Manufacturers and Brands: Is Your Amazon 3P Program Profitable?
Your selling approach and tight management are key to maximizing profitability on the Amazon marketplace.
In my travels across the Ecommerce landscape, I repeatedly run across brands and manufacturers that are reticent to sell their products on Amazon. An objection I often hear: profit margins are too small or nonexistent. In many cases, these businesses are only comfortable selling as a wholesale (first party or “1P”) seller (note: for a definition and discussion of Amazon selling approaches, check out my previous article Amazon 1P vs. 3P.) Or they may have tried direct selling on Amazon as a third party (3P) seller and found it to be too difficult, or the margins are perceived as too narrow. When coupled with the perceived threat of creating channel conflict, some manufacturers end up staying away from Amazon altogether. However, these companies are missing a large – and very profitable - opportunity that can be addressed with diligent and careful management of an Amazon third party (“3P” or Seller Central) program.
Manufacturers maintain a heritage of selling via wholesale channels, e.g. selling in bulk to distributors, retailers, and other resellers. The concept of obtaining the full retail price on a product is foreign to these firms. However, this is exactly what manufacturers earn when selling via an Amazon 3P program. And, given the typically large difference between costs to manufacture and the retail price, brands in almost all categories maintain significant margin that can create highly profitable 3P programs. This provides a great starting point to earn large profits from Amazon selling. The 3P approach also gives the product manufacturer more control over the retail price on Amazon, which allows the brand to manage channel conflict with other selling channels related to price.
So, where does the perceived lack of profitability of 3P programs come from? From what I have seen, in most cases this comes from two areas: 1) a lack of understanding of the true operating cost components of a 3P program (which I will share below), and / or 2) a lack of careful and competent management of the Amazon program itself.
How do you go about ensuring your Amazon program is profitable? In order to understand this, you need to ask yourself two questions:
What are the costs associated with managing my Amazon program?
What should I expect my profit margin to be?
Let’s dive into each of these questions.
Understanding The Costs of Running An Amazon 3P Program
There are essentially five cost categories associated with running an Amazon 3P program. Some of these costs (the Amazon-specific fees, in particular) are inevitable and cannot be negotiated. Some of them, however, you can optimize in order to boost profitability.
These cost centers are:
Amazon’s commission: Amazon takes a portion of your revenues from each sale. The level of fees is largely driven by product category and type. Note that this commission percentage has nothing to do with the seller’s sales volume. Instead the percentage varies by product category, generally from 8 – 20 percent. In many product categories, the commission is 15 percent. For information on products in your category, go to: https://sellercentral.amazon.com/gp/help/external/200336920
Fulfillment costs: These costs typically include warehousing products, picking, packing, shipping, and managing customer service and returns. This also includes warehouse storage costs to have your products ready to go when the customer places the order on Amazon. With Amazon 3P programs, the seller is responsible for shipping the product to the buyer. To make this process easier, Amazon offers its “Fulfilled by Amazon” service (FBA), where sellers ship products to Amazon to handle the entire fulfillment process. Nothing is free, of course, and Amazon charges a fee based on your product’s size and weight. This can range from $3 - $50+ per item, depending on the specifics of the product, and storage fees can also apply. You can check these costs for your own product with Amazon’s FBA calculator, found here: https://sellercentral.amazon.com/fba/profitabilitycalculator/index?lang=en_US If you opt not to use FBA, you can also opt to manage fulfillment yourself or through another 3rd party logistics company (these firms are generally called “3PLs”). While this might save you money in the short run, in the long run it might end up being more costly, particularly if you fail to fulfill or deliver orders on time, which can get you banned from Amazon altogether. I always recommend using FBA if your company does not have expertise in fulfilling small orders or drop shipping (such as is the case with many traditional product manufacturers, who are used to shipping in bulk to distributors or retailers).
Product cost: This is your cost to source or make the product. This is something most manufacturers and brand owners already have a good sense of, but you also need to account for additional costs to make sure it’s ready to go for Amazon, such as shipping products to the Amazon fulfillment center.
Advertising: Amazon provides paid advertising tools to help you drive attention to your listings among the almost 600 Million products on the marketplace. This is especially important if you are new to Amazon. I usually recommend budgeting five percent of total revenue (total 3P sales) for advertising, such as through Amazon’s Sponsored Products ads. Now, you might not need to spend this amount all at once. In fact, you might start spending more (up to 20-25% of total revenue) at first to create visibility on Amazon for your products, then cutting back over time as your product listings gain more buyers and traction. Check out my article Driving Visibility on Amazon for a more complete discussion of Amazon advertising opportunities.
Resources: You are going to need resources – internal or external or both - to help you manage Amazon. With Amazon 3P, you are the retailer and merchant, and this requires management of content, merchandising, marketing, and operations (e.g. inventory management and fulfillment). This takes expertise and people. Amazon 3P isn’t a “set it and forget it” platform. It’s more like a garden that needs tending, which requires time and energy to grow. Whether you hire someone to manage it internally or turn to an agency (like Enceiba) to handle it for you is up to you. Either way, I recommend budgeting about ten percent of your Amazon revenue to this activity. You will achieve some efficiencies as you scale, so this percentage will likely decline a bit as you grow your Amazon 3P program.
Your Amazon 3P Profits: What to Expect
Of course, to figure out what your profit margins will be, you also need to know what your revenues will be. And for that reason, you need to consider the retail pricing on your products on Amazon.
As I mentioned above, many brands and manufacturers fail to price their products appropriately for Amazon, especially if they only have experience with wholesaling. To get a sense for what should be charging on Amazon, it is essential to do some research. This includes looking for what your products are being sold for via other channels (and even on Amazon itself) — B2C and B2B. You also want to look at how competitive products are priced to help you understand what price the market will bear for your items.
Many companies dipping their toes into Amazon think they need to approach the channel as a discounter, and mark everything down from the start. This is far from the truth. In fact, there are many instances where sellers can command a higher price on Amazon than through other channels. Why? Amazon is so deeply ingrained into buyers’ shopping habits that they often assume Amazon offers competitive pricing. In addition, the combination of convenience, speed, and ease of use offered by Amazon are enough to outweigh price for today’s time-pressed buyers.
I often recommend that, when setting their Amazon 3P retail pricing, manufacturers and brands respect and follow the retail pricing approaches of their resellers. In other words, marking retail prices at a level that helps support all of your channels and does not degrade the overall retail pricing on your products. Remember that Amazon is now the starting point for almost 70% of product searches in the United States, so your pricing approach should be carefully thought out. Coming to market with lower retail pricing can negatively impact profit margins and create channel conflict (for a more in depth discussion on channel conflict and how to address it, check out my book Billion Dollar B2B Ecommerce).
So, when you net all of this out, if your product cost is in the range of 20 to 30% of your retail price (70-80% gross margin), I typically see net (fully loaded) operating profits of 20 to 30% from Amazon 3P programs. Not bad, eh? Note that this profitability is against RETAIL prices (NOT wholesale prices), so your absolute contribution margin dollars should be at least twice those you receive in selling through wholesale channels (including Amazon 1P selling). This is really important to understand, as manufacturers usually get confused by these percentages. Look at the absolute dollars (not only the percentages).
If you aren’t hitting these types of profitability numbers with Amazon 3P, you need to take a close look at how you are managing your inventory inside of Amazon’s FBA program, what the cost of goods is on your product you are selling through the channel, and how tightly you are managing your Amazon Advertising program. These are the major risk areas for your profitability in a 3P program, and if they are not well managed, they can sink your margins.
If you need more help in figuring out how to sell on Amazon, Enceiba is here for you. Email us at brian@enceiba.com and let’s talk Amazon strategy!