Summary
In this episode of the Ecommerce Finance Podcast, Stephen Brown and Kelley Birrell discuss the financial implications of tariffs on businesses, particularly in the ecommerce sector. They explore how tariffs affect cost structures, profitability, and pricing strategies, emphasizing the importance of understanding customs value and elasticity of demand.
The conversation also covers potential strategies for managing increased costs, including supply chain adjustments and efficiency improvements, while providing insights into the current economic landscape for ecommerce businesses.
Download the FREE Tariff Impact Calculator: https://ledgergurus.com/portfolio/tariff-impact-calculator/
Takeaways
- Tariffs are impacting businesses in real-time, requiring immediate decisions.
- Understanding customs value is crucial for calculating tariff impacts.
- Higher cost of goods sold leads to greater profitability challenges.
- Elasticity of demand plays a significant role in pricing decisions.
- Businesses must consider whether to absorb costs or pass them on to consumers.
- American manufacturers may benefit from increased tariffs on imports.
- Supply chain adjustments can be complex and time-consuming.
- Efficiency improvements are essential for maintaining profitability.
- Businesses need to scrutinize their spending more than ever due to rising costs.
What We Cover:
00:00 Understanding Tariffs and Their Impact on Business
09:48 Strategies for Managing Increased Costs
20:22 Analyzing Price Elasticity and Consumer Behavior
29:52 Exploring Alternatives and Future Considerations
Work with LedgerGurus
If you need help with your ecommerce accounting, reach out to us at LedgerGurus. We are an ecommerce-specialized accounting firm, and we can handle all your numbers so you can focus on growing your business.
Transcript
Stephen Brown (00:00)
Welcome to the eCommerce Finance Podcast. I’m your host, Stephen Brown, COO at LedgerGurus. In this episode, I have Kelley Birrell with LedgerGurus Marketing. And today we’re going to talk about a financial approach to responding to tariffs. Kelley, you’re back again.
Kelley Birrell (00:14)
I am. And every time I come on here, I learn more and more.
Stephen Brown (00:18)
All right. This is going to be kind of an episode where I’m going to do a lot more of the talking. Kelley’s going to be the one to ask me questions. So one of the things that I’ve been thinking about as the tariffs are rolling out fast and furious is how, how do I make a decision about what to do? Right. for some customers who are importing from China, that, that decision is happening immediately, but I expect almost everybody that’s importing products is going to have to make a decision around how they want to respond to tariffs because of the massive amount of changes that are happening on almost a real time basis.
So the first thing we got to think about is, you know, how do tariffs apply to financials, right?
Kelley Birrell (00:58)
So I actually have a question right off the bat. I’ve been noticing that a lot of these tariffs have been moving forward, but then there’s been a bunch of delays as well. When do these things actually start to impact businesses?
Stephen Brown (01:10)
That’s a great question, Kelley. and I think this is part of the chaos, right? Is Trump is signing executive orders and then we’re seeing like customs and border patrol, USPS who is processing a lot of, orders that are coming from China via the de minimis exception. They’re like, can’t handle it. It’s so it’s too much.
So what we’re seeing in different cases, like the case in point is the de minimis rule, which was the rule, the exception under $800 that went away for a hot second. And then a bunch of the people that are processing those said, we’re not equipped to process the changes in the rules. And so that has been postponed while they can get their processes in place. In other cases, like in the case of Canada and Mexico.
They must’ve said the right things enough to get a month delay. But what I am thinking about if I’m importing anything from anywhere is there’s a chance that you could see an increase in tariff tomorrow with almost no notice. And so now is the time to start thinking about how to approach a tariff that may or may not happen at any time with very little warning and not lose your business. So let’s get into that. The first thing I think about is from a cost perspective, let’s take 10 % because it’s a nice lovely number. It’s also the number that’s being used with the imports from China. If I have an additional 10 % on my tariff, how is that going to apply to profitability?
Kelley Birrell (02:29)
Yeah. This sounds so crazy.
Stephen Brown (02:53)
So there’s this concept of customs value.
Kelley Birrell (02:55)
Okay, I’m really interested. know that I’ve heard about customs value a lot recently, but I’m not sure that I completely understand what it is.
Stephen Brown (03:02)
I didn’t know what it was either until recently. So customs value basically is, the value that customs and border patrol uses to apply the tariff to it’s product costs plus insurance plus international freight. It’s the majority of your cost of goods sold. If you’re importing your products from say China, there is what would not be in your product cost of goods sold is you’re shipping from your port to warehouse if you are buying materials from other locations that aren’t being tariffed. But what we see with lot of ecommerce companies is they’re buying heavily from China. So the majority of that cost of goods sold is going to be tariffed, minus those little exceptions that I talked about. So let’s just take an example, a very efficient cost of goods sold business. Let’s say your cost of goods sold is 20 % of your sales. And that’s probably about as good as I see it, sometimes a little bit better. And let’s say the majority of that, let’s just for round numbers, keep it at 20%. Let’s say the other costs are negligible. A 10 % increase of tariffs would, you would apply that to your cost of sold. So your cost of goods sold, instead of being 20 % of your sale, it would now be 22%, 22%.
Kelley Birrell (04:20)
22 % yeah. okay
Stephen Brown (04:23)
So, this is kind of how I to do the math is, and obviously if we’re doing real numbers, if it was $10 million and I million of cost of goods sold and that tariff applies to that, it’s an extra 200,000. But I wanna talk in terms of ratios because it’s a better way to think about your financials. So that 2 % has to hit somewhere. Let’s just use this for a starting point. If you do nothing,
That’s going to flow down. Let’s say you had a 10 % net income and you don’t want to pass that additional cost along to your customer. That’s going to hit your profitability. It’s going to go down by 2%. Now your, what was 10 % profitability is now 8%. And so the first thing you have to think about is how that, that tariff applies and what, how that flows down to your bottom line profitability. Because it’s, it’s kind of hitting in the middle of your profit and loss statement.
So that’s point number one. Now, obviously that impact is going to be a lot more significant depending on how much of your share of income your cost of goods sold is. So if you’re a reseller, usually your costs, like you’re not doing anything that’s your own branded trademark patented product. Your cost of goods sold is usually a lot higher. I’ve seen it 60, 70%.
Kelley Birrell (05:44)
So these businesses are gonna be taking it in the teeth if they don’t pass the cost along in any way. Like the profitability is gonna go to practically nothing.
Stephen Brown (05:51)
Correct. Potentially, right? So let’s take a 60 % cost of goods sold business, which is not uncommon for resellers or highly commoditized goods. So that 10 % tariff is now gonna take 6 % out of your bottom line. And that’s using the China 10 example. I think what’s freaked people out about like Canada and Mexico, is they were talking about 25 % tariffs. So if you take that 25 % number and go through our examples, if I had a 20 % cost of goods sold business, that’s an additional 5 % points of expense. And if I had a, let’s say a more extreme end, like a 60 % cost of goods sold business, that’s a 15 % additional cost that I’ve got to manage within my business.
Kelley Birrell (06:41)
Wow.
Stephen Brown (06:41)
So the, you know, 10 % is somewhat manageable. 25 % is really painful. And it seems like those are kind of the numbers that we’re seeing tossed around as 10 to 25%. The other thing we’re hearing a lot of this week, the week of Valentine’s, right? So happy Valentine’s is this concept of reciprocal tariffs where they’re talking about looking and saying, Where have we been tariffed? Okay. We’re just going to apply a reciprocal tariff, on that country as well. And there, we’re not really sure probably by the time this episode is published, we’ll have a better understanding, but that could come in form of, you know, specific categories of products. could come at a country as a whole. So, you know, we’ve decided that on average you’re tariffing our products 5%. We’re going to apply 5 % to everything that, that we import from your country. So that’s that is another concept. So the amounts could be below 10 percent. We haven’t heard anything higher than 25 percent, but that 10 to 25 is a good range with the possibility of some lower digits. But essentially the higher your cost of sold, the point I want to make here, the higher your cost of goods sold, the higher the impact to your bottom line.
Kelley Birrell (07:55)
Yeah.
Stephen Brown (07:56)
And so you’ve got to, that’s the starting point. So now you have a decision to make, right? Whether it’s a 2 % increase in costs or on the extreme example, 25 % of a 60 % cost of goods sold as a percentage of income, which would be 15%, I’ve got to decide what I’m going to do with that additional cost.
Kelley Birrell (08:20)
Wow, that, I mean, I’m just kind of in shock here. okay, so I actually want to step back just a little bit. It sounds to me, I’ve heard the idea of a terrafore coming around and like, what’s the benefit to this? What’s the point? Why are these companies? Cause it sounds like the countries are making these decisions, but are they thinking about the businesses that are in these countries?
Stephen Brown (08:34)
You know…
That’s probably for a different podcast. Politicians like to say they care about the little guy and the consumer and the individual,
Kelley Birrell (08:46)
Okay.
Stephen Brown (08:53)
The decisions are being made in that regard. I’ll tell you what is a good, it is a good time to be right now. You know what that is? An American manufacturer, right? Because no, they’re going to have foreign goods are going to be a lot more expensive. So the competition’s going to decrease. So if you are manufacturing in the grand old US of A, this is probably one of the best things that has ever happened to your business. But that’s a pretty rare exception from what we’ve seen.
Kelley Birrell (09:01)
Manufactured. Yeah. Cause then you’re not dealing with any of this.
Stephen Brown (09:21)
We don’t have a lot of manufacturing capacity here anymore and the cost of manufacturing is higher. So that is the one area where it’s going to be potentially good. If anybody has any dollars left to buy stuff, because everything will probably go up in price, which gets us to the next thing. So what do I do? 2 % tariff or 2 % increase in costs or 15 % increase in costs. have a couple of decisions to make. Decision number one, I pass it on to the consumer.
And that’s what everybody’s talking about. Just pass it on to the consumer. Decision number two, absorb it. Decision number three, split the difference. So let’s talk through those three scenarios.
Kelley Birrell (09:59)
Yeah, because that as a consumer, the thought of suddenly all these costs going up precipitously is not exciting at all. But yet I can see how the businesses still have to make a profit. They still have to keep going.
Stephen Brown (10:07)
No. Correct. And this is the challenge of this kind of economic activity is it hurts a lot of parties. So let’s talk about decision one, absorbing that cost and how I would think about that if I was a business. So the first thing you got to think about is number one, can I even absorb the cost? would hope that most businesses, if you’re looking at an increase of 2 % of cost that you could probably absorb it if you chose to do so. I would expect very few businesses could absorb an additional 15 % of cost because I don’t see a lot of consumer products businesses that are doing over 10 % net profit margin.
Kelley Birrell (11:01)
What is a typical net profit margin for consumer businesses?
Stephen Brown (11:04)
Good question. If you’re doing 10%, you’re doing well. And if you’re doing 20%, you’re phenomenal. Like you’re in a really good category. Retail is, know, increasingly what we’re seeing is the profit margins of ecommerce is really looking more and more like traditional retail. And traditional retail has always been fairly low profit margins, but high volume. That’s the game of retail is you sell a lot, but there’s not a lot of profit margin.
You know, it’s about big dollars, uh, volume, not necessarily big dollars from high profitability because there’s so many costs. So I don’t see a lot of 20 % net profit margin businesses. And unless you’re making at least 15%, you’re going to have a hard, hard time absorbing a 15 % additional burden on your bottom line.
Kelley Birrell (11:39)
Yeah, that makes sense.
Stephen Brown (11:59)
So first thing is you have to decide is can I even absorb those costs? The second thing, and for a lot of people the answer is going to be no. The second thing you have to ask is do I want to absorb those costs? Now,
Kelley Birrell (12:11)
What would be the benefits of absorbing them?
Stephen Brown (12:14)
That’s a good question. One thought is like, you’re never like selling in a vacuum, right? Unless you’ve got some super duper unique product, there’s probably alternatives out there. And so one school of thinking would be I absorb the cost, let my competitors raise their prices, and then that’s going to result in more sales volume to me, which will offset those increased costs. my, well, it is, it is, and it isn’t, right? This is where we start getting into economic principles and theory. There’s this concept of elasticity, which is as prices go up, the demand goes down. If you are elastic and almost everything is elastic, especially in consumer products.
Kelley Birrell (12:43)
Sounds a bit iffy.
Stephen Brown (13:04)
but there, also have to think about this in context of a market and that there are multiple people that are selling alternatives to you. I mean, pick a category, right? Like there’s, there’s going to be a million t-shirts. There’s going to be a million supplements. There’s going to be a million skincare products. Right. And this is where we’re we’ve moved into an era of ecommerce where alternatives are everywhere. And there’s a good chance, especially if you look at Facebook marketing, I mean, think about you go and you search on somebody’s website and that their Facebook pixel triggers. And then you go on Facebook and you see their ad and you see everybody else’s ads that are like that product. And so when somebody’s buying and if they’re like trying to do research,
They might be like, well, I could do A or I could do B. And I think that’s, that’s, so that’s one, one thing you have to think about is do I absorb the costs and make up for it in terms of bottom line dollars through more cells volume.
The other option is to pass either all or part of the cost on to the customer. this is where I think you have to really think with economics in mind, because if you don’t, you may have an outcome you’re not expecting. And that is coming back to that, that concept of elasticity. So elasticity.
Kelley Birrell (14:28)
Basically meaning that customers may just say, yeah, that was a bit more than I was willing to spend. And I’m just not willing to buy that particular product anymore.
Stephen Brown (14:35)
Yeah. Well, let me give you good example that everybody’s seeing. Eggs, right?
Kelley Birrell (14:43)
I was thinking exactly the same thing. There’s not a lot of options eggs. Like you have to buy eggs.
Stephen Brown (14:50)
Yeah. So, eggs, you could argue is somewhat inelastic in that you’re like, I need eggs for my ingredients, but let’s, let’s kind of think through this. maybe instead of buying a dozen a week, I’m like, sorry, we don’t get to have eggs for breakfast. I need to save that for, for specific recipes, but I am going to decrease my consumption.
Because it’s just two days. mean, what is it? What are they? Seven. I don’t know what they are for you in Kansas, but I think they’re like seven bucks a dozen here in Utah.
Kelley Birrell (15:23)
It’s thankfully we always buy from like a Sam’s Club or a Costco. So we buy them by the five dozen and we get it cheaper, but we just spent 20 bucks for a box of five dozen eggs and I about died.
Stephen Brown (15:34)
Yeah.
Kelley Birrell (15:34)
And that was cheap in comparison to a lot of places.
Stephen Brown (15:37)
Yeah, yeah. so you think about it, what consumers will do, because here’s the thing you have to think about. It’s not like our wallets are elastic, right? It’s not like the amount of dollars are going to magically increase just because there’s tariffs. And so as a consumer, you’re making decisions. When I was in MBA school, I had a professor who had a really great
Kelley Birrell (15:47)
No, they’re not.
Stephen Brown (16:02)
way to teach some of the concepts of economics. And one of things he talked through was willingness to pay. And the concept of willingness to pay, he used a ski resort being here in Utah. And he had the class, he said, how many of you would pay $10 for a day of skiing at Park City? You know, there’s some people that don’t raise their hand. I don’t care about skiing. but maybe if you go low enough, almost anybody, maybe I guess. And he kind of ratcheted up the price.
And, he kept going higher and higher and less people raised their hands. And he said, this is elasticity, right? As you increase the price, the, demand, the amount of people that are willing to pay decreases. And I think as a retailer, you have to think about it. Like you, we have a big world, lots of people, lots of consumers, but that reality is there is that the higher the price, you’re going to shrink the amount of people that are willing to pay for your product.
Kelley Birrell (17:01)
Yeah, absolutely.
Stephen Brown (17:02)
So as you think about a price increase, for example, it’s not enough to just say, well, I’m gonna pass on the costs to the customer. You may have to, but how much of that can you pass on? talking about elasticity, there is different levels of elasticity. So a highly inelastic product, let’s say eggs, for example, because we use that example. That’s something where like, need eggs. can only, there’s certain recipes that they just require eggs. And so there is a level of willingness to continue to pay for that as the prices go up to a point, right? And so that is, you’re going to see the demand, the amount of people that are going to buy that stay somewhat static as prices go up to a point. On the other end, we have more highly elastic things. that would be, you know, think about like, I don’t know, like what’s for you, like what’s something like, what’s the first thing to go if, if, if things start getting tight, what things that you wouldn’t worry about buying. Close, close is a great example. Like, yeah, you’re just going to stretch it out a little bit longer.
Kelley Birrell (18:10)
probably clothes. I can just keep wearing what I’ve got.
Stephen Brown (18:17)
I think during where we saw kind of the supply chains and then the massive increases of pricing around cars, right? And people like, well, I’ll keep my, I’ll just fix my old, my existing car, drag it along. And I think one of the challenges of ecommerce is it’s heavily populated by what I would call discretionary purchases. Things that are, things that are nice to have, things that might be
Kelley Birrell (18:25)
Yep. Vehicles.
Yeah, just stuff.
Stephen Brown (18:45)
very useful, but they’re not necessarily critical, right? That there are alternatives. So as you do the analysis on raising prices, you have to consider that the demand is going to go down and balance that out. And so you may increase, if your product is, you know, very elastic, meaning that demand will diminish as price goes up. you might be able to improve your what’s known as contribution margin, not improved, but preserve, but the demand will go down. And so your total volume of cells goes down, but you still have a bunch of fixed costs in the form of payroll software rent.
That’s still there. That expense is often known as your fixed expenses. And so if you maintain your contribution margin, which is the percentage of dollars after your sales expenses, so that costs a good sold merchant fees, fulfillment costs. And I like to argue that advertising can or should be considered in that.
Those are, those are expenses that are always going to be there as you sell. And those as a percentage of sale or percentage of income that the sales minus all those expenses is your contribution margin. So let’s say you maintain that ratio. Let’s say your contribution margin is like 40%, which is a pretty good contribution margin in ecommerce. And so you’re like, I’m to pass the costs on and hold my contribution margin. But the actual total dollars that are being produced goes down. So I have great margins, but actually your sales went down and therefore your contribution margin down. And meanwhile, I still have the same fixed costs and I might have a worse profitability outcome, even though I’m thinking, well, I’m going to just pass it along and everything will be good. And so you got to…
Kelley Birrell (20:42)
Okay, so I know that, so let’s think in terms of some more of like practical things, like let’s start putting percentages together so that we can just start figuring out what the profitability would be at the end with this stuff moving up and down in proportion to each other.
Stephen Brown (20:48)
Mm-hmm. Well, this is probably a good point to, and if you’re listening, you may want to flip to YouTube, because we’re going to show a tool that we’ll be releasing, which is our tariff impact calculator. So what I’ve done is I’ve taken these concepts and put them into a spreadsheet where you can plug some numbers in and see what the outcomes are. So I’m going to describe this, but if you wanted to watch, you know, flip to YouTube – ecommerce finance podcast and you’ll be able to kind of watch along. So in this example, I’ve got a business that’s making $5 million in revenue and I have a customs value. So that’s the amount of cost of goods sold that the tariffs are going to apply to of $850,000, which comes out to be about 17 % of my income.
And so I’m going to go in and I’ve got sales expenses of a million dollars and non-sales of expenses of $2.8 million, And then I have some other income and expenses of negative 50,000. Usually that comes in the form of interest expense. So in my, my example here, I have a business that has $5 million in revenue and a net income of $250,000 or translating that into a ratio. I’ve got a 5 % net profit margin. So tight, but I see it all the time. Getting up to 10 % is not easy and getting up to 20 % is, takes a really, really great execution, really smart, you know, sometimes a little bit of luck in the right category. So this is a low cost of goods sold example, because I have really high…
Kelley Birrell (22:17)
feels really tight, actually.
Stephen Brown (22:40)
gross profit or gross margins, which is percent of dollars after my cost of goods sold. Now in this example, I don’t have my contribution margin specifically modeled. contribution margin is an incredible concept, but you don’t see it in a profit and loss statement. for whatever reason, the accounting powers that be decided that contribution margin was not gonna show up in a profit and loss. It’s pretty easy to calculate if you have your accounts broken out cleanly. So like in this example, I would take my gross margin minus my sales expenses or also known as my variable expenses and I come up with 62 % contribution margin. That’s really good. So the thing I’ve got through here in this example is I go through each scenario. So I go scenario one, I apply a 10 % increase in my tariff rate, and that is going to apply in this scenario and be a roughly 2 % or 1.7 % to be precise of my income. And I see that my net profit goes from 5 % to 3.3%. Again, if you’re listening, I strongly recommend you maybe watch this part. It’s a big jump, right? But it’s absorbable. But Then I get into raising prices and I’m using this concept of price elasticity of demand. So price elasticity of demand is the percentage of quantity demanded divided by the percentage change in price. So if I increase my price, I should expect a decrease in demand most of the time.
So that ratio, the price elasticity of demand is a negative number. And I did some research and this is ChatGPT told me. I mean, in reality, you need to test what your PED, price elasticity of demand is, but they’re like, if you’re highly inelastic, like high loyalty items, essentials, you’re gonna be that ratio zero to negative one, meaning if I increase my price by 1%, I might decrease my volume by a comparable ratio of negative 1%. Increase the price by 2%, demand goes down by negative 2%. And that is basically, it more or less evens itself out. In fact, in this calculator, you’re a little bit better off if you have that kind of price elasticity of demand. Does that make sense, Kelley?
Kelley Birrell (25:21)
Yeah, it does that I’m following along.
Stephen Brown (25:23)
Okay, good. Hopefully those of you that are listening.
Kelley Birrell (25:25)
But that’s only for this stuff that has low elasticity, things that you need.
Stephen Brown (25:30)
So let’s look at a couple other examples. So according to the powers of AI, they say like a moderately elastic product would be a negative one to a negative two. So let’s take that negative two. And there, the examples it gave me were branded apparel, premium food, mid-tier electronics. So let’s take like a negative two. That would tell me if I raised my price by, by 1%, my volume of demand would go down negative 2%.
If I raised it by 2%, price by 2%, the demand goes down negative 4%. That’s with a negative two price elasticity of demand. And so you basically take that higher. the highly elastic, it was telling me negative two to negative five. And the categories that gave me their fast fashion, trendy gadgets, non-essential digital goods. You know, a lot of the stuff that’s just like, that’s nice, but it’s not.
It’s just, it really is something that’s a luxury. I’m not even, doesn’t have critical use in my life. So in this example, with negative one price elasticity of demand, you’re, you’re kind of somewhat equalized depending on a lot of values, depending on your underlying, margins from your cost of goods sold, your gross margins. But if I start going higher, say to like a negative two price elasticity of demand.
Kelley Birrell (26:34)
sense.
Stephen Brown (26:55)
I can see in this example that I go from 250,000 of profit against my $5 million business to $185,000 of profit. Translating that to ratios, I go from 5 % net profit margin to 3.8 % net profit margin, which ironically is only a little bit better than if I just absorbed the price altogether.
So the point I’m making is you can’t really make.
Kelley Birrell (27:23)
Interesting. And this is all with increasing, this is all moving it, moving the price increase over to the customers to some extent.
Stephen Brown (27:34)
Yeah, so in these scenarios, one is I absorb the price, two and three is I pass the price along with different levels of elasticity. so this calculator, which I highly recommend you go and download and we’ll have a YouTube video on our LedgerGuru’s YouTube channel that will explain this in greater depth on how to use this. It’s a pretty straightforward tool. Just plug in some numbers and change some values and see what happens.
Kelley Birrell (27:44)
Got it. Okay, that makes sense.
Stephen Brown (28:02)
The point I want to make is you can’t just look at these decisions with a single factor. You can’t just say, hey, my costs are going up X percent, so I’m just going to pass them along. You have to think about it in terms of what are your underlying profit, your margins, and starting with gross margin, which is, just to be clear, your
dollars after your cost of goods sold. And just to clarify one more time, because I see a problem with this all the time, I and generally accepted accounting principles define cost of goods sold as your landed product costs.
Kelley Birrell (28:44)
So everything to the costs to get the product to your warehouse.
Stephen Brown (28:48)
Correct. Yep. You’re, you’re buying the, you’re paying your manufacturer, you’re importing, you’re pairing tariffs and duties and shipping fees and all that. That is really is what your cost of goods sold should be. And that minus your sales is your gross profit and gross profit divided by sales is your gross margin. So it starts with looking at your gross margin and how much of a, how big of an impact to your profitability that increase of tariffs is going to be.
And then it’s got to go into looking at your underlying profitability. Can I absorb that increased cost? And then if you say, no, I cannot, you have to look at not only how much price I want to pass along, but you have to think about elasticity and say, is that change in demand can offset my increase in price? It’s a complicated decision matrix.
Kelley Birrell (29:37)
yeah, it does sound like it. And it sounds like, I mean, okay, so let’s talk really quickly. What are some options? businesses look at these numbers and say, is not going to work, what are some options that they have?
Stephen Brown (29:52)
Great question. So let’s say you get in there and you’re like, I can’t absorb the costs. I do. I’ve put some elasticity in and, and let me just take a tangent here. How do I figure out what my elasticity is? There are tools out there that allow you to test it where you can kind of AB test your prices and you’ll say, Hey, I sell X amount of widgets at this price and Y amount at that price in the same timeframe. You know, you, just send people to different landing pages and then they’ll do some economics math and tell you here’s your elasticity, right? Or here’s your ideal price point. So you can come up with that calculation, but you can kind of eyeball it using the definitions I have here. But let’s say you go in there and you’re like, okay, I can’t absorb the price. I can’t pass the price along without having too big of a decrease. Maybe I split the difference. Some cases that’s probably what’s going to happen. I think a lot of cases you’re going to see that. But maybe I can’t even split the difference. I do the math and I’m like, I’m still losing too much. Then you find yourself in some really difficult decisions. So option number one, if the increase of tariffs destroys the profitability of your business. Option number one is you got to look at a different supply chain. Easier said than done. It’s not like we have, because like there’s a lot of people like, Hey, I’m in China. I’m just going to go to Vietnam. Well, I think nobody is safe at this point except for
Kelley Birrell (31:03)
Yeah, by a long shot.
Stephen Brown (31:13)
manufacturing in the United States and that’s very expensive and probably don’t have the capabilities to do it there. option number one is looking at your supply chain. Can I rework it? But be careful there because that takes time and you may change your supply chain only to find out that that next country is also being tariffed. Option number two is you’ve got to create some efficiencies in your business. So the thing that doesn’t change in this calculation
is your underlying fixed costs. That is, and most of the time, the biggest hits are payroll, rent, software, and marketing. Depending on where you put your advertising in particular, that’s why I kind of like to put advertising as a sales-related expense, because it’s not like you’re gonna stop advertising. So I like…
Kelley Birrell (31:59)
No. Otherwise you don’t sell.
Stephen Brown (32:01)
Otherwise you don’t sell. So there is a little bit of a debate. Not a big day, but I’m starting to debate that advertising expense in my opinion for ecommerce business is more of a variable cost of sale because you kind of have to do it. Like the challenge of it is like those other things that cost a good sold as a percentage of revenue tends to be fairly stable unless you have changes like tariffs. Fulfillment fees as a percentage of revenue tend to be fairly stable. Merchant fees tend to be fairly stable. The argument for why you shouldn’t do that with your advertising is you see it bounce around a lot just because of seasonality and this and that and the other. And so it doesn’t behave like a traditional cost of sale.
But I would argue that it is, even though it doesn’t, you see it bounce around when you kind of do that mapping out. you don’t advertise, you don’t sell. so, you, as you’re looking at reducing some of those fixed expenses, or in this case, a cost of sale that is debatable where to put it, you can try and get more efficient in your advertising easier said than done, but reducing fixed costs. looking at your payroll.
Looking at your rent, do I need that big warehouse? I, know, do I need that big office? software, you know, there’s a ton of plugins that ends up getting into Shopify stores. these are not easy decisions. And I think businesses, if we haven’t been scrutinizing our spend, you know, especially ecommerce sellers over the last couple of years, if they haven’t been scrutinizing their spend yet, boy, tariffs are going to cause that scrutinization of spend more than ever. And so if it was me, I’m kind of going down that equation. Can I adjust my supply chain? Probably not. Maybe I can, but it’s going to take me six months. Can I tighten up other costs of sales? Fulfillment? There’s some things you can do to improve fulfillment. We should do an episode on that. Merchant fees. Those are really hard, but you can improve them. You’re not going to move the needle very much. You can maybe take a…
Kelley Birrell (34:08)
Yeah.
Stephen Brown (34:09)
a fee from 3.5 % to 3 % if you get really smart and strategic with who’s doing your payment processing.
Kelley Birrell (34:16)
You know, it’s interesting as you’re talking about this and you’re bringing in all these different things, I’m thinking about the different podcasts that we’ve done so far, like the Amazon one and the different fees. And just I’m thinking, how, how do sellers actually make it with all of these costs? How, how does profitability even happen with all of these, these costs continuing to go up and up and up? It’s kind of crazy to me.
Stephen Brown (34:37)
Yeah. I mean, it’s, it’s a very tough landscape on top of a couple of years. They’ve been really tough. Like there was the golden era of ecommerce and that golden era is long gone. And now we’re in a sophisticated era where you just can’t show up and get something off of Alibaba and throw it on Amazon or Shopify store, throw a little bit of money at Facebook and you’re printing profits. Like those days are gone and will probably never come back. But does that mean that you can’t make money selling online? Absolutely. You can make money selling online, but you’re to have to be a lot more sophisticated and disciplined than ever. So my recommendation is, you know, one, think through these, these methodologies, take a look at our tariff impact calculator, throw your numbers in there, see what they tell you, change them around.
Kelley Birrell (35:14)
really smart about it.
Stephen Brown (35:30)
and use that to make smarter decisions as you are responding or preparing to respond to the increased costs that come with tariffs.
Kelley Birrell (35:39)
Sounds good. I’m interested to see how all of this goes down.
Stephen Brown (35:41)
Buckle up, it’s gonna be a wild ride, that’s all I can say.
All right, well, thanks for joining me, Kelley, and we will talk on a future episode.
Kelley Birrell (36:13)
Absolutely sounds great. Thank you for having me.