Is my product profitable?Apr 26, 2022
Understanding the profitability of each of your products is essential for financial success.
Is it better to sell a thousand units of your product, or a million?
Well, that depends. If your product is profitable, then go for it — sell as many of them as possible. But if you’re losing even just a little bit of money every time you sell one of your products, then those losses are only going to get bigger and bigger the more you sell. That’s no way to run a financially sustainable business.
That’s why unit economics — being able to answer the question: “is my product profitable?” — is so important.
Once you understand the unit economics of each of your products, you’ll be able to start forecasting the future. How quickly can you grow your business? How many people can you hire in six month’s time? Can you afford to take on that office? Knowing your profitability-per-product is a necessary first step towards figuring out those answers.
Whatever you sell, you have to understand what it will cost you to actually get that product into your customers’ hands, and what the difference is between that number and the amount they’re paying you.
The calculation is pretty simple — but you will have to spend some time gathering the data.
Imagine you’re selling candles, and you sell 100 for £20 each (they are nice candles). To figure out if you’re making a profit, add up the cost of everything that goes directly into making those candles. The wax, the wicks, the jars. The labour that turned those materials into finished products. If you run an ecommerce business, add the cost of shipping, too.
The number you end up with is your “cost of goods sold”, or COGS. If you subtract this number from the £2,000 you made selling your 100 candles, that’s your gross profit. And ideally, that number is positive.
If it is, that means every time you sell a candle, you’re making money that can be used to pay salaries and keep the lights on in the office. You’ll also be able to buy more raw materials, and sell even more candles.
If you convert this number to a percentage, that’s your gross profit margin. It’s a handy number to see how you compare to your industry peers. A good gross profit margin for a software-as-a-service business, for example, is 80%. For fashion brands, industry standard gross profit margin looks more like 55-60%. But don’t let that limit you — financially-speaking, the higher your margin, the better for your company, and there is no rule saying that your margin cannot be higher than your industry average.
What about customer acquisition costs?
The cost of acquiring customers — the amount of money you’re spending on things like social media ads — doesn’t go into your COGS calculation. But it’s good to consider how this spending affects your unit economics, as it will help you understand how much money you’re making after taking marketing into account.
Say you made £800 in gross profit from selling 100 candles, but you also spent £100 on Facebook adverts during that time. If you take that number away from your gross profit, you’ll be left with your “contribution margin” — which in this case, is £700. (Still a positive number, phew.)
So now you’ve done the math, are you shooting to sell a thousand units of your product, or a million?
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