A product can generate plenty of sales and still be less profitable than an ecommerce owner thinks. Ecommerce landed cost helps explain why. The price paid to the supplier may not be the true cost of the product. If you purchase an item for $20, it is easy to think of $20 as the cost of that SKU.
However, freight, tariffs, customs duties and other costs can turn a $20 product into a $26 product. If your accounting system still uses $20, your gross margin may be wrong. More importantly, you may be making pricing, advertising, purchasing and inventory decisions using the wrong number.
What Is Ecommerce Landed Cost?
Ecommerce landed cost represents the total cost of purchasing inventory and getting it to the location and condition necessary for sale.
Depending on the circumstances, ecommerce landed cost can include:
- The purchase price paid to the supplier
- Inbound freight
- Customs duties
- Tariffs
- Brokerage and import fees
- Certain other costs directly associated with acquiring and transporting the inventory
Therefore, the supplier invoice may be only the starting point for determining what a product actually costs.
For an ecommerce business that imports products or moves inventory long distances, the difference can be significant.
A $20 Product May Really Cost $26
Assume an ecommerce company purchases 1,000 units of a product from a manufacturer for $20,000.
The company also incurs:
- $3,000 of inbound freight
- $2,000 of tariffs and customs duties
- $1,000 of other appropriate costs associated with bringing the inventory to its warehouse
The company did not really acquire 1,000 units for $20 each.
Instead, its total cost was $26,000. That makes the landed cost $26 per unit.
Now assume the product sells for $50.
Using only the $20 supplier price, the business may believe it has $30 remaining before considering other selling and operating costs.
Using a $26 landed cost, that amount falls to $24.
Multiply that difference across hundreds or thousands of units, and the economics of the SKU can look considerably different.
Why Does Ecommerce Landed Cost Matter?
Accurate financial statements matter. However, most ecommerce owners do not calculate landed cost simply because they want a better accounting number.
They want better information for making decisions.
If the cost assigned to a SKU is too low, an owner may overestimate how profitable the product is.
That can affect decisions about:
- Product pricing
- Advertising spending
- Promotions and discounts
- Reordering inventory
- Purchasing quantities
- Continuing or discontinuing a SKU
- Comparing suppliers
- Discounting slow-moving inventory
For example, how much can you afford to spend advertising a product? How deeply can you discount it? Does it make sense to place another large order?
Those decisions depend, at least in part, on knowing what the product actually costs.
Therefore, the question is not simply whether the gross margin calculation is correct.
The more useful question is: Is this SKU actually as profitable as you think it is?
How Do You Calculate Landed Cost Per SKU?
At its simplest, you calculate landed cost by starting with the purchase price of the inventory. Then, you add the appropriate costs required to acquire the inventory and bring it to the location and condition necessary for sale.
For a shipment containing a single SKU, the calculation may be relatively straightforward.
Using our earlier example:
$20,000 purchase price + $6,000 additional costs = $26,000 total landed cost
$26,000 ÷ 1,000 units = $26 landed cost per SKU
The arithmetic is easy.
However, determining which additional costs to include can require more thought. The calculation also becomes more complicated when a shipment contains several different SKUs.
How Should You Allocate Additional Costs Between SKUs?
Suppose one shipment contains 15 different SKUs and incurs $10,000 of freight, tariffs, duties and other costs.
How much of that $10,000 belongs to each product?
Simply dividing the cost equally among all 15 SKUs may not produce a meaningful result.
Instead, the allocation method should reflect the nature of the cost. Depending on the circumstances, a business might allocate costs based on:
- Units
- Weight
- Volume
- Purchase value
- Another reasonable measure that reflects how the cost was incurred
For example, allocating freight based solely on units may produce a poor result if one SKU weighs ten times as much as another. On the other hand, allocating a value-based import charge according to weight may not reflect how that particular cost was determined.
As a result, different costs may require different allocation methods.
The goal is not to make the calculation unnecessarily complicated. Instead, identify the significant costs, develop a reasonable allocation method and apply it consistently.
Why Do Ecommerce Businesses Get Landed Cost Wrong?
Calculating ecommerce landed cost sounds relatively simple when every cost is known at the same time.
In practice, that often does not happen.
The supplier invoice may arrive first. Later, the freight company sends another invoice. Customs duties may require a separate payment. Brokerage fees can appear somewhere else. In some cases, the business may not know the final costs until after the inventory arrives.
Meanwhile, the ecommerce platform may already contain the supplier cost for the SKU.
As a result, a business may continue using the supplier price as its product cost while recording freight, tariffs and other costs elsewhere.
Nothing about the supplier cost is necessarily incorrect. It is simply incomplete.
Consequently, the product’s margin may look better than the actual economics of selling it.
Developing a Landed Cost Method for Your Ecommerce Business
There is not necessarily one ecommerce landed cost calculation that works for every business.
Products are different. Supply chains are different. Some businesses import inventory, while others purchase domestically. Some receive one SKU at a time. Others bring containers containing dozens of different products into a warehouse.
Therefore, the important part is developing a landed cost methodology that fits the business.
First, determine which additional costs should be considered. Next, decide how those costs should be allocated among SKUs. Finally, establish a process that applies the calculation consistently from one shipment to the next.
Schultz & Associates can assist ecommerce businesses in developing a landed cost methodology that reflects their inventory, supply chain and accounting system.
We can help identify the costs that need consideration and develop reasonable methods for allocating those costs among individual SKUs.
Once the methodology is established, the business has a consistent way to determine what its products actually cost.
Landed Cost and QuickBooks Online
QuickBooks Online can record inventory costs. However, the accounting system can only work with the information provided to it.
Suppose a business receives a $5,000 freight bill related to inventory that remains unsold at the end of the month. Recording the entire amount as a current freight expense may separate that cost from the products that caused it.
Instead, the accounting should appropriately associate qualifying inventory costs with the related products. As those products sell, the related inventory costs flow through cost of goods sold.
As a result, the financial statements can provide a better picture of the gross margin the business actually earns.
Landed Cost Can Change a Reordering Decision
Imagine two products that each generate $100,000 of sales.
Based only on supplier cost, Product A appears to generate a 45% gross margin. Product B generates 40%.
At first glance, Product A looks like the more profitable product.
However, Product A is bulky and expensive to ship. It also carries significant tariffs. Once the business considers those additional costs, Product A’s margin may fall below Product B’s margin.
That information could change how much inventory the business orders. It could also affect pricing or where the business directs its advertising dollars.
Without accurate landed costs, an owner may put more money into a product that only appears to be more profitable.
Ecommerce Landed Cost Becomes More Important as You Grow
A small difference in cost per SKU may not seem important when a business sells a few hundred units.
At larger volumes, it adds up quickly.
A $2 difference in the cost of a SKU sold 50,000 times represents $100,000.
Furthermore, higher SKU counts and larger shipment volumes make manual landed cost calculations more difficult.
As an ecommerce business grows, it becomes increasingly important to establish a consistent process for identifying and allocating landed costs.
Software can help businesses manage these calculations. Some businesses can calculate landed cost with Excel or another spreadsheet. Others may benefit from dedicated landed cost software. In addition, some ecommerce and inventory platforms include tools that can assist with the calculation.
The right approach depends on the number of SKUs, shipment volume, supply chain and complexity of the business.
Do You Know What Your Products Actually Cost?
Knowing what you paid the supplier is relatively easy.
Knowing what each SKU actually cost by the time it reached the location and condition necessary for sale takes more work.
However, that information affects far more than an accounting entry.
Accurate ecommerce landed cost can improve the information used for pricing, advertising, purchasing, inventory management and product-level decisions.
Before deciding how profitable a SKU is, make sure you are using the right cost.
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Meet the Schultz & Associates Ecommerce Accounting Team
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Best Tools for Calculating Ecommerce Landed Cost by SKU
Compare dedicated landed cost software, do-it-yourself Excel and spreadsheet methods, and ecommerce platforms with built-in landed cost tools. We also explain where an accountant can help establish the methodology behind the calculation.
[Best Tools for Calculating Ecommerce Landed Cost by SKU →]