Do you need to make a profit on every sale? (consider buffet pricing and definition of profit/customer)—
Rags Srinivasan (@rags) February 01, 2013
I gave a one word answer only because this is a question that requires a yes or no answer and likely most won’t be paying any attention until it is answered with simple yes or no. Now that is taken care of let us look at the 50 shades of NO. As usual I don’t have answers only more questions that you can ask to arrive at your own answer.
It depends on what we mean here by “every sale” and “Profit”.
Does every sale here mean sale of each item (or SKU) treated in isolation from the rest of the basket? Is there a basket of items – complements and other unrelated products – or there are only individual units? Is this a transactional sale with customer buying once and never ever buying another item or are there repeat businesses – for more of the same or complements (razor and blades)?
Profit is easy to compute, it is revenue less costs. Profit per sale is easier as well (or is it?) – revenue from that sale less cost of sale. If you ever sell only one product once to a customer whom you will never see, hear or feel the impact of (ahem, Social Media, WOM), then YES, you need to make profit from each sale.
Except profit per sale is the wrong metric because of the points I raise above. The right metric is profit per customer (customer margin). It is the total revenue from a customer from a transaction (for the basket of goods) less the total marginal cost to serve them. Taking it further, it is the total lifetime revenue from a customer less the total marginal cost to serve them during their stay with your business.
But customer margin is not so easy to compute because we need to know all the revenue elements – all complements, incremental sales, now and later, and the truly marginal costs that are attributable just to this customer.
All the revenue sources must be properly quantified and not based on wishful thinking. You can complicate this further with other fringe benefits from a customer like referral sales (if you can quantify them).
The marginal cost needs little more explanation – the cost your business incurs just for this sale and otherwise would not incur. It is not the same as dividing all your costs equally among all your products (or customers).
In cases where there are incremental sales – now or future – it is okay to not make profit on each item as long as it would result in overall total profit from sales that would not have happened if not for selling this item at “loss”. The point to note here is to ensure that you considered all opportunity costs of selling an item at loss.
Let us look at these concepts in the context of running a promotion – Groupon promotion.
Say you run a 50% off promotion for your cupcake that sells for $4 and costs $2 to make. I addition to selling it for $2 you give $1 to Groupon meaning you will lose $1 ($4*.5-$2-$1) on each cupcake sold.
If you will never see (or feel) these Groupon deal seekers again then you are doing it wrong.
If their visit results in incremental sales in the first visit that results in total over all profit or repeat visits that result in overall lifetime profit then you are okay (assuming you have carefully considered other factors).
So the right question is not about profit on each sale but,
Do you worry about customer margin?