There are often so many key performance indicators in online marketing and e-commerce that we reach overkill. That’s why it is so important to use KPIs in a way that is really helpful.
The important questions to ask are: Which indicators are really important? Which ones are KPIs — Key Performance Indicators? And even more importantly: What are the relationships between the indicators? To begin to answer these questions, I would like to share a few "KPI shortcuts" as models and calculations that present e-commerce and online marketing indicators in terms of goals that can help you create successful online marketing and e-commerce campaigns.
Problems with indicator management often begin with unclear goals. In my experience, this is because there is a lot more to manage in e-commerce than in conventional business models without the "E". In online marketing alone, there are, in comparison to conventional advertising, hundreds of possible modifications whose influence on the success of the project can be analyzed and, with the resulting knowledge, optimized. From these indicators, an image quickly arises that can be characterized with the expression, "People staring at data".
But there is no avoiding it – we all have to climb this mountain of choosing and modeling indicators. And when we’ve made it to the peak of Data Driven Marketing, we can take joy in the prospect of more efficient marketing.
By reaching overall objectives, such as reaching targeted goals in profits, we can define accountability and the necessary goals. Each of these goals needs a measurement or metric for which a target value will be set. Thus, the metric becomes an indicator. If a metric is not of any significance for a goal and will not be tracked, it remains a metric. In the analytical hierarchy, the metric is then advanced when it becomes a Key Performance Indicator. All indicators are performance indicators, but only some are Key Performance Indicators, which hold crucial significance for company success.
With the hierarchy KPI – indicator – metric, we have brought some light to the data jungle. The most important step, however, as described above, is to establish a connection between goals, indicators, and KPIs.
A company’s goal can be easily defined as follows, at least according to Harald Schmidt: "Income must surpass expense". Anyone who has ever been anywhere near a business school knows that the pair of terms "income" and "expense" are a trite trivialization of the plethora of indicators that are of significance in the business world. Wouldn’t it be great to be able to bring as many KPIs as possible together in one calculation?
The "e-commerce code" model can deliver just such a unifying calculation. It combines online marketing indicators with profit margins and costs. In this way, the "e-commerce code" is an e-commerce income statement that encompasses all the important costs and performance indicators. The "e-commerce code" is not too detailed, but offers a good, fast overview using the most important average indicators.
The calculation begins with Profit Margin I. This is the difference between specific sales and the directly-related costs for the acquisition of the goods.
(1) PM I = Net-Cost – Acquisition or production costs for a specific product (incl. shipping)
One of the central goals of e-commerce is that customers will not order only one product, but several products simultaneously. Thus, the number of articles sold, represented by n, is significant. The result of this is the Net - Shopping Cart Value as a product of PM I.
(2) n x PM I = Net – Shopping Cart Value
In the next step, it is of interest how many shopping carts have been realized in a given period. This gives us the number of actual Conversions C:
(3) C x n x PM I = Sum of the Net-Shopping Carts = GPM I
With the Conversions, we have finally entered the field of online marketing. As an online marketer, you cannot ignore the conversions. But the conversions first become really interesting when we view them in the context of actual online reach. Thus, we must bear in mind that conversions are the product of Visits and the Conversion Rate:
(4) Conversions = Visits x Conversion Rate
So, we can represent the Gross Profit Margin I as:
(5) Gross Profit Margin = V x CR x n x PM I
But the number of Visits doesn’t just come from nowhere. They are the product of Impressions, or the number of deliveries and views of information about our shop or website, and Click Rates:
(6) Visits = Impressions x Click-Through-Rate
So, our online marketing profit marketing becomes:
(7) I x CTR x CR x n x PM I = Gross Profit Margin I
Thus, we’ve already brought together five modifications to increase the Gross Profit Margins. This calculation would not be quite complete, however, if we were to ignore the costs associated with performance marketing. These come from every contact, or visit.
(8) Direct Marketing Costs = V x CPC
If V = I x CTR, then we get as the marketing costs:
(9) Direct Marketing Costs = I x CTR x CPC
And if I now subtract the direct marketing costs from our Gross Profit Margin I, I get:
(10) I x CTR x CR x n x PM I – I x CTR x CPC = Gross Profit Margin II
Now, I can factor out I x CTR:
(11) Gross PM II = I x CTR (CR x n x DB I – CPC)
This defines Profit Margin II, which is available to cover the business’ fixed costs after deducting the costs for the merchandise sold and for Direct Marketing Costs. The Gross PM II is identical to the gross earnings, or the earnings from the operative business of an e-commerce company.
With the help of this "e-commerce code", we can extrapolate specific KPI shortcuts:
The Gross Earnings per Visit can be used to rate the operative value of the online marketing activities. This measurement is the bracketed expression in e-commerce code:
(12) Gross Earnings per Visit = CR x n x DB I – CPC
If this value is 0, then the business breaks even and can just finance itself, but covers no overhead and provides no profit. The Gross Earnings per Visit matches the contact price, since:
(13) 0 = CR x N x PM I – CPC
(14) CPC = CR x n x PM I
Outcome: the operative business can cover only the direct online marketing costs. The higher these are, the higher the conversion rate, article number per conversion and/or profit margin have to be to just break even at the operative level.
Of course, the goal of every e-commerce business should be more ambitious than just breaking even. Profitability is reached when the gross earnings, as we established above with the e-commerce code, are higher than the Overhead Costs (OC) of the business.
(15) OC < I x CTR (CR x n x PM I – CPC)
This value can also be incorporated in online marketing management. If you consider the overhead costs per visit, you get the minimum returns per visit:
(16) OC/V < CR x n x PM I – CPC
An example demonstrates the relationship:
Operating costs per month: $150,000
Visits per month: 300,000
n x PM I: $40
Then we have:
(17) OC / V = $150,000/300,000 = $2
(18) PM II / V = 0.05 x $40 - $1 = $1
In this case, the overhead costs per visit are higher than the gross earnings per visit; the business is running a loss. If it were possible to raise the average shopping cart value to $50 and the CPC to $0.50, then the overall business would still not be profitable, but could at least cover its total costs. It pays to have a streamlined e-commerce business, and not just in this example.
An alternative indicator that represents online marketing expenditures is the Cost per Order. This can be determined relatively easily when you take the direct costs for online marketing as the output value:
(19) CPO = Direct Marketing Costs / Conversions
(20) CPO = (Visits x CPC) / Conversions
(21) CPO = (Visits x CPC) / (Visits x Conversion Rate)
(22) CPO = CPC / CR
It quickly becomes clear that high CPCs and a low CR leads to high CPOs, which are generally not profitable. The following example demonstrates the problem:
Shopping cart = $70
CR = 3%
CPC = $1
CPO = $33.33
Percentage of online marketing revenue: 47.6%
If, as in the example, almost half of your income is being spent on online marketing, the remaining costs for products, overhead, and profit can scarcely be financed.
Another shortcut has to do with the planning of the online marketing budget. This can be derived as a KPI shortcut from a general sales plan as the following example shows:
This example also shows how important ambitious goals are for performance values in online marketing. Despite having a low CPC, the revenue share is exceptionally high at 33%. The causes are certainly a relatively low conversion rate and low shopping cart values.
In the fourth KPI shortcut, the Gross Earnings statement will take the Return Ratio (RR) into account. To do this, the conversion rate is multiplied by the inverse of the Return Rate (1 – RR) to get the conversions after returns. (1 – RR) is also the percentage of the non-returned products:
(23) Gross Earnings = I x CTR (CR x (1 – RR) x n x PM I – CPC)
If you set the Gross earnings back to 0 for the operational break-even point, you will see the conditions at which the operative business will cover costs but will not finance any overhead or provide profit:
(24) 0 = CR x (1 – RR) x n x PM I - CPC
(25) CPC = CR x (1 – RR) x n x PM I
(26) CPC / CR = (1 – RR) x n x PM I
(27) CPO = (1 – RR) x n x PM I
Conclusion: The higher the return ratio, the lower the CPO that an online business can support without plunging into negative gross earnings. As a corollary we can say: high Return Ratios have to be financed through low online marketing costs or high Profit Margins I.
These and other KPI short cuts will help you keep the most important indicators in focus and arrive quickly at the best decisions for online marketing and e-commerce. By combining values from the cost and performance calculations with performance indicators from online marketing, online marketers can manage their online marketing portfolio while keeping an eye on the overall success of their company.
Published on 01/17/2017 by Dominik Große Holtforth.
Prof. Dr. Dominik Große Holtforth teaches business studies and media management at Fresenius University of Applied Sciences in Cologne. He is also head of the e-Commerce department which deals with strategy-related questions, the controlling of key performance indicators as well as competition strategies in online marketing and e-Commerce. Prof. Große Holtforth is co-founder of the e-Commerce agency Warenkorb.com and founder of the online plant shop “Meine Orangerie.” This is how he combines scientific expertise and practical experience.