a men's personal care product that I think is interesting on a few different levels. I wish I could say a little more about it, but it's not quite ready to launch. And so I'm not quite ready to do that. But there's a number of things I think of. And when I say like what I think can make a Shopify brand work and a DTC brand work, what I'm really thinking of is sort of like the breakdown of the P &L. Maybe the way to think about it is what are the distinct advantages of DTC as a channel and as a business model that make it so that a brand can be successful. So it's sort of trying to apply those to my own brand.

2:57And then on top of that, just like, you know, there's some things I care about in the space and the relationship to men and some of that stuff sort of on a personal level that I think could be really interesting to try to message through a brand. So yeah, so it's sort of a mix of personal passion interests mixed with like some theses about what makes a DTC brand work well. Yeah, it sounds like you're being really thoughtful about the next career chapter. I guess the question here is regardless of what brand I'm trying to start, which industry I'm trying to get into. What are some things I should think about when I'm trying to build a direct to consumer brand when I'm thinking about launching something within the e-commerce space?

3:32I think one of the key things to think about at some point in your journey, and this is not necessarily where a lot of people start. I tend to be a little bit of an analytic kind of thinker. I'm not really a super creative producty person first and foremost. So I had to go like find a product that fit my sort of analytical framework. Whereas some people I know are coming at this from the level of like product first and creativity first, you know, and then they got to go fit that into a business framework, right? I'm kind of coming the other direction. But somewhere in that journey for everybody, you have to have a sense if you want to be really successful of what makes a good ecommerce business.

4:08And essentially what I would call like a P &L strategy, like, what is it? Where is it in your business that you're going to create meaningful value, uniquely, and really thinking like, what part of your P &L do you have a distinct advantage in, in your category and in your business that can then you can then use as a way to generate essentially leverage in the business to create profit. And here's an example of what I'm talking about. Supplement brands, there's a lot of reasons why supplement brands are good brands for e-commerce. But one of the things that makes them work so well is subscription orders generate a huge amount of customer lifetime value.

4:45And what the net effect of that over time is that you generate a ton of revenue apart from ad spend because returning customer revenue, as opposed to new customer revenue, that returning customer revenue is typically driven not by spending money on ads, which means if you look at your P &L, your ad advertising spend as a percentage of your revenue over time goes down and down and down and down. And, and if you have more revenue and less cost than the net effect of that as profit, right? So, so like, that's like an example where like, there's a really specific way in which subscription brands generate leverage on their P &L.

5:20And your brand doesn't have to be a subscription brand doesn't have to do that. There's other ways to do it. In fact, there's a number of ways to do it. There are some things that I think are core to DTC as a business model that make it work. But in my view, at some point along the way, every operator needs to understand where is that place in my business. And if you're listening to this or watching this, that's what I would ask you to think about right now. If you don't have a clear answer to this question. What is it in your business that is the place where you can uniquely generate outsized value because of the way your business is structured?

5:49And there's a lot more I could say about that, but that's a way I'm thinking about framing it. And certainly that's part of what's motivating my brand. Yeah. Like looking at the lifetime value in total, I think we have some really great past episode that explore this. We've interviewed the founder of Jolie, which is the showerhead that has the filtration system that you'll be a subscriber to. We've interviewed the founders of Siri, which is a beautifully designed electric toothbrush that has a composable brush head that you'll also be subscribing to. So the lifetime value aspect of both of their business models are so healthy and also interesting within this space.

6:28When we are looking at profit and loss and making sure the balance is healthy for your own business and building a great runway, what are things new founders should think about when they're trying to build their own runway and make sure that their business can be self-sufficient? The way I would frame this is like a lot of people, they sort of believe that the economics of their business are or they behave like even if they don't believe this, like the economics of their business were handed down from them to them on hot from on high. Like like the P &L is something you're sort of stuck with. Right.

7:01So so like here's an example for my brand. I'm looking at something right now where our packaging is a really important part of our product. Like it's in a category where the packaging matters a lot. And so we've taken pains to design the packaging really well. And it's the place where we've been most willing to spend a lot of money, essentially, right? Like at a per unit basis. Okay. And so now we're kind of looking at where our costs, our manufacturer are going to come in at. And we're starting to go like, ooh, did we go too far here? It's too early to tell. But like, do we need to actually redesign our packaging to make it so that we generate more margins, so that we have less cost going into the packaging?

7:40Because the packaging is expensive right now for us to make, relatively speaking. It's more expensive than the product. So the reason I say that is that I then get to make some decisions around that. Let's say my packaging costs are coming in to be more expensive than I think. Well, first of all, what way are they more expensive? One way they could be more expensive is they could be expensive to ship. It could be that I designed too large of packaging, and therefore it costs me a lot of money to ship it to a customer. And this is like a crucial thing. D2C, right there in the name, direct-to-consumer, is the idea that I take something from my warehouse or my 3PL or whatever, and I ship it out to a customer straight to their door.

8:14Well, that means that shipping costs, like the cost of shipping it there, the money I pay is like a really crucial part of the cost structure of the business. And so if my packaging is too big, maybe I need to redesign it to make it smaller so that it's cheaper to ship because that is like one of the core costs of DTC, right? And well, another thing I could think about is like, what are the materials in my packaging? Like, could I redesign equally beautiful package that cost me$2 less by taking out a feature that I think is cool, but that a customer doesn't care about? because if I need my business to have better margin, I have the choice of going to do that and to go and redesign that thing, right?

8:47Another one that we're thinking about is I can raise the price. The price is not handed down for me on high. A lot of people behave like it is. It's not. You get to make the price whatever you want. Now, it may work better or worse and there's ways to test that another time, but like that's up to me as the business owner to do. And so what I'm saying is like all the way through your business, like you've got to look at your P &L and say, I need to have a strategy for how, if everything goes the way I expect it to, and it never will, but like at least a model, some kind of a forecast, I'm going to have an idea in your mind of like, okay, I have this much cost in humans and an office or whatever my fixed costs are in my business.

9:19I have this much cost at every level of my unit economics, all my cost of goods, my packaging, shipping costs, credit card fees, like everything that goes into processing a single order and getting that order to the customer. And then I have my advertising costs. And my job as the CEO of the brand or the founder or whatever you want to call it, right, is to go and tweak all those things until at the end of the day, there's a profit number on the bottom of my P &L that looks good. And if there is no amount of tweaking that is going to make that work, then I have a broken business. Okay. But if there is, then I can go, okay, here's the strategy I'm trying to execute.

9:51Now I'm going to go figure out what's going to go right, what's going to go wrong and make adjustments along the way. And so that's what I would say is the way to think about this in every level of your P &L. Now there's some other distinctions in DTC that I could talk about if you want, about what makes a good DTC business uniquely. And I'm happy to discuss those things. That's the way I'm thinking about it. Yeah. And it sounds like before getting to the nuances of how different business models might work, initially, you should think about the fixed costs associated to the business idea that you have.

10:17Is there a range of fixed costs that a founder should try to aim to be below at or think about or at least try to achieve? Okay. So let's make a distinction first between variable costs and fixed costs, just so people are clear about that. Variable costs, I would say are all the costs associated with getting a product from the customer's order to the customer's door. So that includes my manufacturing costs for both the product and the packaging that includes the freight of those products from the manufacturer to my warehouse, wherever that is, okay, or my bedroom, if I'm shipping out of my bedroom, that's fine.

10:51If I'm shipping through a 3PL, the cost of order fulfillment, that's usually like$1,$1.50, something like that. And then the pick and pack costs. So how much it costs every time they pull one item off the shelf and put it in the package. I have shipping costs like freight to the customer, right? So essentially, like, what am I paying USPS or whatever it is, credit card fees, that's basically usually I think your friends and mine at Shopify are charging 30 cents per order, plus I think between 2.1 and 2.9 % on average for a regular credit card swipe, it's higher if you're using a buy now pay later machine, you know, this is changes for Amazon.

11:21So you go through all of those things and lay them out. And if you go to my website, ajfgrowth.com, enter your email address, you will find a unit economics calculator that I use with my brands to like calculate all of these things, add them all up, put them in one spot and then see how I'm doing, okay? So all of those variable costs are there and then that leaves me some margin left over. I'll say right there, I want to get at least above, for most brands, the target would be at least above 60 points of margin after all of those costs. That is a DTC business that will hum, okay? If you can get above 65, you're really good.

11:51If you get above 70, you're best in class, okay? So after every other cost is associated. So if you're wondering why there's 5 ,000 skincare brands out there, actually, this is probably undershooting it. There's probably more skincare brands than 5 ,000, right? It's because at the level of unit economics, there is extremely high margin. And that's why, like it's a built-in advantage to the business, okay? Then there's fixed costs, right? Which is like all of the costs that do not go up or down relative to the order volume. The way I always like to illustrate this is a graphic designer who designs an email costs the same amount of money to you, whether that email goes out to 100 people or to a million people, right?

12:23And therefore, there is an advantage in scale in an e-commerce business to that kind of fixed cost being truly fixed at that level. Now, if you're sending your email to a million people, probably you've added headcount over time, so there's some other costs that grow. But that one act actually takes the same amount of work to do that designed email. And so the fixed cost in the business, and this is, I think people need to really understand, this is like one of the crucial places that e-commerce businesses can uniquely thrive. I believe the like sort of fundamental to the advantage of running a DTC store is the fact that you can run extremely lean on fixed costs.

12:56And so what I mean by that is that probably sub 15 % of your revenue and often sub below 10 % of your revenue that would get you towards like best in class numbers can go into all of the fixed costs like humans, again, office, software, a lot of times accounts in here. Those are like the big ones. But those costs are the fixed ones where, again, like the graphic designer costs the same amount no matter how many people they're reaching. Especially if you add another layer to this, which is offshoring, you can make this cost go really low. I'm a big passionate proponent of this. I work with a team in the Philippines.

13:31My people in the Philippines are incredible. And I can pay at the top of the market in the Philippines. And it's less than hiring equivalent talent in the U.S. And that ends up being another advantage on the fixed cost side of things. So yeah, there's like a lot of ways you can do that. So those are the two things I would say, like that 60 points plus on the variable costs, 60 points of margin plus in the variable costs, and then 15 % of your revenue or less in fixed costs. That's like, I would say, a baseline way to think about it. Those are not hard and fast rules. There are exceptions to this in a bunch of different ways, but that's the beginning way I'd think about it.

14:04Definitely a really useful guideline. And I think even listening to you describe this framework, I think you're also thinking about ways to save costs. What are things that founders are not thinking about when they could look at areas to reduce their costs? I mean, the goal, right, is to think about how to generate the highest profit number in your business possible over whatever time period. So sometimes that's about savings and sometimes it's about growth. I'd say another one for me that I think is really core to this. if you look at almost any e-commerce business that's DTC, the two largest costs in their business are number one, cost of goods sold.

14:41So just like the actual product costs, right? That ends up being up there. Number two, and sometimes actually number one is Facebook ads. Like for many, many businesses, it is that. So then if I'm looking at my P &L and just trying to figure out where can I take the biggest bite out of my costs, then the place I want to look at my P &L is where the biggest costs are, right? So start with that COGS thing and say like, like, so on the COGS side, something that in my experience is the case is that people have not talked to enough manufacturers. So like for the brand that I'm starting, I worked with a supply chain team also like in the Philippines, okay, so like people who are deep supply chain experts, great e commerce resumes, they've been in e commerce for, you know, as long as I have, which like 10 years, something like that building e commerce supply chains, they really know what they're doing.

15:23And they're like a very short flight to China, which is really important, right? So for a lot of them. So they when when I was working on my supply chain for the business that I'm starting, they sourced 60 manufacturers in the first, like week of talking to them and reached out to 45 of them. So I just had like this massive advantage on getting the cost to where I wanted because they were doing that. Whereas like most e commerce operators I talked to have talked to like at most five. And so that's one of the things I would say is like, you need to think more about where you can build better value in your supply chain with manufacturers.

15:56And that sometimes just means having more conversations. I know that's a big job. Sometimes it's hard to go sort through things. It depends on where your manufacturer is and how specialized your product is and all of these things. But that's, that's, um, one of those things that I, that I think is just like, uh, sitting right there. We also talked to 20 or some odd packaging manufacturers in that process, you know? So it was like a really big deal and it still has been a challenge to sort that out because it's a hard problem to solve. Okay. So that's the, that's one area of it. Just like talk to more manufacturers.

16:20Okay. Number two on the meta ad side, because like I said, that's either the number one or number two biggest costs. I'm a huge proponent is actually where I spend a lot of my time and have put up quite a bit of content on this on my own stuff of manual bids. So that means cost caps, bid caps, target ROAS campaigns on meta ads. The basic concept here, if you aren't familiar with this is that instead of just telling meta, here's how much budget I have spent through all of it every day. And and then meta will spend through it as efficiently as it can. Instead, you say, here's the target ROAS or CPA that I'm trying to get, cost per acquisition on customers that I'm trying to get.

16:56You tell Meta, spend as much money as you can while maintaining this target. I'll say 99 plus percent of the ads that I launch on using those tools. And I think it is a huge, huge, huge element of success, including at the level of like creative testing. This is another thing that Meta ads people talk about a lot, where it's like, how do you launch new creative and test it? Instead of guaranteeing the allocation of dollars towards those creative tests, which can get really expensive because many of them will perform under your target. Instead, just launch them all with a manual bit, launch them all with your cost cap, with your bid cap, with your target ROAS, and then let meta spend as it sees fit.

17:31And what inevitably happens when brands do this, they end up suppressing the spend on their worst ads and more efficiently scaling the spend on their best ads. And that ends up being the most efficient distribution of your dollars on ads. The net effect of that is that your P &L looks better because you end up most efficiently allocating your advertising dollars. And if you think about that, again, if that's the number one or number two cost in your business, then the efficient allocation of that money has a massive impact on your P &L. Yeah. Two very practical advice and also looking at two very different areas.

18:01I do want to touch on the manufacturers and suppliers side because a lot of times when you're new into an industry, you're kind of just happy to get a call and you are probably a little shy with negotiating. Do you have any tips there to feel confident and also just advocating for what you're looking for? To be totally honest with you, the thing that I have done is worked with, like I said, that supply chain company that is both affordable and experienced. I just got help because it is such an important part of the business. The thing I would say about this, first and foremost, is that having more margin is a gigantic e-commerce cheat code.

18:39I mean, it's probably a cheat code in any business, but like my experience is DTC, right? So like I have one brand that I've worked with client of mine, a figure brand that is like, they just have like, have had 70 plus points of margin landed to the customer for a long time. And it just makes absolutely everything about running their business better. So they're really best in class on this area. And, and it's just crazy how much easier it makes running the business. And I think people need to internalize this as best as they can, like going and finding where you can do that is a huge deal for the success of your business.

19:09It really does make everything else easier. So this is a place that I would be willing to spend a little bit more money and time up front, right? Like my business I'm starting, I'm not, I don't have some giant file of cash. I'm trying to be cautious about not blowing money on this thing. And this is like a place where I've spent some money on the early stage. So that's one thing I would say more practically, there's a couple of things I would say, but at the core, what I would look for is, is understanding what the the manufacturer's best interest for their businesses. That's that's like the thing, right?

19:37This is like just good partnership in general with almost any partner you ever work with, including an employee, anybody like the more that your operation can serve them, as they serve you, the more that everybody truly does win, the better equipped everybody is to get the most value out of the relationship. Okay, so so for a manufacturer in China, for example, many Chinese these manufacturers have zero interest rate financing. So you can go to them and sometimes they probably not at the jump if you're earlier stage, right, they're not going to offer you great incredible terms on day one, because you have not proven that with them.

20:07But as you get like essentially a little bit of credit with them over time, as you build some relationship, you can go to them and say, Hey, can you finance storing more materials on hand without passing that cost on to me for a little bit? If you can do that, we can scale a little bit faster. And as we scale faster, we'll give you more volume because another aspect of manufacturing businesses is that manufacturing businesses work on volume. Volume is the key. Volume is what creates efficiency in their businesses. And so understanding what makes what advantages they have and what makes a good business for them ends up being like the crucial point in helping you have a relationship with them where that where that happens, right?

20:41So it so I won't go through tons of details there. But like that basic thing, trying to understand as best as possible, how they win, and then what advantages they have in their business model versus which ones you have in yours, right? So the disadvantage of a DTC business is that you have to store a bunch of inventory on hand, and it's really hard, and it makes growing hard, and it makes financing growth really hard. Well, if they can store the inventory for you, and at the same time, they can grow faster, and then that allows you to scale a little bit faster and provide more value to them, then possibly you can make something work as you scale.

21:09Again, that's not going to happen on day one, you got to build up relationship. It's just like building credit, you know, in any situation where like the better that relationship, then the more people are typically willing to do that volume You almost always comes with discounts with manufacturing. But yeah, those are some things that I would begin to think about. Understand them. If you are really, really serious about this, there's actually no substitute for getting on a plane and getting yourself to China or to wherever your manufacturer is and having a meal with people and getting to know them and understand their business and something like that.

21:37Like just getting there in person, relationships matter and people experience that and it really helps everything a lot. So versus sending an email, you know? Yeah. Also cue those notes from Economics 101 and Economies of Scale. But yeah, it sounds so great that you're developing those relationships and being able to offload some of the stress of carrying an inventory. The second section you mentioned is basically tweaking and understanding, building out good meta ads. And I think this is a section where in this current era of direct-to-consumer is an area of hardship for founders just because the landscape has changed so much.