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Deep Dive Into Contribution Margin and Why It's Important in Marketing
17th July 2024 β€’ The Google Ads Podcast β€’ Solutions 8
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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:

Blue Sense Digital website: https://www.bluesensedigital.com.au/

Nathan on LinkedIn:  

 / nathan-perdriau  

YouTube channel:   

 / @bluesensedigital  

Podcast:   

 / @blues-brothers-podcast  



Related videos:

πŸ”₯ The Move to a One-Click World and How It’s Changing the Agency Space:   

 β€’ πŸ”₯ The Move to a One-Click World and H...  


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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Transcripts

Nathan:

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.

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:

been a little while.

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:

no, thanks for having me.

18

:

I'm looking forward to this one.

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:

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.

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:

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

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:

one of those topics that is being

discussed more and more, however,

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:

there's a lot of variables to that.

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:

it's not as simple as just saying,

Hey, this contributed to this.

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:

There's so many other factors that

are outside of marketing, that we

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:

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.

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:

I think tracking contribution

margin for most e com operators

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:

is the best North star.

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:

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

but at the end of the day, contribution

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:

margin is going to tell you whether

you're covering your OPEX expenses or not.

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:

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?

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:

So let me define it.

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:

And let's zoom out because when people

say contribution margin, they're often

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:

talking about different things because.

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:

There's actually three

contribution margins.

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:

There's contribution

margin one, two, and three.

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:

One is the same as product cost.

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:

So you could almost look at it as gross

margin as well, where it's just the

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:

price of the product minus the cost

to buy the product from the factory.

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:

So that's contribution margin one.

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:

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

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:

contribution margin two

is the cost of delivery.

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:

So it's the price of the

product minus the cost.

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:

But also minus the cost to deliver it.

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:

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

and then the transaction fees as well.

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:

So now you're starting to

get lower down the P& L.

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:

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

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:

the product level, or the order level, or

you could look at the time level, which

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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

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:

on them, but our cap's 30?

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:

And so we're not actually driving any

incremental profit to the business

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:

because the bottom 20%, quartile of

orders are just negative cash flowing.

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:

you can track contribution

margin one at the product level.

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:

And that's what I would recommend to

most e com operators do is what I'd

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:

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.

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:

And then you can see what the

gross margin is per product.

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:

And that's going to be really

indicative of where you should be

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:

allocating budget, across campaigns.

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:

And that's why understanding

contribution margin across all of

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:

these levels is really important

in the actual campaign creation.

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:

Because I know one thing that Sol8 talks

about a little bit, I talk about it quite

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:

a bit, which is that anytime that you can

consolidate campaign structures, you're

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:

generally going to see better performance.

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:

Because you're going to have tighter

allocation of conversion data, which is

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:

going to enable better customer modeling.

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:

And so you'll see better performance,

but the issue there is that you give

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:

away all of this control to Google.

96

:

And so you do still want a degree of

segmentation in your Google campaigns.

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:

You do still want a degree of

segmentation in your Facebook campaigns,

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:

but it has to be very strategical.

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:

Based on contribution margin in most

instances, which is, do we have products

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with 20 percent margins and then we

have products with 80 percent margins.

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:

Okay.

102

:

We probably shouldn't be trading them the

same and we probably shouldn't be having

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:

a blanket target row as across them.

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:

in terms of implementation and all

that, so would you say that it's a

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:

good idea then to, let's say a client

has like a thousands and thousands of

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:

products, So they're just, breaking

down every single bit in a spreadsheet,

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:

they're going to look at it and

just, their head's going to blow up.

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:

Would you say like a good starting point

or something you've seen is like starting

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:

with for example, the top sellers and

then working your way down from there,

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:

or is there another way that you've seen

work best for clients that maybe have

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:

passed that, a hundred product range?

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:

that's normally good start

is sold by top sellers.

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:

we have an automated, model, which is

going to be very difficult to build.

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:

So I'm not going to try to walk you

through how to build it, but what

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:

it does is you could, if anyone's

technical in Google shades, they'll

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:

be able to do this quite quickly.

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:

Which is you can take an order

export of all previous exports

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:

with product titles associated.

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:

And then you can do an equals

unique, pull in all unique titles

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:

into a separate sheet, and then

you can do an equals count.

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:

If title is in the order and you can

count how many orders are associated

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:

with each title, and then you can,

just do basic pivot tables and look

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:

at all the top selling products with

the associated gross margins that have

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:

already been tagged in there because

they're in the Shopify order export.

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:

And so you can actually

automate the whole thing.

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:

If you really want to get into the.

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:

technical details of it, but if you want

to be like start off basic, you have

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:

barely understood what I've ever been

talking about for the last five minutes.

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:

Just take the top five to 10 products,

get the gross margins on them, and then

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:

that's going to be a big indicator of

how you should be structuring campaigns

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:

across all platforms moving forward.

132

:

Got it.

133

:

No, that makes total sense.

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:

It's like one of those nice parts about

if you have all these products, you have

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:

tons of growth opportunities as you go

and develop it further down the line.

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:

So make the biggest impact first and

those top products makes total sense.

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:

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

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:

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

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:

contribution margin is great.

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:

So it makes a lot of sense having if

you can, like you're saying in that

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whole spreadsheet, organize it all.

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:

but if you just started out more

of a, smaller client, then makes

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:

a lot more sense to have it more.

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:

So from like the top down, what's

going to help us right away and

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:

then go from there for sure.

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:

And then there's also at the order level.

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So you can look at the product level and

that's Really helpful in terms of what

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:

products you should be prioritizing.

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:

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

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:

clients that you manage right now.

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:

Clients that sold out, clients at other

agencies, which is brands that stock Nike

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or brands that stock like Adidas shoes.

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:

They will always have a ROAS, but the

distributor margin on those products, and

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:

like I know this because I've seen behind

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

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:

And so you're actually barely

profitable even at a 10 ROAS if you

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:

take into consideration shipping

costs and any kind of free shipping

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:

thresholds that are within your offer.

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:

So right away, an agency that's

not looking at gross margin or

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:

isn't looking at these things, Is

going, okay, that's a good product.

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:

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

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:

And you're just pushing a product

that has terrible gross margins.

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:

Isn't driving any profit.

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:

And then at the end of the quarter

or at the end of the year, when the

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:

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

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:

how is this even possible?

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:

And it's because they didn't have that

extra degree of nuance of looking at how

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:

much contribution profit was actually

being pushed an individual product level.

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:

That was a spiral away from

talking about orders though.

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:

And you can also do an order export

you can just look at contribution

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profit at an individual order level.

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:

The softwares that do this store hero

does this really good job at this.

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:

And so you can definitely look into store

hero or any other SaaS solution, but it's

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:

a simple equation, which is you take your

gross sales, you might as well discounts.

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:

You then minus off COGS, and then

you minus off an assumed 3 percent

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transaction fee, and then you minus off

an assumed shipping and fulfillment fee.

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:

You could pretty much get an average

based on your, historical 90 day data.

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:

And then you have profit contribution

at an individual order level.

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And then you can do a pivot table,

sort by lowest contribution profit,

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:

and you'll start to discover things

like, wow, we're selling this

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:

product, but it costs 16 to ship it.

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:

And the cogs are pretty high.

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We're getting 1 profit.

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And then you can go into your

Google campaign and go, how much

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are we spending on this product?

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And you'll go and look and

you'll see the CPA is 19.

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And you can go, we're just losing 18

on this product, trying to sell it.

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This is not a profitable order.

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or you might find that

people are combining.

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:

individual products in a way where

they're getting a discount, and

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it's ruining your margins again.

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Or you might find that when people hit a

free shipping threshold, once again, it

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erodes your margins again, and you start

having all these unprofitable orders.

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At the end of the day, what's the

point of fulfilling an order if

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there's no contribution profit on it?

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:

And so that's another really good analysis

that you can start to pull together.

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even if you were just to look at

yesterday's orders, or maybe two days

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:

worth of orders, you don't have to go

and look at historical three year order

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:

data, you could do this on much smaller,

More simplified time horizons so that

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you can get a better idea of identifying

where the inefficiencies are within

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the business and then Working on that.

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

careful of sales because you might find

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that, Oh yeah, our overall sales are up.

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But then you look at, like you were

saying, you're well, contribution

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margin is just not profitable.

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It's not worth it.

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I could see all the CFOs that are

just like, Oh my God, finally, someone

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that's like speaking my language.

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It's not just about rows.

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It's about actual like net profit sales.

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because I see that a lot in accounts

too, where, they'll run a sale and

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

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NCAC is a lot better.

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Everything looks great profit.

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And then you go into the actual net

profit and you're like, wait a minute.

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Something's off.

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What happened?

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Oh, this product that, should

have been moved, didn't move.

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And they actually did a sale on this

other product that didn't have as

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big of a margin trying to move it.

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And so then it caused a lot of

other issues in the actual business.

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:

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.

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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.

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:

which for, marketers like me

that are more on the creative

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side of things, it's a headache.

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:

And so having tools that allow you to do

that, like you're talking about just in

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spreadsheets, simplify the process a lot.

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:

And especially if.

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you have a business owner that,

can't afford a CFO or, wants to make

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:

this a lot easier in the process

of just saying, okay, I need to

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:

get 80 percent accurate with this.

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:

you could totally do that in a

spreadsheet, like we're talking about.

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:

that's a huge value, bomb for people just

because it's, I still have clients that

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:

will be looking at end up numbers and I'm

trying to slowly pull them away from it.

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:

And it's going from okay,

we're not looking at ROAS.

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We're looking at, global,

like what's your MIR?

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:

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

look at your overall profitability.

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:

It's like slowly trying to

pull them away from that.

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for the case of just, helping them

understand like net profit is the

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:

be all end all for everything.

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:

even LTV, you can't fully rely on.

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:

So that's an added benefit of

looking at contribution margin

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is it will take out discounting.

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And so if you're running discounting,

it will appear within the

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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

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:

in the weeds of finance, but what this

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

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:

screen, but the premise of it is that as

you increase discounting from 5 to 40%,

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your breakeven ROAS goes up significantly.

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And so if you're running a 20 percent

discount, you no longer need a 1.

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

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But more importantly, if you have a

target contribution profit per order,

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your target ROAS goes up exponentially.

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And you can see that in the graph here,

because you're approaching an asthmatope,

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which is the target contribution, and

so you don't have much to work with.

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And so it squeezes so quickly, so much

faster than anyone typically thinks.

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Which is that, Oh, we'll

do a 20 percent discount.

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:

And yeah, okay.

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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.

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:

So I thought that was a really good way

to visualize for clients that as you

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:

start to escalate in discounting, you need

your units per transaction to increase.

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So you need your average order

value to inflate as well.

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:

you can't just be discounting and

expecting that a higher ROAS is going

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:

to drive more profit because it won't.

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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

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the relationship of that with and

how do you look at it in that sense?

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:

this is the thing about LTV is.

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I think people hear LTV and then

they think they know what it is

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:

or they can conceptualize how it

applies into campaigns and that's

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what I really don't like about it.

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:

I made a LinkedIn post about this a

couple of weeks ago and it's because

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:

everyone comments this on all my

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

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:

post about something technical about

contribution margin, on first order

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:

or the importance of first order

profitability and someone will come in

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:

with Yeah, but what about the LTV and

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

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:

I have an issue with it is to number one

There's a time decay associated with LTV.

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:

And so when we're talking about

LTV, what are we talking about?

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We're talking about 30 day.

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We're talking about 90 day.

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Are we talking about lifetime LTV?

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So since the inception of the company What

is the lifetime value being since then?

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Because as you start to go out in

time you start to increase number one

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:

your risk and number two your cost of

capital You Because if you're going

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:

to be acquiring customers and hoping

for profits to unlock over a very long

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:

time period, there's a huge cost of

capital in just pulling that forward.

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:

and then the second reason I don't

like it is because it's revenue based.

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:

It's telling you how much revenue

you're getting from a customer over

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:

its lifetime, but if you look at the

unit economics of any brand, and you

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:

break down first time versus returning

customers, and once again, you can do

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:

this in Excel sheets just out of the

back end of Shopify, you'll almost always

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:

see returning customers are getting

like average of 30 percent discounts.

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:

And the reason being is that the brand is

just sending emails with 20 percent off

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:

codes, 30 percent off codes, 40 percent

off codes to try to get people back.

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:

And so these customers profit

contribution is so minimal.

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:

And then factor it on top of all of that

is that most advertisers are spending

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:

20 percent of their budget on existing

customers and they don't even know it

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:

because they're running Pmax and Advantage

And so now you also have a CAC associated

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:

with getting these customers back.

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:

And so you run all the math

and it's easy math to run.

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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

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:

we're taking 30 percent discounts.

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:

Okay.

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:

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

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:

any profit or very minimal profit.

320

:

We're in a very different position.

321

:

We shouldn't be scaling acquisition.

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:

We should be fixing acquisition

first and potentially we should be

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:

changing our retention strategy.

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So we're not discounting.

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:

So heavily as well.

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:

it makes sense.

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:

I think the idea of in that graph you

showed earlier, it was a really good

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representation of that is start with

a very small discount, see who bites,

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:

take them out of the list, your email

list, wherever the case may be, and

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then go to the next process and see how

far you can push it until you hit that

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:

actual point of diminishing returns.

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

who knows, based on your business.

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that's where you'll find

the most profit from it.

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And I've actually, talked to clients in

the past about that and it saved them

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a lot of money and actually allowed us

to increase our volume on just going

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:

after new customers because they didn't

realize that their LTV was actually

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eating into their net profits like crazy.

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:

so something just like that can

really change a business from.

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Both the financial side

and the marketing side.

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:

whenever, we hear CFOs, it's

okay, like I got to try to

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:

explain to them what's going on.

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But then they're also coming

at it from their angle.

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

but I'm also trying to explain to you,

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what's going to actually make us money.

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And so it's up to both sides to understand

like what the algorithm, but also,

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okay, from the, actual acquisition side

of it, is it actual benefit or not?

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It might look better for us, but we

don't know if that's actually true.

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I think that gives a really

good understanding of

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contribution margin though.

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:

we went through contribution margin went

through a few different ways that you can.

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look for inefficiencies, order,

product level, and then LTV.

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:

it's not what you, not what

it seems on the front end.

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:

So making sure that you are also

tracking contribution margin

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:

across the lifetime of customers.

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Perfect.

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I love the insight.

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we don't really get much of this

from just the space in general.

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:

It's too focused on in

app and what's going on.

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:

if people want to learn more

about you and, get more insights,

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:

where can they find you?

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the first thing is the YouTube channel, so

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

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:

look at the below, it's Bluesense Digital.

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:

The second is the podcast, it's more

longer format if you want to hear

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me talking for an hour and a half

straight to some people in Australia.

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it's Blues Brothers Podcast.

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And then LinkedIn is the

easiest way to message me.

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If you want to ask any questions

about any of this CFO jargon

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:

that I like to talk about.

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:

That would definitely be

me as well, but awesome.

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:

thanks for coming on.

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:

And like I said, we'll probably,

have you on more just to give some

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:

more insight for us all and I guess

demystified the CFO side of things.

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Thanks again, Nathan.

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