Tradeoffs

Let's say your average price per item sold is $40.00. Your average cost of goods is $20.00. Your annual rebuy rate is 30%, if a customer purchases the customer spends $160.

• Average Future Margin (AFM) = 0.30 * ($160 * (1 - 0.50)) = $24.00.

Now your suppliers tell you that your cost of goods increases to $24.00. If you keep prices where they are, your Average Future Margin changes.

• Average Future Margin (AFM) = 0.30 * ($160 * (1 - 0.60)) = $19.20.

Nobody likes that scenario. Your CFO demands that you increase prices by 20%. Two things happen in this scenario.

• Rebuy Rates Decrease by 20%.
• Spend per Repurchaser increases by 10%.

Here is what Average Future Margin looks like:

• Average Future Margin (AFM) = (0.30 * 0.80) * (($160 * 1.1) * (1 - 0.50)) = $21.12.

Two things happen here.

• You recoup some of your AFM via the price increase.
• You hurt your Customer Development efforts because your rebuy rate dips from 30% to 24%, meaning you'll have fewer customers next year, meaning you'll have less profit next year.

These are the tradeoffs every single one of you should be evaluating.

I've been amazed, in the past year, how many of you have emailed me to tell me you are not evaluating the scenarios.