Maybe you shouldn’t advertise that product!
Advertising can get you sales but it doesn’t necessarily make you money. This is because of the cost of building your product, shipping it, Amazon fees, and your advertising cost of sale can exceed your selling price. We’ve developed a three step approach to help you figure out if you should keep running ads. You can run this on your own, but Seller Ascent AI does it for you automatically 60 days after add a product to advertise.
Before you begin your analysis it’s important that you set up your product for retail success. Second, make sure you run - and optimize - single-ASIN campaigns for your product, for about 30-60 days.
Apply these three tests to see if you should keep advertising
We apply these tests in the order of the confidence they give us in the economic value of ads, with test #1 being the most clear signal. The three key tests, or questions, you need to answer to keep advertising are:
- Are the ads profitable on the first purchase?
- If not, do the ads acquire customers whose lifetime value justifies the spend?
- If not, do the ads increase total account profit beyond what they directly attribute?
Test 1: Advertise if your ad campaigns are profitable
Look at your campaigns overall: if your Advertised Cost of Sale (ACoS) is less than your Contribution Margin fraction you’re profitable. ACoS is calculated as ad spend/ad attributed sales. Contribution Margin is the money you make after all your expenses but before ads. We’re using Contribution Margin here, not just Landed Cost (product cost plus shipping cost), because you need to add up all of your typical costs, such as inventory holding costs, seller fees, coupons/promos, average losses due to returns, and so on. Seller Ascent uses Amazon’s SKU Economics Report to assess your Amazon fees, which we add to your Landed Cost of Goods to estimate your contribution margin fraction.
A trivial example of computing contribution margin and testing would be:
Contribution Margin fraction = (Price - Landed Cost - Amazon Fees - Other variable costs) / Price, e.g. 30%
ACoS = Ad Spend/Sales, e.g. 25%
→ Continue advertising
If the test passes and you should continue advertising, what's the next step? If your budget isn't lasting the whole day, then increasing budget will often unlock more sales at similar performance. However, if you're not running out of budget then you’ll have to increase bids or add targets to gain additional sales. These increases and additions could increase your overall ACoS - decreasing your profitability - so you have to proceed carefully and make incremental changes, comparing ACoS to Contribution Margin fraction as you go.
Test 2: Advertise if you can acquire customers with profitable long term value to you
If your ACoS is above your contribution margin you may still make money from ad-attributed sales if customers buy more than one product from you over time. The classic example of this pattern is selling razor handles cheaply and making money on razor blades: you can afford to sell the handle at an advertising loss because the customers will buy razors over time and you will make a profit in time. However, if your customers only buy a single product from you, this test doesn’t apply and you should rely on test #3. There are multiple ways to think about the customer acquisition cost comparison, but we think you should treat the “Lifetime Value of a Customer” (LTV) as the average full lifetime profit including first purchase. Compare this value to the cost of acquiring a new customer - the difference is the profit you will recognize in time.
To calculate your LTV, you will need to look at your historical sales and see how much each customer spends. This will be a little work, but it will be worth it because you’ll have a real benchmark for what you can afford to spend on marketing to acquire a new customer.
Then, use Amazon’s New To Brand metrics, which are available at the sold-ASIN level in the Sponsored Ads reports, to see how many new customers you acquired for your ad spend. Amazon’s New-to-Brand metrics are a helpful proxy, but they are still attributed metrics, not a perfect measure of incrementality. Use New to Brand to calculate Customer Acquisition Cost, or CAC:
Customer Acquisition Cost = Ad Spend / number of new customers
If Customer Acquisition Cost is less than the LTV of the customer, you’re likely profitable.
If you’d like Seller Ascent AI to optimize your ad spend and campaigns towards LTV for you, all you need to do is update your Brand Strategy in the Settings to say “Optimize my campaigns towards my customer lifetime value, which is $X for each new customer.” We’ll take care of the rest.
Test 3: Consider advertising if ads are growing the overall account faster than ads alone
The third approach - and we do see this play out - is to test whether driving direct ad-attributed sales increases NON-ad-attributed sales. There are a few factors that can drive this behavior: you might pick up new reviews. The impressions you’re generating but not paying for (since you only pay for clicks with the Seller Ascent CPC focus) are driving increased consideration. Increased traffic to your detail pages drives performance of Amazon Ads’ click and conversion probability algorithms. The key is to figure out if it works and if it’s efficient.
To apply this test, look at your total sales of a product for the past 30 days compared to the previous 30 days. Ideally you’d also look at the same period in the previous year, because you’re trying to ensure that holidays or special events are not inflating your comparison. Exclude out-of-stock or not-winning-buybox days. You’ll also need to make sure that other factors are the same, such as pricing or promotions or listing differences.
When you’ve controlled for these factors, you can ask: how much more did overall sales increase beyond the ad-attributed sales? If your total sales are up $200 period over period, and your ads drove $100 on sales, you may be influencing organic sales, because you picked up an additional $100 of sales period over period. The key is then to look at your Total Advertising Cost of Sales, or TACoS: is your total ad spend reasonably less than the contribution profit generated by the total sales of that ASIN? If so, you made money.
You also want to monitor your search rank and your overall position within search terms in the Brand Query Report available in Seller Central. Improvements in your search rank and increasing the fraction of clicks you receive for searches are good indicators of future success.
Should you advertise that product or not?
If any of these tests passed, you should likely continue advertising. Your next step is to incrementally increase budgets and refine targets to achieve more of the same level of performance.
If you answered no to all three questions, then your product and ad campaigns are not yet set up for long term growth. You don’t necessarily have to stop selling on Amazon, but pause your product ads in Seller Ascent and set up your product for success.
Sometimes this high-level overview is what you need to identify a systematic change in your campaigns - for example, perhaps choosing not to spend on display or broad sourcing terms would be enough to make your ads profitable. If you or the AI notice patterns like this, it’s worth making changes and re-running the tests after a week or two.
What if I want more help?
Feel free to schedule time with us. Or, talk to the Seller Ascent AI and it can help you understand these ideas in the context of your current product performance.