Profitability Gap for Amazon Sellers - What is it and why should you care?
If you're an Amazon seller, then you're likely familiar with the term "profitability gap." It's become a buzzword in the e-commerce community, and for good reason: it describes a growing trend among Amazon sellers who are struggling to turn a profit. What is this mysterious "gap" that's causing so much trouble? Why does it matter? And how can you fix it? Keep reading for everything you need to know about the profitability gap—and how to close yours!
What is the profitability gap?
The profitability gap is the difference between profits and losses. It's a measure of how well a business is doing, and it can be calculated by subtracting your customer lifetime value from your customer acquisition cost.
For example, if you have 100 customers who spend $1 each and spend an average of $10 with you over their lifetime as customers--and if it costs you $20 to acquire each new customer--then your profitability gap equals:
- 100 x 1 - 20 = 80 (this represents profit)
👉 See our step-by-step guide to diagnose your profitability gap
What causes a profitability gap?
The profitability gap is caused by a number of factors, including:
- Inefficient product sourcing
- Poor advertising strategies
- Unoptimized product listings
But the two main factors contributing to a profitability gap are:
- The difference between your customer lifetime value (CLV) and customer acquisition cost (CAC). If you're spending more money to attract new customers than those customers are worth, your business isn't profitable. This can happen when you're paying for advertising or promotions that don't convert well enough, or if you've chosen an expensive way to advertise/promote your product.
- Poorly priced products that aren't selling well enough on Amazon's marketplace compared with other similar products being sold there at similar prices--this is known as "product mix."
The relationship between customer lifetime value and customer acquisition cost
Customer lifetime value (CLV) and customer acquisition cost (CAC) are two important metrics for Amazon sellers. The relationship between them is the profitability gap, which can be calculated by subtracting CAC from CLV.
If you can lower your customer acquisition cost, you'll increase your profit because it will allow you to generate more revenue with each sale while spending less money on advertising or other marketing efforts.
How can you close your profitability gap?
You can close your profitability gap by focusing on improving customer lifetime value, reducing customer acquisition costs, increasing the number of customers you serve and increasing their average order value.
- Customer lifetime value: If you sell higher-priced items and have a low conversion rate (the percentage of visitors who buy something), then it's likely that your customers aren't sticking around for long enough to make up for all those expensive ads. You should consider optimizing your listings (both image design and content) so that it appeals more to people who are likely to buy from you multiple times over time.
- Understand your customer retention rate and purchase intervals. If you know, for example, that customers are going to come back in three months to purchase your product again, then you can largely ignore the first purchase CLV and focus instead on the gap between your three-month CLV and your CAC, since you know that your cost to acquire a customer will be paid back two- or even three-fold later down the line.
- Customer acquisition costs: If getting new customers is costing too much money or time, then there may be ways to reduce those costs while still reaching an audience that matches well with what you're offering them in terms of products and services (and price). Try using social media channels to increase your brand reputation and reach.
- Analyze your CAC and CLV by ASIN: There will be some products which have an excellent retention rate, and in this case you may be able to afford spending more up front to acquire new customers. Other ASINs might need more attention and tweaking to make your ads more efficient.
Amazon sellers need to find ways to make more profit from their business.
We hope that by understanding the profitability gap and how to close it, you can increase your Amazon sales. If you want to learn more about diagnosing your profitability gap, check out our Nozzle Nugget - our interactive guide on this topic!
👉 See the step-by-step guide to diagnose your profitability gap
Want a more in-depth look?
👉 Download the Standard Operating Procedure (SOP) for using your profitability gap to grow your new-to-brand customer base