If you are an eCommerce business, you must read this article to understand:
- What is Overhead Cost?
- What are Different Types of Overhead Costs?
- Why Should an eCommerce Business Reduce Overheads?
An eCommerce business may have fewer overhead head costs to incur as compared to physical stores. However, it is important to control or reduce overheads so that these do not impact the bottom line of your business. Further, you need to understand the types of overhead expenses to know what to regulate and how much so that these do not impact your business growth.
Also, it is typical of eCommerce store owners to confuse operating expenses with overheads. However, these are two different costs that you incur to run your eCommerce business.
Further, you must know the type of overheads that you have to incur as an eCommerce business. Most of the eCommerce overheads might not be visible on the outside. However, these exist and if left uncontrolled can eat into your profits.
Let’s first understand what are overhead costs and how are these different from operating expenses.
What is Overhead Cost?
Overhead costs are the cost that supports your business activities but are not directly linked to the production of goods or services. These are expenses that you incur to run your business. However, these do not include direct costs that are linked to producing goods or services.
They appear on the income statement after all the direct costs of production have been deducted from the sales revenue. Further, these are categorized into selling, administrative, and distribution expenses and are of various types. That is, these can be fixed, semi-variable, and variable.
In addition to this, you as an eCommerce business are required to pay these expenses continuously irrespective of whether you are producing or selling goods or services. For example, for your eCommerce business, you will have to pay hosting fees, employee salaries, etc on an ongoing basis regardless of how much you are producing or selling.
Now, to understand what expenses can be controlled and how much, you need to categorize your eCommerce overheads into fixed, variable, and semi-variable costs.
What is Included in Overhead Costs?
As mentioned earlier, you as an eCommerce business pay overhead costs regardless of how much you are producing or selling. These expenses may not be directly linked to the production of goods or services. But they are necessary to carry out business operations and reflect on your income statement. That is why it is important to keep a check on the overhead costs of your eCommerce business as they impact your net income.
Net income is determined by deducting both operating expenses and overheads from your eCommerce business’s net revenue.
Now, these overhead costs are further divided into fixed, variable, and semi-variable costs.
1. Fixed Overhead
Fixed overheads are costs that remain unchanged with the change in the level of production or sale of goods or services. That means, as an eCommerce business, these are the costs that you have to incur regardless of the level of your business activity.
Fixed overhead examples in the case of an eCommerce business include:
- the warehouse rent you pay to store your goods
- weekly or monthly payroll
- depreciation of equipment
- rent for office
- hosting fee you pay for your eCommerce website
- the subscription fee for eCommerce platforms like BigCommerce, Shopify, etc.
- internet access cost
Since these are costs are fixed in nature, they help in determining some important metrics like the number of sales at which your eCommerce business will break even.
2. Variable Overhead
As the name suggests, these are overheads that vary or change with the change in the level of output or sales. That is, they increase with an increase in production or sales of goods and decrease with a decrease in the production or sales of goods.
Variable overhead examples in the case of your eCommerce business include:
- shipping and handling costs
- amount paid towards payment processor’s fees (like Stripe, PayPal)
- utilities like electricity bill
- affiliate and influencer marketing cost
- social media marketing cost
- contractual employee payments like a designer, developer, social media expert, etc.
3. Semi-variable Overhead
Semi-variable overheads are the costs that are a mix of fixed and variable overhead. Part of these expenses is fixed and part of it changes with the change in the level of production or sales.
For example, you may have to pay Mailchimp, an email marketing tool a fixed cost towards the plan and pay them over and above this fixed cost based on the contacts to whom you have to shoot out emails.
For instance, your base plan may include emails for up to 500 contacts. As and when your contacts increase, your cost for email marketing increases.
Likewise, some of the other semi-variable costs for your eCommerce business include:
- The pay-per-click cost that requires you to pay the base charge and then the cost as per the number of clicks on your advertisement
- Fulfillment By Amazon charges a basic fee for the plan with the cost increasing with the quantity of inventory being managed.
Why Should Your eCommerce Business Reduce Overheads?
eCommerce businesses have fewer overheads any day when compared to the physical store owners. Yet, there are sudden overheads that may look obvious and meager on the outside. Similarly, certain overheads may be hidden and therefore must be tracked and controlled as they may come in the way of your business growth if left unchecked.
Typically, as a business owner, you must always focus on reducing costs for better profit margins. For instance, you may be using a premium or custom plan for web hosting. Whereas your eCommerce store can run on a lower-priced web hosting plan.
Likewise, there can be certain software that you might have purchased but may not be using them. These could be a project management tool, design tool like analytics tool, etc.
Thus, it is important to predict your overheads to understand what expenses can you cut down on. It will also help you to figure out overhead cost reduction strategies that you can adopt.
1. Firstly, put down all your eCommerce overheads like web hosting fees, salaries, rent, the software you use, etc.
2. Next, divide these expenses into fixed, variable, and semi-variable costs. As mentioned above, expenses like warehouse cost, office rent, salaries, internet access cost can be categorized as fixed. Similarly, shipping and handling costs can be put under variable cost. Likewise, email marketing tool costs can be taken as semi-variable costs.
3. Once the overhead expenses are listed and categorized, the next step is to figure out expenses that you can easily cut down on. For instance, you may be paying towards an analytics software which does not need as of now. Or you may be paying too much towards web hosting where a less expensive plan or option can work equally well for you.
4. Finally, based on these expenses, see how much amount would you need to meet your overhead expenses including fixed, variable, and semi-variable costs.
How to Reduce Overhead Costs for Your eCommerce Business?
Now that you are aware of the eCommerce overhead costs, you should also beware of strategies to reduce overhead expenses. Although you may already be taking certain steps, here are certain ways in which cost reduction in eCommerce business can be done.
1. Track Your Overheads
One of the critical ways in which you can reduce overheads for your eCommerce business is by tracking your overhead expenses. You may think that keeping a check on software tools that cost a few dollars a month wouldn’t help much in reducing overheads. However, these small expenses pile up eventually to impact your bottom line and growth.
Let’s say you have an online accounting software integrated with your Shopify eCommerce store. Since you are self-employed, you are a freelancer, or a basic starter plan with one user may be as good to maintain your bookkeeping and accounting.
However, you have subscribed for a plan that is good for a firm that needs access for 2-3 users. Thus, a smaller plan may be good to track your expenses, inventory, manage receipts, sales, identify trends, and generate useful reports.
Similarly, you may be using an expensive hosting service where a cheaper one can prove to be as good. Therefore, keeping a close check on your eCommerce overheads can help you identify avenues where you can cut down your expenses without impacting your eCommerce business’s operations.
2. Look into Shipping Costs
We have seen eCommerce businesses facing a major challenge with shipping charges. Often, customers are convinced to buy your products. However, they have incomplete transactions in their shopping cart because the shipping cost is one aspect of the product price that they are not willing to pay. So get customers to buy your products, you may be offering them free shipping.
And you may be using shipping solutions like ShipBob for reliable shipping to your customers. Now, offering free shipping as bait may get you, customers. But, make sure that the shipping charges do not severely impact your profit margins and other key performance metrics.
Therefore, it is important to look for various shipping solutions before going for one that is the best fit for your business. Similarly, you may go for multiple shipping solution providers if you are shipping products both outside your country.
3. Regulate Your Packaging Cost
Packaging is one of the critical aspects of your eCommerce business. Poor quality packaging can add to the expenses instead of saving costs in the long run.
Protection of items is si the sole motive of packaging them. And especially in the case of items that are fragile and need to be handled with care.
Poor packaging results in breakage and return orders which can be a huge cost for your eCommerce store. That’s why, considering inexpensive packaging may not always save you money.
Likewise, using packaging cartons that are huge and filled with excessive packaging material to avoid breakage may add up the additional cost.
It’s not just the boxes but the contents inside like fillers that are put to protect the items from spoiling or breakage. Make sure you’re not overdoing it. Similarly, it’s always cost-effective to source these fillers from a single vendor over sourcing different things from multiple suppliers. This is because a good relationship with a single supplier can help you to place bulk orders and achieve economies of scale.
Not only this, but you can also replace these cartons with customized mailing bags in case you are sending clothes. They can fit in easily in a mailbag and won’t need these bulky cardboard boxes.
4. Concentrate on Best Sellers
Many of the eCommerce store owners are under the myth that the more variety they offer, the more revenue they will generate. There may be certain items that sell instantly, while there are others that keep sitting in your warehouse for months before they get sold.
Now, items with large turnaround times simply add to your overheads. This is because you have to incur storage costs. Thus, it’s better to sell products that customers want and such items in bulk.
As you know, not all items sell as well as the best sellers. As the 80/20 rule says, 80% of your total revenue comes from 20% of your items. And these items are the best sellers.
Therefore, identify the items that are high in demand and drop the items that simply sit on your shelves and add to the overheads.
5. Expand to Current Customers
As is said, it is more costly to acquire a new customer than to upsell to the existing customers. This is because as an eCommerce business, you will spend money on advertising, sales, and marketing to gain visibility and come into the eyes of potential customers.
However, your existing customers know the quality of goods and services you offer and would be willing to buy more from you. Two of the key metrics that are measured by eCommerce businesses are the Customer Acquisition Cost (CAC) and Customer Lifetime Value (CLTV).
Now, it is important for you as an eCommerce business to cover CAC during the time tie customer shares the business relationship with. Covering CAC also means that you break even as a business. However, if a customer leaves before you can cover the amount spent to acquire him, you end up spending more than earning from that customer.
Whereas, retaining existing customers is cost-effective because you don’t need to spend money on educating them about your products or services. Thus, you can offer them incentives like product discounts, coupons, etc through your website, email campaigns, and social media platforms.
6. Leverage Discounts
Many times, the software tools or services that we use to run our eCommerce stores roll out their offerings at discounted prices.
For instance, if you use Asana for internal management, you can see that buying an annual plan is cheaper relative to the monthly plan. If you see carefully, a premium plan for Asana would cost you $10.99 per month. However, if you go for a monthly purchase, it would cost you $13.49 per month.
Similarly, many SaaS applications like online accounting software that you integrate with your eCommerce store come up with clearance sales. During these times, the products are offered at huge discounts. Which you must encash on.
Thus, there are several ways in which you can be offered discounts on these software tools and services. These could be:
- holiday season sale
- discounts on payments to vendors before time
- discounts on bulk orders, etc.
7. Check Inventory Frequently
Another key strategy to reduce overheads is to track your inventory regularly. This is because it helps you to identify trends and know the best-seeling and least selling items on your shelf.
Such valuable data helps you to know what to order when to order, and how much to order. Thus, you can anticipate the demand and forecast the quantity of inventory you need to avoid excess inventory or insufficient inventory.
Where excess inventory of a least-selling item would add to storage cost, insufficient inventory will make you lose the opportunity of sales to the competition.
Also, there may be instances where an inventory check may reveal that you have excess inventory that is still unsold. You can adopt various strategies to get this unsold inventory off the shelf.
For instance, you can give discounts, bundle them with bestsellers, and make space for fast-selling items or best sellers.
8. Look into Freight Charges
Many online store owners purchase the items to be sold from various locations across the globe. Now, such sourcing of items needs to be checked as it may cost you more. As a result, you may not able to keep a good profit margin on such items.
Now, there are a host of factors that can impact the transportation cost you incur to get these items.
- quantity of items you order as ordering smaller quantities turns out costly. You should always place bulk orders.
- the location from which you’re sourcing your items
- weight and size of packaging
- whether you’re getting them shipped or transported by air.
Advantages of Cutting Overhead Costs in Ecommerce Business
There are several advantages of cutting overhead costs in your eCommerce business.
- Tracking overheads and making efforts to reduce them translates to higher returns. As discussed above, variable costs like shipping, packaging, etc need attention for better profits and growth.
- The overhead cost that you save on can be used for gaining visibility for your eCommerce store to get more customers. For instance, you can go for paid promotion, use that for content creation, etc.
- Tracking overheads can help you identify trends in terms of which items are sitting on the shelf and add to the storage cost.
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