Nathan Perdriau, Co-Founder and Head of Paid Media at Blue Sense Digital, is back to talk about contribution margin and its importance in marketing and business operations. Listen to this episode as Caden Thompson, our Google Ads Strategist, sits down with Nathan in this deep dive about contribution margin. Learn more about:

What contribution margin is

The three types of contribution margin and which one to track for eCommerce

Methods for tracking contribution margin

The relationship between contribution margin and other KPIs

Connect with Nathan Perdriau and Blue Sense Digital here:

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0:00 Intro

0:25 Deep Dive Into Contribution Margin and Why Its Important in Marketing

1:55 What is contribution margin?

5:33 How to start if you have a lot of products

12:10 Methods for tracking contribution margin

13:16 eCommerce Discounting Model

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Contribution margin and net profit is the be all end all

2

for a lot of different angles

when it comes to marketing.

3

it's just hard to essentially, tell

the algorithm to optimize for it.

4

You have to be aware of the actual

financial side of business too.

5

We're in a very different position.

6

We shouldn't be scaling acquisition.

7

We should be fixing acquisition

first and potentially we should

8

be changing our retention

strategy so we're not discounting.

9

Hey, how's it going everyone?

10

So upon popular request,

we have Nathan back here.

11

going more into the technical

side of things that hurt my

12

brain, but also helped me learn.

13

so yeah, anything you want to say in a

little introduction back to the platform?

14

I don't think we made a

video for us so late either.

15

So it's cool.

16

been a little while.

17

no, thanks for having me.

18

I'm looking forward to this one.

19

It'll be, it'll be good talking

about CFO, CMO kind of topics again.

20

So this is going to be a very technical

video from what we've been discussing.

21

and so Nathan has a lot

of good insights on.

22

how CFOs think and what are

some areas of improvement.

23

were talking a little bit about

contribution margin, and this is

24

one of those topics that is being

discussed more and more, however,

25

there's a lot of variables to that.

26

it's not as simple as just saying,

Hey, this contributed to this.

27

There's so many other factors that

are outside of marketing, that we

28

don't really have control over.

29

So measuring the right ones are, Obviously

the most important set of things.

30

So yeah, I'll let you jump right into it.

31

I think tracking contribution

margin for most e com operators

32

is the best North star.

33

You can look at MEI, you can look at CAC,

but at the end of the day, contribution

34

margin is going to tell you whether

you're covering your OPEX expenses or not.

35

And then I'm probably going to start

talking about contribution margin now.

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And some people are watching

going, what even is that?

37

So let me define it.

38

And let's zoom out because when people

say contribution margin, they're often

39

talking about different things because.

40

There's actually three

contribution margins.

41

There's contribution

margin one, two, and three.

42

One is the same as product cost.

43

So you could almost look at it as gross

margin as well, where it's just the

44

price of the product minus the cost

to buy the product from the factory.

45

So that's contribution margin one.

46

That's really what I'm referring to there.

47

contribution margin two

is the cost of delivery.

48

So it's the price of the

product minus the cost.

49

But also minus the cost to deliver it.

50

So that's the shipping fees, the 3PL fees,

and then the transaction fees as well.

51

So now you're starting to

get lower down the P& L.

52

And then contribution margin three

is where you also take away CAC.

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So you take away the cost

to acquire the customer.

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And now you're all the way down at

the bottom of the P& L where the

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only last thing to minus off is

OPEX, and then you've got net profit.

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And so contribution margin three

is what most e com operators should

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be tracking on a day to day basis.

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And you can do that very easily using.

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Really any software you can use

data studio, and it's just basic

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equations on minusing off average cogs.

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You can pull in cogs from Shopify.

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And so you can actually

have cogs being dynamic.

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You can have average shipping,

average transaction fee assumptions.

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And so you can see what your contribution

margin is on a day to day basis.

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Where it starts to get even deeper and

where you can draw more insights is

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when you start to look at where you

can gain efficiencies and contribution

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margin at all different levels within

the business, And this is where, as a

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marketing partner or an e com operator,

you can look at contribution margin at

69

the product level, or the order level, or

you could look at the time level, which

70

is what I was just talking about, and you

can start to figure out, are we driving

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orders that aren't even profitable?

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Or are we driving orders that

have 5 profit or 1 profit

73

on them, but our cap's 30?

74

And so we're not actually driving any

incremental profit to the business

75

because the bottom 20%, quartile of

orders are just negative cash flowing.

76

you can track contribution

margin one at the product level.

77

And that's what I would recommend to

most e com operators do is what I'd

78

recommend most agencies do if you onboard

a new client, which is to have a basic

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Excel sheet, have all of the products.

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And now this is going to be

really difficult if they have

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60, 000 products, Let's assume

that they have 30 to 50 products.

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You can very easily pull all product

titles and then have associated cogs.

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pull out a basic price export out of

Shopify or whatever platform they're on.

84

And then you can see what the

gross margin is per product.

85

And that's going to be really

indicative of where you should be

86

allocating budget, across campaigns.

87

And that's why understanding

contribution margin across all of

88

these levels is really important

in the actual campaign creation.

89

Because I know one thing that Sol8 talks

about a little bit, I talk about it quite

90

a bit, which is that anytime that you can

consolidate campaign structures, you're

91

generally going to see better performance.

92

Because you're going to have tighter

allocation of conversion data, which is

93

going to enable better customer modeling.

94

And so you'll see better performance,

but the issue there is that you give

95

away all of this control to Google.

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And so you do still want a degree of

segmentation in your Google campaigns.

97

You do still want a degree of

segmentation in your Facebook campaigns,

98

but it has to be very strategical.

99

Based on contribution margin in most

instances, which is, do we have products

100

with 20 percent margins and then we

have products with 80 percent margins.

101

Okay.

102

We probably shouldn't be trading them the

same and we probably shouldn't be having

103

a blanket target row as across them.

104

in terms of implementation and all

that, so would you say that it's a

105

good idea then to, let's say a client

has like a thousands and thousands of

106

products, So they're just, breaking

down every single bit in a spreadsheet,

107

they're going to look at it and

just, their head's going to blow up.

108

Would you say like a good starting point

or something you've seen is like starting

109

with for example, the top sellers and

then working your way down from there,

110

or is there another way that you've seen

work best for clients that maybe have

111

passed that, a hundred product range?

112

that's normally good start

is sold by top sellers.

113

we have an automated, model, which is

going to be very difficult to build.

114

So I'm not going to try to walk you

through how to build it, but what

115

it does is you could, if anyone's

technical in Google shades, they'll

116

be able to do this quite quickly.

117

Which is you can take an order

export of all previous exports

118

with product titles associated.

119

And then you can do an equals

unique, pull in all unique titles

120

into a separate sheet, and then

you can do an equals count.

121

If title is in the order and you can

count how many orders are associated

122

with each title, and then you can,

just do basic pivot tables and look

123

at all the top selling products with

the associated gross margins that have

124

already been tagged in there because

they're in the Shopify order export.

125

And so you can actually

automate the whole thing.

126

If you really want to get into the.

127

technical details of it, but if you want

to be like start off basic, you have

128

barely understood what I've ever been

talking about for the last five minutes.

129

Just take the top five to 10 products,

get the gross margins on them, and then

130

that's going to be a big indicator of

how you should be structuring campaigns

131

across all platforms moving forward.

132

Got it.

133

No, that makes total sense.

134

It's like one of those nice parts about

if you have all these products, you have

135

tons of growth opportunities as you go

and develop it further down the line.

136

So make the biggest impact first and

those top products makes total sense.

137

and then as you grow from that,

then look for other opportunities.

138

You might find that a product

that doesn't sell anything and

139

hasn't sold, much at all, and

you've been using for a marketing.

140

might actually be a really good

source of new customers and the

141

contribution margin is great.

142

So it makes a lot of sense having if

you can, like you're saying in that

143

whole spreadsheet, organize it all.

144

but if you just started out more

of a, smaller client, then makes

145

a lot more sense to have it more.

146

So from like the top down, what's

going to help us right away and

147

then go from there for sure.

148

And then there's also at the order level.

149

So you can look at the product level and

that's Really helpful in terms of what

150

products you should be prioritizing.

151

cause as we said, if you have an agency

that isn't looking at margin at a product

152

level, they might see a product performing

really well, and then go and push it.

153

And in fact, I could almost guarantee

this is the case for probably

154

clients that you manage right now.

155

Clients that sold out, clients at other

agencies, which is brands that stock Nike

156

or brands that stock like Adidas shoes.

157

They will always have a ROAS, but the

distributor margin on those products, and

158

like I know this because I've seen behind

what they sell for, it's about 18 to 22%.

159

And so you're actually barely

profitable even at a 10 ROAS if you

160

take into consideration shipping

costs and any kind of free shipping

161

thresholds that are within your offer.

162

So right away, an agency that's

not looking at gross margin or

163

isn't looking at these things, Is

going, okay, that's a good product.

164

Push it, let's push more spend to it.

165

And you're just pushing a product

that has terrible gross margins.

166

Isn't driving any profit.

167

And then at the end of the quarter

or at the end of the year, when the

168

Ecom operator gets their P and L,

they look at it and they go, what?

169

Revenue's up 70 percent for

profits to say, profits down

170

how is this even possible?

171

And it's because they didn't have that

extra degree of nuance of looking at how

172

much contribution profit was actually

being pushed an individual product level.

173

That was a spiral away from

talking about orders though.

174

And you can also do an order export

you can just look at contribution

175

profit at an individual order level.

176

The softwares that do this store hero

does this really good job at this.

177

And so you can definitely look into store

hero or any other SaaS solution, but it's

178

a simple equation, which is you take your

gross sales, you might as well discounts.

179

You then minus off COGS, and then

you minus off an assumed 3 percent

180

transaction fee, and then you minus off

an assumed shipping and fulfillment fee.

181

You could pretty much get an average

based on your, historical 90 day data.

182

And then you have profit contribution

at an individual order level.

183

And then you can do a pivot table,

sort by lowest contribution profit,

184

and you'll start to discover things

like, wow, we're selling this

185

product, but it costs 16 to ship it.

186

And the cogs are pretty high.

187

We're getting 1 profit.

188

And then you can go into your

Google campaign and go, how much

189

are we spending on this product?

190

And you'll go and look and

you'll see the CPA is 19.

191

And you can go, we're just losing 18

on this product, trying to sell it.

192

This is not a profitable order.

193

or you might find that

people are combining.

194

individual products in a way where

they're getting a discount, and

195

it's ruining your margins again.

196

Or you might find that when people hit a

free shipping threshold, once again, it

197

erodes your margins again, and you start

having all these unprofitable orders.

198

At the end of the day, what's the

point of fulfilling an order if

199

there's no contribution profit on it?

200

And so that's another really good analysis

that you can start to pull together.

201

even if you were just to look at

yesterday's orders, or maybe two days

202

worth of orders, you don't have to go

and look at historical three year order

203

data, you could do this on much smaller,

More simplified time horizons so that

204

you can get a better idea of identifying

where the inefficiencies are within

205

the business and then Working on that.

206

So what I'm hearing from all this, is be

careful of sales because you might find

207

that, Oh yeah, our overall sales are up.

208

But then you look at, like you were

saying, you're well, contribution

209

margin is just not profitable.

210

It's not worth it.

211

I could see all the CFOs that are

just like, Oh my God, finally, someone

212

that's like speaking my language.

213

It's not just about rows.

214

It's about actual like net profit sales.

215

because I see that a lot in accounts

too, where, they'll run a sale and

216

I'm like, Oh, we're doing great.

217

NCAC is a lot better.

218

Everything looks great profit.

219

And then you go into the actual net

profit and you're like, wait a minute.

220

Something's off.

221

What happened?

222

Oh, this product that, should

have been moved, didn't move.

223

And they actually did a sale on this

other product that didn't have as

224

big of a margin trying to move it.

225

And so then it caused a lot of

other issues in the actual business.

226

makes a lot of sense that contribution

margin and net profit is, The be

227

all end all for a lot of different

angles when it comes to marketing.

228

it's just hard to essentially, tell

the algorithm to optimize for it.

229

You have to be aware of the actual

financial side of the business too.

230

which for, marketers like me

that are more on the creative

231

side of things, it's a headache.

232

And so having tools that allow you to do

that, like you're talking about just in

233

spreadsheets, simplify the process a lot.

234

And especially if.

235

you have a business owner that,

can't afford a CFO or, wants to make

236

this a lot easier in the process

of just saying, okay, I need to

237

get 80 percent accurate with this.

238

you could totally do that in a

spreadsheet, like we're talking about.

239

that's a huge value, bomb for people just

because it's, I still have clients that

240

will be looking at end up numbers and I'm

trying to slowly pull them away from it.

241

And it's going from okay,

we're not looking at ROAS.

242

We're looking at, global,

like what's your MIR?

243

What's your, It's okay, now let's

look at your overall profitability.

244

It's like slowly trying to

pull them away from that.

245

for the case of just, helping them

understand like net profit is the

246

be all end all for everything.

247

even LTV, you can't fully rely on.

248

So that's an added benefit of

looking at contribution margin

249

is it will take out discounting.

250

And so if you're running discounting,

it will appear within the

251

contribution margin that you're

reporting on a day to day basis.

252

I also visualize this for clients it's

hard to conceptualize this if you're not

253

in the weeds of finance, but what this

shows, and there's a lot of numbers on the

254

screen, but the premise of it is that as

you increase discounting from 5 to 40%,

255

your breakeven ROAS goes up significantly.

256

And so if you're running a 20 percent

discount, you no longer need a 1.

257

8 ROAS to be breaking even, you need a 2.

258

But more importantly, if you have a

target contribution profit per order,

259

your target ROAS goes up exponentially.

260

And you can see that in the graph here,

because you're approaching an asthmatope,

261

which is the target contribution, and

so you don't have much to work with.

262

And so it squeezes so quickly, so much

faster than anyone typically thinks.

263

Which is that, Oh, we'll

do a 20 percent discount.

264

And yeah, okay.

265

We need a little bit of a better

ROAS, but it's no, you now need like

266

ROAS because you've cut your profit,

which was on the top end in half.

267

If you're operating on,

let's say 30%, gross margin.

268

So I thought that was a really good way

to visualize for clients that as you

269

start to escalate in discounting, you need

your units per transaction to increase.

270

So you need your average order

value to inflate as well.

271

you can't just be discounting and

expecting that a higher ROAS is going

272

to drive more profit because it won't.

273

So I guess going further down that

pathway for clients that have a good

274

LTV, so what would you say is the

impact of contribution margin and

275

the relationship of that with and

how do you look at it in that sense?

276

this is the thing about LTV is.

277

I think people hear LTV and then

they think they know what it is

278

or they can conceptualize how it

applies into campaigns and that's

279

what I really don't like about it.

280

I made a LinkedIn post about this a

couple of weeks ago and it's because

281

everyone comments this on all my

posts I put up which is I'll put up a

282

post about something technical about

contribution margin, on first order

283

or the importance of first order

profitability and someone will come in

284

with Yeah, but what about the LTV and

I'm like that's it's so the reason why

285

I have an issue with it is to number one

There's a time decay associated with LTV.

286

And so when we're talking about

LTV, what are we talking about?

287

We're talking about 30 day.

288

We're talking about 90 day.

289

Are we talking about lifetime LTV?

290

So since the inception of the company What

is the lifetime value being since then?

291

Because as you start to go out in

time you start to increase number one

292

your risk and number two your cost of

capital You Because if you're going

293

to be acquiring customers and hoping

for profits to unlock over a very long

294

time period, there's a huge cost of

capital in just pulling that forward.

295

and then the second reason I don't

like it is because it's revenue based.

296

It's telling you how much revenue

you're getting from a customer over

297

its lifetime, but if you look at the

unit economics of any brand, and you

298

break down first time versus returning

customers, and once again, you can do

299

this in Excel sheets just out of the

back end of Shopify, you'll almost always

300

see returning customers are getting

like average of 30 percent discounts.

301

And the reason being is that the brand is

just sending emails with 20 percent off

302

codes, 30 percent off codes, 40 percent

off codes to try to get people back.

303

And so these customers profit

contribution is so minimal.

304

And then factor it on top of all of that

is that most advertisers are spending

305

20 percent of their budget on existing

customers and they don't even know it

306

because they're running Pmax and Advantage

And so now you also have a CAC associated

307

with getting these customers back.

308

And so you run all the math

and it's easy math to run.

309

You can go a hundred dollar

average order value, LTV is 200.

310

we've doubled the profitability of the

customer, but really let's say that

311

we're taking 30 percent discounts.

312

Okay.

313

So now it's really only like 70, 170

in revenue, maybe 160 in revenue.

314

and then you take into consideration

that there's maybe a 10 CAC there and

315

you're like, okay, it's only like 150 and

now it's a completely different story.

316

Because if you were looking at, okay,

we double the profit of a customer over

317

time, and you were using that to KPI and

benchmark the entire business, but you

318

look into the details and you actually,

these returning customers aren't driving

319

any profit or very minimal profit.

320

We're in a very different position.

321

We shouldn't be scaling acquisition.

322

We should be fixing acquisition

first and potentially we should be

323

changing our retention strategy.

324

So we're not discounting.

325

So heavily as well.

326

it makes sense.

327

I think the idea of in that graph you

showed earlier, it was a really good

328

representation of that is start with

a very small discount, see who bites,

329

take them out of the list, your email

list, wherever the case may be, and

330

then go to the next process and see how

far you can push it until you hit that

331

actual point of diminishing returns.

332

Whether it's 10%, 20%, 30%, 50%,

who knows, based on your business.

333

that's where you'll find

the most profit from it.

334

And I've actually, talked to clients in

the past about that and it saved them

335

a lot of money and actually allowed us

to increase our volume on just going

336

after new customers because they didn't

realize that their LTV was actually

337

eating into their net profits like crazy.

338

so something just like that can

really change a business from.

339

Both the financial side

and the marketing side.

340

whenever, we hear CFOs, it's

okay, like I got to try to

341

explain to them what's going on.

342

But then they're also coming

at it from their angle.

343

It's yes, I know what you're saying,

but I'm also trying to explain to you,

344

what's going to actually make us money.

345

And so it's up to both sides to understand

like what the algorithm, but also,

346

okay, from the, actual acquisition side

of it, is it actual benefit or not?

347

It might look better for us, but we

don't know if that's actually true.

348

I think that gives a really

good understanding of

349

contribution margin though.

350

we went through contribution margin went

through a few different ways that you can.

351

look for inefficiencies, order,

product level, and then LTV.

352

it's not what you, not what

it seems on the front end.

353

So making sure that you are also

tracking contribution margin

354

across the lifetime of customers.

355

Perfect.

356

I love the insight.

357

we don't really get much of this

from just the space in general.

358

It's too focused on in

app and what's going on.

359

if people want to learn more

about you and, get more insights,

360

where can they find you?

361

the first thing is the YouTube channel, so

I'll give the link to you, you can scroll,

362

look at the below, it's Bluesense Digital.

363

The second is the podcast, it's more

longer format if you want to hear

364

me talking for an hour and a half

straight to some people in Australia.

365

it's Blues Brothers Podcast.

366

And then LinkedIn is the

easiest way to message me.

367

If you want to ask any questions

about any of this CFO jargon

368

that I like to talk about.

369

That would definitely be

me as well, but awesome.

370

thanks for coming on.

371

And like I said, we'll probably,

have you on more just to give some

372

more insight for us all and I guess

demystified the CFO side of things.

373

Thanks again, Nathan.