May 19, 2020

Then Discounting Just Ruins Everything

We have our example from yesterday.  Let's say you have a $100 average order value ... you sell five items at $20 each, to make the math easy. Let's also make the math easy ... say it costs you $7 to have the item seamlessly returned to you, and we'll say it costs $5 to reprocess the item in your distribution center ... you lose $12 on every item that is returned.
  • Let's also say that your cost of goods sold is 40%.
  • Let's also say that pick/pack/ship expenses are 10% of gross sales.
Pretend that the customer keeps 100% of this order.
  • $100 average order value.
  • Cost of Goods = 0.40*$100 = $40.00.
  • Pick/Pack/Ship Expense = 0.10*$100 = $10.00.
  • Contribution / Variable Profit = $100.00 - $40.00 - $10.00 = $50.00.
Pretend that the customer returns one item.
  • $100 average order value.
  • Net Sales = $80.00.
  • Cost of Goods = 0.40*$80.00 = $32.00.
  • Pick/Pack/Ship Expense = 0.10*$100 = $10.00.
  • Net Returns Expense on One Item = 1 * ($5 + $7) = $12.00.
  • Contribution / Variable Profit = $80.00 - $32.00 - $10.00 - $12.00 = $26.00.
Pretend that the customer returns two items.
  • $100 average order value.
  • Net Sales = $60.00.
  • Cost of Goods = 0.40*$60.00 = $24.00.
  • Pick/Pack/Ship Expense = 0.10*$100 = $10.00.
  • Net Returns Expense on Two Items = 2 * ($5 + $7) = $24.00.
  • Contribution / Variable Profit = $60.00 - $24.00 - $10.00 - $24.00 = $2.00.
Now your vendor partners are going to ask you to take 20% off to "stimulate" a purchase. Of course they're going to ask you to do that ... the promotion makes their software/solutions look even more important and even more valuable.

Pretend that the customer keeps 100% of this order.
  • $100 average order value.
  • Cost of Goods = 0.40*$100 = $40.00.
  • Promotional Amount = $20.00.
  • Pick/Pack/Ship Expense = 0.10*$100 = $10.00.
  • Contribution / Variable Profit = $100.00 - $40.00 - $10.00 - $20.00 = $30.00.
Pretend that the customer returns one item.
  • $100 average order value.
  • Net Sales = $80.00.
  • Cost of Goods = 0.40*$80.00 = $32.00.
  • Promotional Amount = $16.00.
  • Pick/Pack/Ship Expense = 0.10*$100 = $10.00.
  • Net Returns Expense on One Item = 1 * ($5 + $7) = $12.00.
  • Contribution / Variable Profit = $80.00 - $32.00 - $10.00 - $12.00 - $16.00 = $10.00.
Pretend that the customer returns two items.
  • $100 average order value.
  • Net Sales = $60.00.
  • Cost of Goods = 0.40*$60.00 = $24.00.
  • Promotional Amount = $12.00.
  • Pick/Pack/Ship Expense = 0.10*$100 = $10.00.
  • Net Returns Expense on Two Items = 2 * ($5 + $7) = $24.00.
  • Contribution / Variable Profit = $60.00 - $24.00 - $10.00 - $24.00 - $12.00 = ($10.00).
Without discounts/promotions, we earned:
  • 0 Items Returned = $50.00 Profit.
  • 1 Item Returned = $26.00 Profit.
  • 2 Items Returned = $2.00 Profit.
With 20% off? Oh Boy!!
  • 0 Items Returned = $30.00 Profit.
  • 1 Item Returned = $10.00 Profit.
  • 2 Items Returned = ($10.00) Profit.
Your vendor partners and pundits and all the other folks who want you to do things that cause them to make money cause you to make less money.

Now I get it ... the pundits will tell you that the promotion will cause more customers to buy, thereby increasing profit. Woooooo!!! But if the customer returns anything (and yes, customers return stuff), profit evaporates at an ever-increasing rate.

Why are we so stupid?

Well, we don't run the math ahead of time, for starters.

Is there a way to stop customers from returning stuff? Maybe not.

Is there a way to mitigate returns via email marketing and print? ABSOLUTELY! More on that topic in upcoming posts.

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