As an Amazon seller, you need to consider your profit margins and what makes for a good return on investment, or ROI.
As you choose the products you sell on Amazon, it’s important to aim for a realistic profit margin that works for your business. Factoring in Amazon fees and the costs of shipping your stock to the Amazon FBA warehouse is essential as you calculate your ROI. Your profit margin can be greatly affected by these expenses.
Remember, your ROI is simply the difference between the price you can charge for a product and the price you pay to acquire it. To some this may seem obvious, but many sellers just starting out fail to understand the way profit margins work and this means they risk investing in a stock that cannot yield them a profit.
What’s a healthy ROI for FBA sellers?
If you’re a new Amazon seller and you find all the numbers and fees intimidating, you’re not alone. How do you decide if your profit margins are going to make you money?
Let’s take a moment to understand profit margins and ROI.
To calculate your ROI, divide the profit of your item by how much the item costs you. For example, an item you acquire for $10 that provides a $10 profit has an ROI of 100%.
You need to consider several factors when deciding if your ROI is healthy for your business.
A common mistake that new Amazon sellers make is forgetting to factor in Amazon’s fees.
Someone starting out on Amazon might mistakenly think that acquiring a product for $15 and selling it for $25 results in a $10 profit. A more experienced FBA seller knows that after the selling and shipping fees are taken by Amazon, the profit on such an item would be under $5. This means that rather than an ROI of 67%, the seller would be looking at an ROI of under 30% — much less enticing.
Start by using the x3 rule
If you are looking for a strategy that skips the overwhelming numbers, try looking for products that can sell for three times what you buy them for. This is called the x3 rule and it can be handy for new sellers since it sidesteps detailed calculations.
Generally, the x3 rule will provide approximately 100% on a seller’s investment, which is a healthy profit margin for an FBA seller. This might play out with a product sourced for $5 being sold for $15, allowing $5 for Amazon fees, and another $5 of profit for the seller.
Limits of the x3 rule
Though a profit margin of 100% is a good fit for Amazon sellers who are just starting out, those who are more seasoned will want to take on a more advanced approach. The reason for this is that the x3 rule can only take a seller so far if they want to maximize their profits.
Keep in mind, that if you can consistently use your whole sourcing budget to acquire products that give 100% ROI, you should proceed with this strategy for as long as you can.
However, eventually, you may notice you are no longer able to fully use your sourcing budget on items that have an ROI of 100%. This occurs when your budget has expanded to the point that you simply cannot source any more of the items that give a 100% ROI. At this point, it’s time to consider decreasing your ROI standards in order to expand your sales further.
This idea may sound surprising if you are just starting out, but once you can no longer spend your entire sourcing budget on items with an ROI of 100%, you can actually make your business more profitable by expanding to sell items with a lower ROI. This is because you will not be as limited in how you can make your sourcing budget work for you, and rather than ending up with money left over, you will put it towards items that can still be profitable.
Maximizing your profits
If you are curious about how to ensure you maximize your profits, consider the following 2 examples.
For the sake of the scenarios that follow, let’s establish a few assumptions. First, let’s assume that the example seller in question can spend $5,000 per month on products that offer 100% ROI and that the number of such products available limits this. Then, let’s assume that this seller also has $10,000 per month to spend on products that offer 50% ROI.
- The seller starts with a sourcing budget of $10,000.
- The seller commits to only source products with an ROI of 100% or more.
- The seller can only consistently source $5,000 in products with 100% ROI each month.
- Every month the seller is able to sell every item they source with 100% ROI.
- The seller knows of $10,000 in products with an ROI of 50% but never sources these for sale.
- The seller takes in $5,000 per month and their sourcing budget grows to $15,000 per month.
- Despite the increased sourcing budget and a consistent take of $5,000 per month on average, the seller cannot further grow their business due to the limit on available products with an ROI of 100%.
- The seller starts with a sourcing budget of $10,000.
- The seller is open to sourcing products with an ROI of 50% or higher.
- The seller acquires all the products with an ROI of 50% or higher whenever they can find them.
- During their first month of selling, the seller spends $10,000 on products to sell with $6,700 spent on 50% ROI items and $3,300 spent on 100% ROI items.
- The seller takes in $6,700 in profit during their first month.
- The seller’s sourcing budget expands to $16,700 for their second month of selling.
- During the second month, the seller is able to source $10,000 in 50% ROI products as well as $5,000 in 100% products with $1,700 leftover. By the end of that month, after those items sell, the seller’s budget has increased to $26,700.
- The seller goes on to acquire every 50% ROI item that can be sourced and keeps making $10,000 each month.
Despite the lower ROI, the second example makes much more money in absolute terms.
It is worth keeping in mind that the above scenarios offer theoretical examples as opposed to an exact practice. In reality, the amount of inventory that you will be able to source each month may vary, and the numbers used in our examples are arbitrary.
When applying the above concept, you can plug in your own monthly budget to check if the approach can work for your business. It’s also important to consider the variables and risks that can occur in reality. Consider your prep and shipping time and how this will be affected by managing additional inventory. Also, remember that prices are not necessarily static and this possibility should be accounted for as you plan your budget.
With the concepts outlined above, you will be better able to go forward with a healthy profit margin for your Amazon business.
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