This is a guest post by Maxim Mironov of OptimaLogica.
Are you an adventurous person? Have you ever dreamed of finding a pirate chest full of treasure? Well, I’ve got a secret map pointing to the treasures hidden inside your own company. You’ll need to dig a bit, but any pirate treasure that’s worth finding is certainly worth doing a little digging for, right?
Verifying your latitude and longitude
Print out your Profits and Losses statements for one of your slow months. Express your numbers as percent of Net Revenue and compare with these benchmarks:
- Shipping Cost
- Lost Revenue = Gross – Net (cancellations, returns, damaged in transit, fraud etc.)
Most retail companies, regardless of product mix, can keep Gross Margin at 35%, Net Margin above 10% and grow at 50% a year. Are you there yet? Hold tight, off we go!
Island of COGS
I bet your Cost of Goods Sold is lower than you think (7.5% on average) and you are making suboptimal business decisions based on inaccurate data. Here are two factors inflating your COGS:
- Outdated wholesale costs
- Improper reconciliation of customer returns and other fulfillment issues
Outdated wholesale costs
When was the last time (if ever) you compared vendor invoices against the price lists? Do you synchronize wholesale costs in your system with manufacturers` price lists?
On average, wholesale costs in the system are 10% higher than your negotiated prices. This leads to overstating your Cost of Goods Sold by (10% * 50%) = 5% of Net Revenue.
Improper cost reconciliation
Fulfillment is tricky and full of exceptions. Example: customer returns a product; vendor acknowledges the receipt and issues a credit memo for original costs minus restocking fee. Here is a proper way to reflect returns in the accounting system:
- COGS: (-$500) <--> Returns: $500
- Vendor Credit Memo: $400 ($500 – 20% restocking fee) <--> Returns: (-$400)
Returns account is up by $100 and COGS is back to its original status. Is this how your system is configured? If your answer is yest, you are an exception. Most of the companies do not reverse the sale transaction and simply increase the Other Revenue account by $400 (the credit memo amount).
One might argue these are accounting technicalities; yet your numbers are distorted and real issues remain invisible (high return rate, excessive damage in transit rate, lack of control over vendor`s shipping accuracy, etc).
Let the numbers speak for themselves: returns, damages and vendor errors affect about 5% of your orders and, unless accounted for properly, increase your Cost of Goods Sold by (5% * 50%) = 2.5% of Net Revenue.
Your actual COGS might be lower than you think by about 7.5% of your net sales due to inaccurate wholesale prices and improperly reconciled fulfillment issues. If you knew your costs were lower, would you make different pricing decisions? Would this make you more competitive in your category?
Monthly reconciliation on the Purchase Order level is the best solution to the problem. It requires certain change in your business processes and accounting practices but opens up a new world of accurate cost information, competitive pricing and collected credit memos. It tells you exactly how much you under-collect in credit memos. At 50% collection you are leaving on the table. (50% * 5% (fulfillment issues) * 50% (COGS)) = 1.25% of Net Revenue!
Good news is that reconciliation is scriptable and can be effectively outsourced. The most lightweight and effective solution is doing PO-level reconciliation in Excel and providing Finance with aggregated data.
Shipping Cost Cave
Shipping cost is another gold mine. Most of the online retailers can reduce their shipping costs by 7-10% of Net Revenue. The best results are achieved in 4 steps:
- Consolidate shipments with fewer carriers and renegotiate pricing,
- Convert vendors to ship on your account,
- Inspect shipping invoices for errors,
- Reconcile shipping costs on the product level for the best pricing decisions.
Shippers love big accounts. Even if you are small you can still present yourself as a desirable client by consolidating your shipments and demonstrating significant growth of your business. For specific advices on negotiation strategies check out my article Retailers and Shippers: Friends or Foes.
Convert vendors to ship on your account
Having vendors ship on your account is the cornerstone to lower shipping expenses. Most of the vendors are happy to switch. They need a simple process; you need PO numbers on the shipments. Help them create your company profile in the UPS/ FedEx systems and send a PDF of a Bill of Lading with your details pre-printed for LTL (Less Than Load) and White Glove carriers.
Once you made your vendor`s life easier you can expect them to put your PO numbers on each of the shipments as a return favor. Follow up on every order missing the reference and pretty soon you will have a perfect process.
Inspect your shipping invoices for errors.
Stuff happens. Vendors ship somebody`s else orders on your account. Shippers apply wrong discounts. Catch them and call the party immediately to find the cause and prevent errors in the future. I`ve reduced shipping by 10% by identifying and correcting the errors.
Reconcile costs on the product level.
You will be amazed how different your actual costs are from expected. In the article How Free is your Free Shipping?, I made an argument that incorrect shipping costs lead to the situation when several highly profitable products subsidize the rest of the catalogue suppressing your sales on one side and diluting margins on the other.
Shipping cost reconciliation can be a part of COGS reconciliation and should be run monthly for top-selling SKUs.
You can reduce your shipping costs by 7-10% of Net Revenue through negotiating better shipping discounts, converting vendors to ship on your account and monitoring your invoices. My strong recommendation is to outsource logistics management on a performance fee basis.
There are teams of experts that will work hard to get you the last cent possible. You get the expertise and pay only when it saves you money. Perfect arrangement, isn`t it?
Reef of Lost Revenue
Lost revenue is a bit of an enigma for every company. How can you know for sure how much sales did you lose due to uncompetitive pricing and operational inefficiency? I want to share our way of addressing both issues.
COGS and Shipping cost reconciliation will equip you with data necessary to optimize your pricing. In another article on my blog I spoke about some of the secrets behind 10X sales increase for managed stores.
The recipe was simple. We updated shipping costs, recalculated margins on the products and reduced prices whenever possible to beat the lowest price by $5. Practically overnight, sales went up. Despite price reduction total margin for the managed stores increased significantly.
Shoppers coming through price comparison engines are extremely sensitive to the price, and the retailer with the lowest price typically attracts 80% of the clicks. Get your costs accurate, re-price and convert.
In my experience, retailers lose 7-10% of Net Revenue due to a variety of order issues, including:
- Customer Remorse
- Damage in transit
- Orders shipped after cancellation
- Out of Stock or Discontinued product
- Fraud etc.
Most of these issues can be prevented or resolved through order policies and proactive customer service. General advice: give customers every reason to keep the product and discount if necessary. Frequently, you are better off giving 30% discount than dealing with the return. Know the numbers and train your customer service folks to calculate discounts on the fly.
Let’s take a return of a $999 platform bed as an example. Wholesale price is $500 and shipping cost is $100 each way. Your gross margin is $350. Can you convince customer to keep the order?
Your policy says: if the customer wants to return the product, he is liable for 2 way shipping and 20% restocking fee. Walk the customer through refund calculation:
- Retail price $999
- Shipping, both ways (-$100 x 2) = (-$200)
- Restocking fee (-$999 x 20 %) = (-$199.8)
- Customer refund ($999 – $200 – $199.8) = $599.2
Most customers do not realize that their refund will be significantly less then the price they paid. Frequently, just doing this calculation with a customer on the phone is enough to save an order. In case he still wants to return, offer a discount. Remember, your gross margin is $350 and it is better to earn something rather then nothing.
Accurate cost information is the universal key. It helps you experiment with pricing, catapult sales and reduce operational costs.
Arriving at your Dream Land
I have explored some of the problems online retailers face and shared our best practices to solve the issues. Borrow our ideas and share yours. Every company is unique but most problems are typical. I am eager to hear your success stories.
Sometimes it is best to do everything internally. Most of the times it makes sense to develop core expertise in something and complement it with external knowledge. If your operations need a hand, you can reach me at firstname.lastname@example.org and my team will help you arrive at your Dream Land.
About the Guest Author:
Maxim Mironov is a seasoned Supply Chain expert and a founder of OptimaLogica. At OptimaLogica, Maxim and his team help online retailers build highly efficient and scalable supply chains. Prior to starting the company he was a Director of Operations at Mercantila, a $35 million online retail company in San Francisco, where he`s reduced shipping costs from 25% to 10% of sales, built reverse logistic processes to recover over $500K annually from “damaged in transit” and returned items and managed over 50 people in Customer Service and Supply Chain Departments in Bangalore, India.
Before joining Mercantila in 2005 Maxim had been project manager with Avalon Organics, a $40m natural cosmetics company in Petaluma, CA and an enterprise solutions manager with Accenture and BearingPoint focusing on Consumer Goods and Retail companies. Maxim holds an MBA degree from MIT Sloan and after graduation drove cross-country from Boston to San Francisco with his wife and cat.