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How DTC brands rely on fulfillment to increase product margins

Feb 6, 2023





Inventory is stored on stacked shelves in a warehouse. DTC brands can increase product margins through effective fulfillment strategy.

Retail businesses are constantly striving to tip the scales of production costs and sale price. The less a product costs to produce, the better the company’s product margins are likely to be—providing a competitive advantage and greater profits. 

Some expenses, like raw materials, are unavoidable. But direct-to-consumer brands can significantly lower their product cost by optimizing their ecommerce fulfillment strategy. 

What are product margins?

A company’s product margin is how much it profits from the sale of each product. Sometimes called product markup, it’s the difference between the total cost of producing a product and the sale price. Product margin is expressed as a percentage.

The formula to calculate product margin is (sale price minus cost of goods sold) divided by sale price.
Product margin measures how profitable the company's actual offerings are.

Product margin is sometimes confused with profit margin. While profit margins represent how much the company pockets after all expenses—including overhead and operating expenses like employee salaries and marketing costs—product margins reflect the profitability of the goods, not the company. Product margin can be calculated for the company’s entire product mix—referred to as gross margin—or on a per-product basis. 

Product margins tell an important story: they indicate how profitable the company’s actual core offering is. Even the leanest, most efficiently run company won’t survive if its product margins aren’t healthy. Calculated on a per-product basis, product margins can identify the products that bring in the most revenue, which can help inform decisions around discounting, advertising, and the discontinuation or expansion of a particular product line. 

What are healthy product margins for DTC brands?

There’s no magic number when it comes to product margin, because the health of a margin is relative to an individual company’s unique products, operating costs, target demographic, and region. 

For example, a company with a low average order value but high order volume—like razor blades—may have a low product margin compared to other DTC brands, but can still turn a profit because consumers need to make regular, repeated purchases. Meanwhile, a brand with a very high average order value, like a mattress company, might have a much higher product margin—but consumers will only make a repeat purchase every 5-10 years. 

While the optimal product margin will vary from business to business, our research found that DTC brands that have scaled to the point of going public almost always had gross margins north of 40%. Achieving healthy product margins was a key part of those businesses’ strategies, achieved in part by streamlining their distribution and fulfillment processes. 

When evaluating your product margin, consider whether your company is making enough of a profit to invest in growth. One of the most important factors of scaling is ensuring the business’ gross margins align with customer acquisition costs. 

Remember, gross margin is a measure of how much the company profits from all sales after the cost of goods sold (COGS)—in other words, the product margin in aggregate, across all SKUs. This number should align with your customer acquisition costs to ensure you can invest your revenue into growing your consumer base without incurring losses. 

How to calculate product margins

To calculate a given product’s margin, take the sale price and deduct the total cost for producing that product—COGS per unit—and divide by the sale price. 

For example: Let’s say your company sells umbrellas. It costs $3.50 to produce each umbrella, and you sell them to consumers for $7. The product margin would be 50%. 

The formula is simple enough, but determining the total COGS comes with its own complexities.

Should fulfillment be considered in COGS?

COGS is the direct cost of producing an item for sale. It does not include other operating expenses like overhead, salaries, marketing, or business software. 

Traditionally, COGS included only the fees associated with the company manufacturing or acquiring the product: raw materials, production, and inbound freight to the fulfillment center

But the DTC business model isn’t traditional. Unlike the brands of yesteryear that sent massive purchase orders to a handful of retailers, direct-to-consumer brands incur fulfillment and shipping costs on a per-order basis. Fulfillment costs have an enormous impact on this business model—so, many DTC brands opt to lump those expenses into their COGS. 

To fully understand their expenses, DTC brands often differentiate between product and non-product COGS. Product COGS are those traditional costs: material sourcing and manufacturing. Non-product COGS are the “indirect” costs associated with getting the product to the consumer: warehouse storage, the labor associated with preparing a package, and shipping. 

Following this DTC-specific definition, COGS includes: 

  • Manufacturing (raw materials, production)
  • Freight (transporting the products to the fulfillment center)
  • Fulfillment (warehouse storage, pick and pack, packaging costs)
  • Shipping (carrier rates, surcharges including fuel and holiday rates)

How to bolster product margins through fulfillment

If your COGS includes fulfillment costs, optimizing your fulfillment operations can significantly improve product margins. Some expenses, like the cost of raw materials, have little wiggle room—but there are many other fees that can be lowered through careful planning. 

Here are the five ways you can increase product margins through fulfillment:

  1. Work directly with the manufacturer
  2. Evaluate your fulfillment provider’s efficiency
  3. Cut packaging costs
  4. Optimize your shipping methods
  5. Reduce storage costs through efficient inventory management

Work directly with the manufacturer

When looking for a vendor to produce your inventory, you’ll come across many trade companies and wholesalers posing as manufacturers. These businesses act as middlemen, selling manufactured goods at a markup. You can cut costs and increase product margins by going directly to the source and developing a relationship with the factory. 

Pro-tip: Look for a manufacturer that is already producing products similar to yours. They may have existing molds that you can use to make your own inventory. Producing these molds yourself can rack up thousands of dollars.

Evaluate your fulfillment provider’s efficiency

Less time spent preparing orders means lower labor costs. Dig in to your 3PL’s pick and pack processes: how long does it take, on average, to prepare and label an order? 

Storing popular products close together, creating a streamlined floor plan, and having an organized packing station can go a long way in making the fulfillment center more efficient. If your provider is charging exorbitant base order or pick fees, you may want to consider looking for a new 3PL to maximize your product margin.

Cut packaging costs

The expense of obtaining packaging materials is often overlooked, but a few cents per order can add up fast. 

Most 3PLs provide basic packaging free of charge, but branded packaging will be paid for out of your pocket. This might be an important part of your marketing strategy, but small compromises like keeping the inside of the box plain or reducing the number of colors in your design can significantly reduce your expenses. You might also consider customizing smaller elements of the packaging, like branded wet tape, and using standard boxes. 

Packaging costs—both the container your product is sold in and the box that is handled by the shipping carrier—is a major component of your product margin.

Optimize your shipping methods

Your shipping strategy provides the most opportunities to lower expenses. There are six things to consider: 

  • Your fulfillment provider’s negotiated rates: Outsourcing fulfillment means your company benefits from the provider’s negotiated shipping rates. Take advantage of their rate tables and choose the most cost-efficient carrier.
  • Your preferred shipping method and carrier: If your fulfillment provider uses a la carte billing, you’ll also have the freedom to choose the shipping methods you use on each order. Depending on your product, the cheapest shipping method will vary—flat-rate shipping is ideal for small, heavy products, while ground shipping may be better suited for large, lightweight items. 
  • Offset shipping costs through your sale price: Shipping is a huge expense that eats at your product margins. If your target consumer is not overly price-sensitive, you may want to factor shipping costs into your overall markup so you can offer free shipping—something consumers have come to expect. 
  • Offer multiple shipping speeds: Amazon trained consumers to expect their orders in three days or less, which is nearly impossible for most retailers. To meet this demand, you might offer free (slower) shipping and expedited options with an upcharge. The fee should be enough so that these shipments won’t affect your product margin.
  • Billable rate: Using packaging that is larger than the product needlessly increases your dimensional weight, which can wreak havoc on your product margin.
  • Use a multi-warehousing strategy: With the right integration between your WMS and ecommerce store, you can send orders from the warehouse closest to the customer—reducing your overall shipping zones and cutting travel time.

Reduce storage costs through effective inventory management

Outsourcing fulfillment means your storage fees are variable, so you only have to pay for as much storage space as you’re using at any given time.

Manage your inventory carefully to further lower your storage fees. If you store less inventory, you’ll likely reduce your dwell time (but be careful to avoid backorders). Selling fewer SKUs can also raise your product margins: If you sell just two or three unique items, most of your inventory can be stacked while it’s stored, because warehouse employees will only need to be able to access two or three pallets or storage bins at a time. Most fulfillment centers charge less to store stacked inventory.

Healthy product margins will let you achieve economies of scale faster

Every element of distribution is a scale economy that benefits bigger companies with greater volume. As your business scales, your expenses per order will fall; but the challenge lies in getting to that point. 

By raising your product margin, you’ll have more to invest in acquiring customers, adding sales channels, and expanding into new markets—all of which will put your company on a trajectory to reach economies of scale. 

Learn how Airhouse helped Oregon-based brand Good Life cut fulfillment costs by 30%

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