Introduction to Break-even and ROI analysis
It can be difficult to make the best business decisions – should I invest or not? Further, I know these projects will all create benefit, which one should I do first? The good news is that simple financial metrics have developed over time to help business owners and managers make those decisions more easily and quickly, and importantly help reach the best decision. Two financial metrics that are popular are Return on Investment (ROI) and Break-even. We explore both of these ideas below and calculate Break-even and ROI for Frankie as examples.
When you use a financial metric, it’s important to understand how the underlying investment works, to ensure you correctly model the opportunity correctly.
How does Frankie work
Ecommerce stores use a range of digital marketing techniques to drive traffic to the store.
Once traffic reaches the store, the proportion of visitors that buy or make a sale is measured by the conversion rate. It is = buyers/visitors. The higher the conversion rate, the more sales are generated from the same marketing spend.
Frankie works by taking your existing traffic (whatever the amount), and converting more of that traffic into sales. Put another way, Frankie increases sales with no increase in marketing spend.
Break-even analysis is often the easiest technique to quickly indicate whether you should “invest”. Break-even analysis tells you the minimum return you need, before you’ve met the cost of your investment. Ideally, you want to exceed the minimum, but it’s often easier to determine whether you can meet the minimum rather than ‘know’ what the return will be. If you can achieve the minimum, it means you are not losing money, and any additional return generates extra profit or a positive ROI for you.
If we examine the cost of Frankie for a business working with a 40% COGS. We see the break-even point can be calculated by taking the cost of Frankie and divide that by (1-COGS %). This table illustrates the breakeven of Frankie at 3 different price points.
|Cost of Frankie||$ 100||$ 50||$ 20|
|Extra sales from Frankie to break-even (40% COGS)||$ 167||$ 83||$ 33|
|COGS (40%)||$ 67||$ 33||$ 20|
|Extra profit from Frankie||$ 100||$ 50||$ 20|
|Cost – extra profit||–||–||–|
|Break-even for Frankie||$ 167||$ 83||$ 33|
The break-even for Frankie can be determined by:
Break-even analysis allows you to quickly estimate the likelihood that you will gain from your investment.If considering Frankie, the break-even point is the cost of Frankie divided by (1-COGS %). This is normally a number not much higher than the costs of Frankie. So Frankie only needs to lift sales by a small amount before extra profit is being contributed to your bottom line.
Return on Investment – ROI
Return on Investment (ROI) measures the gain (or loss) generated on money invested. ROI is normally expressed as a percentage and is frequently used to compare the return or expected return of different investments. ROI is calculated by dividing the return of the investment by the cost of the investment. The result is expressed as a percentage or a ratio.
We can use the ROI formula to calculate the expected return from investing in Frankie.
An easy way to do this is to start with some base assumptions and calculate the ROI in several different scenarios. To calculate the ROI for Frankie, the key assumptions is the Cost of Good Sold (COGS %). In the example below we’ve used a COGS of 40% and Indirect costs of 55% leaving a 5% profit.
COGs and indirect costs can vary business to business, just keep in mind that a lower COGS will mean a higher ROI from Frankie, (and a higher COGS will mean a lower ROI from Frankie). Indirect costs do not affect the impact of Frankie in terms of ROI. The table below shows the ROI for a range of different lifts in revenue from Frankie. We have published a number of case studies showing Frankie boosting sales by more than 10%.
|Frankie ROI @ 40% COGS||ROI from||ROI from||ROI from||ROI from||Base case|
|Sales iincrease from Frankie||10% lift||5% lift||2% lift||1% lift||(no Frankie)|
|Store revenue ($1m turnover)||$1,000,000||$1,000,000||$1,000,000||$1,000,000||$1,000,000|
|Extra sales from Frankie||$ 100,000||$ 50,000||$ 20,000||$ 10,000||n/a|
|COGS (40%)||$ 440,000||$ 420,000||$ 408,000||$ 404,000||$ 400,000|
|Gross Margin (60%)||$ 660,000||$ 630,000||$ 612,000||$ 606,000||$ 600,000|
|Frankie fee||$ 2,000||$ 2,000||$ 2,000||$ 2,000|
|Gross Margin after Frankie||$ 658,000||$ 628,000||$ 610,000||$ 604,000||$ 600,000|
|Indirect costs (fixed)||$ 550,000||$ 550,000||$ 550,000||$ 550,000||$ 550,000|
|Profit||$ 108,000||$ 78,000||$ 60,000||$ 54,000||$ 50,000|
|Net return on Frankie||$ 58,000||$ 28,000||$ 10,000||$ 4,000||n/a|
Frankie produces an ROI that ranges from 200% – 2,900% as the lift in revenue from Frankie improves from 1% to 10%, assuming a 40% COGS. If the COGS is lower, Frankie’s ROI is higher. At these return rates, it is clear that Frankie provides a very healthy return on investment (ROI) and stacks up as an easy decision for merchants to adopt and place on their store.
Frankie increases engagement, conversion rates and revenue. In this blog, we’ve examined the ROI of Frankie. Given merchants limited time, they should look to implement high ROI projects – like Frankie – first.