Identifying the true top line could be a challenge. When comparing different businesses with different business models, make sure you use the right one.
Amazon or e-commerce for most business owners/entrepreneurs/directors does not exist in isolation.
When you’re trying to compare different businesses with different business models, you need to be very careful which “top line” or “revenue” metric you choose.
In e-commerce, a lot of your revenue numbers are really “pass-through costs”. This is similar to other businesses like the construction industry for example.
You pay Amazon pays you your revenue but only when you make a sale.
We see this literally within the mechanics Amazon payouts. We receive an “Amazon payout” every two weeks which is equal to Amazon revenue net of Amazon costs including sales and fulfilment costs.
This isn’t just a cashflow thing – it reflects a profound difference in profit and loss and accounting on the true topline.
Effectively, we just have money come into our hands which we immediately pass on to Amazon before we even get it into our own bank accounts.
Whether or not it comes into our bank accounts, or appears on our Profit and Loss statements, doesn’t change the fact that we basically are passing money straight from one place to another.
In this case, we are passing a percentage of our gross revenue straight back to amazon in the form of amazon costs.
Let’s say that a business has just one SKU/product line to keep it simple.
If you, for example, sell 10,000 units of a widget per month at $10 each selling price, that is a Gross Revenue of $100,000 per month.
However, most of the costs are arguably “pass-through” costs ie they go pretty much straight to other businesses that supply yours on the true top line.
Here’s a sample P & L for the traditional e-commerce business:
Gross Revenue: $100,000
$20,000 manufacturing cost – goes to your factory upfront
$10,000 – goes to your freight forwarder upfront
$5,000 goes straight to Amazon in storage costs
$35,000 Fulfilment and sales fees go to Amazon only when you sell something.
$10,000 goes straight to Amazon in advertising costs
Gross Profit: $20,000
This may sound wrong in isolation. But as soon as you try to compare two business models, it makes a lot more sense on the true topline.
Let’s say that the same business owner of a traditional Amazon e-commerce business – that actually buys (or has made) physical products and sells them – wants to consider an agency offering.
Typically in an agency, s/he will not have to invest upfront for the product costs, nor pay the Amazon fees. They will typically take a percentage of sales, profits or cashflow – plus sometimes fixed fees per month etc.
Let’s say that the agency business made a revenue of $40,000 a month while the traditional e-commerce business made $100,000.
It’s tempting to see the agency business as “Smaller” or possibly less “successful” than the traditional eCommerce business.
Leaving aside the obvious issue of profits vs. revenue for the moment (which we’ll address in another podcast), let’s examine the true top line
The Agency monthly Gross P &L might look like this:
$10,000 inhouse Direct labour costs (managing listings and PPC)
$5,000 inhouse management costs (overseeing labour and creating managing systems)
$5,000 in advertising costs (say Facebook ads etc.)
$20,000 Gross Profit
The e-commerce business may look more impressive upfront, but the gross profit is the same on the true top line.
Furthermore, In the Amazon business, the Amazon fulfilment fee and the sales commission costs are only incurred and paid when a product sells. So effectively these are going straight to Amazon.
And in fact, that is exactly how we experience it as Amazon business owners – the Amazon “Payout” is made of revenue on Amazon minus Amazon costs in each period.
Therefore, according to the logic of Greg Crabtree, you should really be comparing the businesses without to Pass-through costs”
His rule of thumb is that if your Gross Profit is under 40%, you should use Gross Profit as your topline number, NOT Gross Revenue.
This is not universally accepted by any means but I think it makes a lot of sense.
Viewed through this prism, a “$10 million a year” Amazon business – ie a business doing $10 million a year in revenue – at 30% Gross Margin would, in fact, be seen as a “$3 million a year business”.
A more Humbling metric – but more helpful!
* I’m indebted to the excellent book Simple Numbers, Straight Talk, Big Profits!
By Greg Crabtree. Crabtree is a CPA (Accountant) who specialises in accounting to really help CEOs/MDs of small and medium businesses (SMEs) for these very helpful distinctions. I can’t recommend it too strongly for anyone scaling an e-commerce business.