LevelUp – Understanding Business Models – Estimating Profitability

Businesses vary widely in their profit margins from a paltry 2% to 80% or more.  Grocery stores work on razor-thin margins and may only have single digit profits.  On the other extreme, many online businesses have much higher profit margins especially if they sell digital goods.  These margins can be upward of 80%.

Profitability is influenced by a number of factors including

• Cost to create or purchase a product
• Cost to acquire a customer
• Seasonality
• Conversation rates

In the online world, an affiliate marketer typically receives a commission between 10 and 30%.  While this percentage is low, the profit of an affiliate can be very high because they do not have significant costs beyond web site development.  So, this is an example of a highly profitable business.  Sellers of ebooks and other digital goods like videos also have high profit margins because the cost of these products occurs up front during their creation and are not that expensive to produce.  Ecommerce store owners likely have lower profit margins than those who sell digital goods since the cost to create or purchase the product is much higher.

The cost to acquire a customer also influences profitability.  Email marketing and pay per click advertising campaigns are the major expenses when trying to acquire online customers.  Pay per click campaigns can be expensive so you need to spend your dollars here wisely to ensure high profit margins.

You may have heard of the term loss leader.  This is a technique used by many brick and mortar retailers to entice customers into the store.  A good example of this are Black Friday deals offered around Thanksgiving.  The retailers put a particular product on sale but don’t make any money on it so it is called a loss leader.  In fact, they lose money on the sale product but they attract the customers to their store so hopefully they will also purchase profitable products.

Seasonality can also influence profitability.  For example, an online store selling clothing may have a lower profit margin on winter coats whereas swimming suits have much higher returns.  A warm winter can also influence profit margins since you may need to have special sales to clear out winter merchandise so profit margins are affected.

Conversation rates influence the profitability of your online business significantly.  If you can increase your conversion rate without significant additional costs, then you will see a greater profit in your business as a result.

View the video below to see how to estimate profit and visitor value.

Keep in mind, we’re only calculating the value of the first time customer to Godaddy.  We’ll look into the Lifetime Value of these customers in a later module (which will represent the vast majority of Godaddy’s Sales and Profit).  Also keep in mind that Compete only takes into account US traffic and the number it spits out is a relative number. The important thing here is not how much money overall Godaddy makes, but how much profit and sales it makes per visitor.

Exercise

Estimate profits and visitor value for each competitor.

Profits can be estimated based on the average purchase price (which you can hypothesize based on what the website actively promotes), as well as profit margin, which you can hypothesize based on what you know about the industry.

Visitor value is calculated using 2 methods – based on sales and based on profits.

The sales formula should look familiar as you saw it in a previous module.

Total Sales/Website Visitors

As an example, if I am selling a $100 product and I sell 20 of them in a month, then my total sales are $2000.  If I know 1500 visitors came to my site then I can calculate visitor value:

$2000/1500 = $1.33

To get a more accurate gauge of visitor value, you can calculate it using profit:

Profit/ Website Visitors

As an example, if I am selling a $100 product with a 50% profit margin and I sell 20 of them in a month, my profit is $1000.  If I know 1500 visitors came to my site then I can calculate visitor value:

$1000/1500 =$0.67

So my visitor value using profit is 67 cents which is really a more accurate representation.  In other words, I have a 67 cent profit for every customer coming to the website.

Example

Success Criteria

• You have estimated the % of First Time Customers for each competitor
• You have estimated the Number of First Time Customers Per Month for each competitor
• You have estimated the Average Sale for a First Time Customer for each competitor
• You have estimated Monthly Sales From First Time Customers for each competitor
• You have estimated the Profit Percentage for First Time Customers for each competitor
• You have estimated Visitor Value of First Time Customers Based on Sales for each competitor
• You have estimated Visitor Value of First Time Customers Based on Profit for each competitor