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Navigating Amazon advertising costs for maximum ROI

Until recently, companies who wanted to achieve higher profits would primarily focus on increasing sales as much as possible.

Author:

Ann Imke

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In this simplified advertising attribution model, a €10,000 investment generated €100,000 in revenue, resulting in an attributed profit of €90,000. This translates to a Return on Ad Spend (ROAS) of 10 or an Advertising Cost of Sales (ACOS) of 10%.

While production cost and fixed costs, such as employees, office spaces, and production facilities are normally included in ROI calculations, businesses often fail to account for other flexible costs involved in running their businesses, especially those directly tied to activities such as sponsored ads, where the variable costs adjust with the scale of production or sales.

Let's apply this to an Amazon business example:

Imagine a business produces an item which costs €10 and sells it to Amazon for €30. The production cost of €10 is a variable cost. However, when assessing media return on investment (ROI) the calculation shouldn't stop at production costs.

Let's take fees imposed by Amazon, such as shortages and chargebacks, which are often variable and linked to logistics performance. For instance, when products need to be repacked by Amazon, the vendor must pay additional fees.

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Other variable costs include price claims and co-op agreements, which add to expenses with each product sold.

Though, it's not just costs that need to be considered to get the whole picture. Investments in advertising measures such as Amazon sponsored ads, Amazon DSP, and retail promotions are another cost which affects a product's profitability.

However, there's a reason why these costs often get “lost". They are typically managed separately by different teams—production costs within the finance team, Amazon costs within the key account team, and advertising costs divided between marketing and key account teams.

This division of responsibility keeps these different teams from having a comprehensive understanding of the true impact of business activities. To navigate this landscape effectively, businesses must instead consider all these elements collectively to understand the costs associated with products and investments.

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Calculating Profit Margin for Informed Investment Decisions

Calculating profit margin is an essential first step before venturing into any media or retail promotion activities. Here are a few tips you should consider when making this calculation:

Use adjusted shipped COGS (Cost of Goods Sold)

Shipped COGS is the cost of goods sold based on the list sales price, adjusted for returns and attributed to the day of shipment. This price is before adjusting for contractual conditions granted to Amazon. Cost of Goods needs to be adjusted for those to get the actual profit margin generated for your business. Using adjusted shipped COGS is important for a few reasons:

Using the adjusted Cost of Goods is critical because it reflects the negotiated terms and conditions with Amazon. For instance, if a product is listed for €30, but after a 30% discount, the actual sales price is €20. Reporting might still show €30 - but adjusted shipped COGS will be accurate.

Adjusting for returns is also important, since a returned product is treated as if the sale never occurred. Unlike sipped COGS, advertising metrics do not account for returns.

Shipped COGS is attributed to the day of shipment. Sell-out data is a more relevant metric than sell-in to understand how revenue from sales will be affected by media investment time frames.

Consider all additional costs

Aside from your production costs, be sure to account for other cost types before you invest in advertising.

When calculating profit, your negotiated terms and conditions with Amazon, which typically range from 5% to 30%, need to be deducted.

For a comprehensive picture of your profit margin, you also need to subtract Amazon's costs.

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Track the profit margin of all products

Understanding each of your product's profit margins is pivotal because it provides the baseline for making informed decisions that align with financial goals and product profitability. This includes determining how much budget can be allocated to advertising activities.

You should implement a process for all products with a structured system for product classification. Amazon tools, such as Catapult, facilitate the upload of tax or classification data, ensuring that pertinent information is accessible throughout your organization. Plus, these tools can ensure that the exact profit margins for each product are accessible to all relevant teams.

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You can simplify your product classification into categories like "high profit margin," "low profit margin," or even "invest" versus "avoid investment."

This allows for a more manageable and actionable overview so you can make better decisions. For example, you may reduce investment in products with lower profit margins or choose to invest more heavily in high-margin products.

Align on goals and measurements across teams

Once there is a clear understanding of the margin for all products, an overarching strategy can be developed regarding growth, profitability, and product positioning. Additional decision-making approaches, such as a BCG matrix, can be used to sort through the identified categories and set goals for your products.

Based on these decisions, all relevant teams (such as marketing, key accounts, and logistics) should be aligned on the specific goals for each product category. While an initial product classification requires effort, a company-wide alignment is well worth it.

To implement the strategy effectively, all relevant teams (such as marketing, key accounts, and logistics) should be aligned on the specific goals for each product category. And then, the bigger challenge: These different departments will need to communicate with each other properly on an ongoing basis despite different goals and ways of working.

Automation is essential to create cohesion across different teams. We've developed customizable dashboards that combine both product classifications and live data from multiple departments into holistic overviews, ensuring that different parts of the company can stay aligned and easily “speak the same language” when pursuing overarching company goals.

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 Refining Sponsored Ads Calculation for Precision

Let's revisit the sponsored ads calculation from above, accounting for the full picture of the profit margin. We can again assume €100,000 in Amazon revenue and take the €10,000 media investment from the first example, which results in an ROI of €90,000. Now we can take other costs into account:

Returns:

Since returns aren't factored into sponsored ads and DSP activities, it is necessary to deduct 8% (in this instance, €8,000) from the attributed revenue to account for returns.

Amazon's Margin:

Crucially, Amazon reports attributed sales to the net sales price, not the actual revenue. Considering Amazon's margin, typically around 30%, only 70% of the revenue is left after accounting for their margin. To simplify, we deduct 30% (€30,000) from the €100,000 to reveal the actual revenue.

Production Costs:

Assuming that the product is sold to Amazon at a fourfold markup from the production cost, we deduct 25% of the cost of goods.

Incrementality Score:

Your investments in advertising may not be responsible for all resulting sales, as some customers would have made a purchase even if they didn’t encounter your ad. This scenario is particularly relevant when advertising on branded keywords. When a customer searches for a well-known brand name, it is highly likely they would purchase that brand regardless of ad exposure.

You can use incrementality scores, expressed as a percentage, quantify this concept. Assuming a realistic score of 90%, it implies that out of €100,000 in revenue, €10,000 would have transpired without the ad, necessitating a deduction.

Additional Costs:

Amazon charges for a variety of cases such as chargebacks, shortages, co-op agreements, and price claims. These are incurred with each product sold, meaning the more is sold, the higher these costs become.

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In this case, the resulting ROI stands at approximately 3.3, rather than the score of 10 which resulted from the first calculation. By comprehensively breaking down all relevant costs, you gain clarity on the impact that sponsored ads have on your return on investment.

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With this overview, you can isolate your media ROI by accounting for returns and incrementality in your calculations. In our example case, you can add +0.8 to your ROI to account for the €8,000 from returns and +1 to account for the €10,000 of revenue which was not incremental. This results in a ROI of 5 for the media spend.

Alternative Avenues for Enhanced ROI in Media Investment

Now that you understand how to accurately deduce your true ROI for your media investments, what other steps can you take to maximize your ROI?

Firstly, keep return rates in mind. By strategically advertising products with lower return rates or addressing return issues effectively, the company in our example case could have potentially saved up to €8,000.

Secondly, increasing advertising incrementality makes it possible to improve your ROI. You should strive to allocate your investments so that you get the most impact from what you choose to spend.

Because the impacts of these optimizations are not visible in Sponsored Ads metrics, collaboration between key account teams and advertising teams is crucial. Only with a holistic view can you understand how these additional factors impact your ROI and make decisions about how to strategically reduce costs and make the smartest advertising investments.

In summary – if you fully understand your costs, maintain an overview of the products which have the most potential, and ensure coordination across your teams, you will be able to know your true media ROI – ultimately allowing you to focus both your investments and effort where they will have the most impact.

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Putting the pieces together

Interested in putting your data insights into action? If your current tool stack doesn't provide you with a real-time overview that bridges departments to ensure seamless alignment of advertising, key account, and retail data, you may be interested in Catapult. Our tool, designed using insights from Amazon vendors, provides a centralized dashboard that automatically transforms Amazon data into an actionable view of your performance.

This is particularly crucial for manufacturers whose operations span multiple countries and have diverse product categories. Here, you need to combine seamless global integration with a system that facilitates easy categorization and comparison. And of course, you need your insights in real time. Catapult can help with all of that.

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