As a full-service Amazon agency, a common question that arises from most of our clients is “How can I improve my profits on Amazon Vendor Central?” Typically, vendors are focused on getting their wholesale price increases approved by Amazon Vendor Managers, but this is only one aspect of profitability and often the hardest to achieve.
A holistic approach to profit margins must be utilized. Wholesale price or “Item Cost” in Amazon terms is just the tip of the iceberg. You must also consider, Amazon Vendor Terms (i.e., co-op, accrual, and allowances), marketing costs, invoice reconciliation, operational chargebacks, and ultimately ASIN level profitability. Below, we dive deep into what it takes to fully understand your Amazon Vendor profit margin, common issues that decline profitability, and the actions needed to have a healthy profitable Amazon business.
Research & Analysis
Before any vendor can begin trying to improve their Amazon profit margins, they must gather data to determine their Contribution Profit (CP) at an ASIN level. To complete this work, you will need to have your landed COGS, Vendor Terms (sometimes referred to as trade terms or trade discounts), and marketing costs. You’ll also need your internal Selling, General, & Administrative costs (SG&A) specifically related to selling on Amazon. The calculation to get to an item level CP is below, this is needed to prepare for Amazon’s Annual Vendor Negotiations (AVN), SKU Rationalization analysis, Marketing Cost review, etc.
Amazon Vendor Terms
All vendors have specific terms with Amazon that apply discounts to the wholesale price Amazon pays you. These terms are a key element to profitability on Amazon and must be reviewed carefully. Never accept an Amazon agreement that you do not understand. Often these agreements auto-renew so vendors can feel stuck if they don’t read the fine print. If you have inherited these terms, pay attention to the details like applicable dates, vendor code, and product group, as it is very easy for mistakes to occur and find duplicative agreements. The 3 core discount or vendor funding agreements are:
- Co-Op: Activities include automated site marketing and search functionality. This is a discount in the form of a percentage of Net Receipts based on Cost Price.
- A common incorrect assumption is that advertising, promotion, or other event-based marketing activities can be funded from this discount. It is not, these activities are all additional vendor-funded activities.
- Negotiation Tactic: Amazon does not provide data to justify this discount percentage. If they are asking for Freight Accrual or Damage Allowance increases, this is a place to ask for a reduction to offset the impact.
- Freight Accrual: Activities include offsetting Amazon’s inbound PO freight and consumer freight costs. This is a discount in the form of a percentage of Total Receipts based on Cost Price.
- If you are a vendor that pays directly for your inbound shipments to Amazon, you should not have a freight accrual agreement. You also should not have a freight accrual agreement for your Amazon Direct Fulfillment vendor code(s).
- Negotiation Tactic: If Amazon is asking for an increase in Freight Accrual due to ever-rising shipping costs, ask for participation in programs like Direct Fulfillment or Pallet Ordering which can reduce Amazon’s freight costs allowing you to either maintain or reduce your current freight accrual discount.
- Damage Allowance: Activities include the cost of damaged inventory during inbound shipping, damaged customer returns, and the cost of customer return freight. This is a discount in the form of a percentage of Net Receipts based on Cost Price.
- Negotiation Tactic: If you have a high damage allowance rate or Amazon is asking for an increase, ask for a list of high damage rate and high return rate ASINs. Consider removing these from Amazon to negate their impact. If the root cause of damage is insufficient packaging, consider changes to reduce the damage rate, and ask for a reduction the following year when the data will reveal improvements.
Additionally, other agreement types are Discretionary Vendor Funded Discounts, generally used for Subscribe & Save (SnS) and Amazon Business (B2B) discounts. There are also Straight Payments, which are for programs such as Amazon Vendor Services (AVS), in which Amazon provides a Brand Specialist as a point of contact to help grow sales and visibility and resolve issues quicker than self-service methods.
Marketing Costs
One of the first levers Amazon Vendors often pull when tasked to improve profitability is to reduce their marketing costs; it is one of the only levers they control almost entirely independently. While some of these costs can be reduced without impacting sales and purchase orders received, others can negatively impact the business if reduced too far. Let’s examine the different types of marketing costs:
- Sponsored Advertising (Amazon Marketing Services or AMS)
- Demand Side Platform Advertising (DSP)
- Vendor Funded Deals, Promotions, & Coupons
Sponsored Ads are advertising campaigns that use criteria like keywords and limited audience targeting.
- Sponsored Product Ads: Campaigns that are keyword-based and appear in search results on Amazon as “Sponsored” product placements. These are utilized for “bottom-of-funnel,” or conversion-based advertising and are generally important to maintain at certain levels to ensure there is no impact on the top line.
- Sponsored Brand Ads: Keyword-based advertising that appears in search results as banner ads or video ads. Depending on keyword strategy, these are typically “mid-funnel” or consideration advertising techniques and are an important tool to drive new customers to your products that are “in aisle.”
- Sponsored Display Ads: Target-based advertising that appears on Amazon Product Detail Pages (PDPs) as well as other Amazon-owned platforms like Twitch and IMDb. Shoppers are targeted by interest, life events, related products, or shopping behaviors. This ad type can be used for consideration, new-to-brand customer acquisition, or remarketing efforts. Like Sponsored Brand ads, if used correctly, Sponsored Display is an important driver of new customer acquisition and shouldn’t be reduced entirely to improve profitability.
DSP is an Amazon-based software tool that allows for the purchase of programmatic display advertising on and off Amazon platforms. It allows advertisers to strategically target relevant audiences. In general, DSP is utilized for “top-of-funnel” or awareness-based advertising. Depending on targeting, it can also be used as part of a consideration strategy.
Vendor Funded Deals, Promotions, and Coupons are discounts that are given to the Amazon customer but funded directly by the vendor. Depending on your product category and seasonality, participating in “tent-pole” events like Prime Day or Black Friday/Cyber Monday (BFCM) with promotions may be critical to driving sales and new customer acquisition. In contrast, running deals on lighter promotional events like January New Year/New You, Valentine’s Day, Easter, Mother’s Day, and more, you can afford to pass on. If marketing costs must be reduced, consider reducing a pre-planned discount amount or the number of events you are participating in.
When considering marketing cost reductions to improve profitability, understand your goals. Generally, a vendor needs to cut expenses without impacting topline sales. Start by reducing non-essential spending first like DSP, reduce promotional discounts, or remove promotions for non-tent pole events. If further savings are required, use your ASIN level CP analysis to determine the ASINs that you can afford to maintain Sponsored Ads on. You can also carefully reduce spend on campaign types that are not achieving your new threshold targets.
Invoice Reconciliation
Your Vendor Central invoices contain the item cost and quantities of products shipped to Amazon. A critical piece to Amazon profitability is regularly reviewing the invoice against your shipping records to ensure that Amazon pays you for what was shipped. All too often we find that invoice vs. shipment discrepancies are a source of lost profit margin for our vendors.
The most common area for error is quantity shortages. This occurs when Amazon requests a specific amount of an item, you ship that exact amount, but then an invoice is received with a different quantity. Disputes can be raised if you can provide evidence in the form of proof of delivery such as a Bill of Lading (BOL’s) or screenshots from small parcel carriers like UPS and FedEx.
The other type of error is cost variances. While less common, a review to ensure that costs are correctly reflected on your invoice should be done as well. To do this, you will need to compare the invoice cost to the item cost in your Amazon Vendor Central catalog and review any applicable agreements for discounts. If you find an error once again, you will need to provide evidence for a dispute claim in the form of previous invoices that used the correct cost, catalog cost files, and any funding agreements.
Operational Chargebacks
Amazon is a well-oiled logistical machine, built to delight customers with an easy shopping experience and fast delivery. When vendors throw a wrench into Amazon’s machine by not following their rules, Amazon penalizes them in the form of chargebacks. They hope that your financial pain causes you to change your operational procedures to match Amazon’s policies.
While some chargeback fees seem small at first, they can quickly add up if not monitored. Reducing chargebacks in the form of disputing errors or complying with Amazon policies is a quick way to return money to your bottom-line. To dive even deeper into Amazon Vendor Chargebacks, the different types, why they happen, and how to dispute them, check out our Chargeback blog here.
SKU Rationalization
If you have read this far, you are ready for the main event: SKU Rationalization! Remember that ASIN-level CP analysis you did? Now it’s your spreadsheet’s time to shine. Add in ASIN-level Net PPM% from your Retail Analytics reports in Vendor Central (and you now also know what Amazon considers a profitable ASIN). With this information, a vendor can determine the right course of action for each profitability group. Below we outline the four levels of ASIN profitability:
- Mother Lode: ASINs that are profitable for both the vendor and Amazon
- Gold Mine: ASINs that are profitable for the vendor only
- Fool’s Gold: ASINs that are profitable for Amazon only
- Canary in a Coal Mine: ASINs that are profitable for neither the vendor nor Amazon
Mother Lode ASINs should be kept in your assortment regardless of total sales volume. Highly profitable ASINs are often not top unit drivers. Use promotions and advertising to increase unit sales to increase profitability penetration to total business.
Gold Mine ASINs should also be preserved in your catalog. These ASINs generally provide the base of your profitability. If you have margin room, consider improving Amazon’s profitability on top drivers to move top drivers into the Mother Lode group. Additionally, a vendor may want to trade a wholesale price decrease here to get a price increase you need elsewhere (like in the next group, Fool’s Gold).
Fool’s Gold ASINs should be considered for removal from Amazon’s catalog, even if they are top drivers. If you are losing a significant margin on each unit sold, it will impact your ability to have a healthy Amazon business. If you cannot completely remove due to unit velocity, limit the quantity confirmed on purchase orders (POs), and then negotiate a wholesale price increase with the assurance that POs will be 100% confirmed in the future.
Canary in the Coal Mine ASINs should be discontinued immediately on Amazon, assuming Amazon hasn’t already done the heavy lifting for you by placing the ASIN into CRAP status (Can’t Realize A Profit) and blocking all PO’s.
Additionally, if you have a hybrid account in which you have both Vendor Central and Seller Central accounts, you should consider moving ASINs to the platform where you will be the most profitable. Effective SKU Rationalization that is performed on a quarterly or annual basis can ensure that your Amazon business stays healthy and drives success to your overall bottom line.
Taking Action
In addition to reviewing your vendor terms and marketing costs, performing invoice reconciliation, and reducing chargebacks and SKU Rationalization, vendors can bring it all together in Q1 when Amazon’s Annual Vendor Negotiation (AVN) begins. AVN is an excellent opportunity to reapproach your Amazon profitability holistically. You can bring all parties to the table to discuss wholesale price increases, vendor terms, marketing investments, operational performance, and available selection to Amazon.
If the above sounds like a lot of work, we’re sorry to tell you that it is. You need to meticulously go through your Amazon catalog and look under every stone to improve profitability. No Amazon Vendor Manager is going to just give you a wholesale price increase and save the day. Amazon is running a business in which they are trying to maximize their profits too.
But here is the good news. Here at Hinge Commerce, we do this all the time for our vendors (and we have the track record to prove it). We have saved hundreds of thousands of dollars in CP annually for our clients through wholesale price increases, Amazon Vendor Term discount decreases, and SKU Rationalizations and Invoice Disputes. If you want to see how we can improve your Vendor Central profitability, contact us!