How To Calculate Dropshipping Profit Margin

Dropshipping profit margin refers to the amount of money, or its percentage, that you get to keep after paying all your business expenses, including your taxes.

Businesses can only survive if the profit margin is not negative. As a dropshipper, you must understand profit margin principles and calculations so you can make a reasonable financial decision.

Today, you will learn:

• Different pricing strategies
• How to increase your profit margin
• How to calculate your net profit margin

In the end, I believe you should be armed with enough knowledge to decide on your margins, how to increase them, and make your e-commerce business profitable.

The Typical Cost Of Operating A Dropshipping Business

Some people would say that starting a dropshipping ecommerce store is free. Well, not exactly. At the very least, you must spend money on hosting or your dropshipping platform. In this section, I will provide you with a list of the most common startup costs that you will incur if you dropship.

1. The Cost Of The Dropshipping Store

Dropshipping can only be free if you dropship on a popular ecommerce platform like Etsy, Amazon, and eBay. The thing is that while these platforms are free to use, you must pay them a fee. For example, Etsy charges $0.20 per listing every four months.

What I want to focus on are two things: Shopify and self-hosted dropshipping stores using the WooCommerce system.

Shopify offers several plans, the most affordable of which is $25 per month. Please see the screenshot below:

Prices can change, so always check Shopify’s website for an updated price matrix. You can get a discount with the Basic plan and pay only $19 per month, provided that you pay one year’s worth of subscription in advance.

At this rate, you can now build a fully functional dropshipping store, with no domain name. I cannot give you an exact price of domain names because they vary. You can get a domain name for as little as $20 a year, or get a free one from Shopify, but that would carry the Shopify domain, which is not recommended.

Next, you can use WooCommerce via the WordPress content management system. There are two ways you can do this.

1. Use WordPress.com – I will call this WPCOM

2. Use WordPress.org – I will call this WPORG

WPCOM is like Shopify—you will pay a monthly subscription. Each plan has its limitations, and you must subscribe to the higher plan tier to be able to turn your website into an e-commerce store. As such, I do not recommend it.

The second option is through WPORG. Before you can start with this setup, you need to buy a hosting plan. There are many out there, such as Hostinger, Hostgator, BlueHost, etc.

A hosting service provider is the company that manages your servers and storage. You can get a subscription for shared hosting for as low as $3 per month.

Once you have that server up and running, you now have to install WordPress for free, and then install WooCommerce for free. This setup is the cheapest, based on my experience, but it requires a lot of technical know-how.

If your inclination for technical stuff is low, I suggest that you use Shopify. There are others you can use, such as Ecwid, BigCommerce, Squarespace, etc. However, Shopify and WooCommerce are the biggest and the best when it comes to ecommerce platforms.

2. Advertising Costs

Some say that “if you build it, they will come.” This could not be farther from the truth. Gone are the early days of the internet. Today, you are competing against millions of websites and sellers globally.

You need a marketing plan when you dropship. At the very least, I can say that you must spare at least $300 per month for your ads. This does not include your budget (in terms of time and effort) in marketing your products on social media sites like Instagram.

If your ad and creatives are bad, do not expect people to come flocking to your ecommerce site. I can tell you right now that paid advertising is not a walk in the park.

At best, I would recommend marketing strategies that do not need a lot of money and are efficient. Or, do marketing that can make you go viral. TikTok or Instagram organic marketing is a great way to market your product or store.

3. Product And Shipping

Although dropshipping is an online business model where you do not pay for stocking inventory, you still need to pay your supplier before they ship the item to your customer. You need to front this money.

After receiving payment from your customer, say, in your PayPal account, the money does not go directly to your bank account. It can take days for that money to process. Because of this, you need to spend your personal money to pay your suppliers and have them ship the item to your customer—all while waiting for your customer’s payment to clear.

So, if you are starting a dropshipping ecommerce business an item whose capital and shipping cost is $50 and you have 10 orders in a day, you need $500 right now to process all these orders.

I cannot tell you how much you need to set aside for this cost—it is you who knows your marketing costs, product and shipping costs so just make simple mathematical assumptions.

4. Automation Tools

There are many automation tools that you can use to make your life easier as an entrepreneur. The best I can recommend is Tradelle, a tool that does the following things:

• Product research
• Automated order fulfillment
• Trending products list
• Analytics and product metrics

With Tradelle, the system will automatically place the order to the manufacturer even if you are asleep. The manufacturer gets notified and ships the item without your intervention.

For product research, you will have easy access to winning products—products that have a demand in the market. With Tradelle’s analytics, you will see reports and metrics of how products move. Because of this, you can make informed business decisions, not hunches.

If you do all these manually, I can tell you right now that you will spend time in your ecommerce store just like an employee—eight hours a day doing laborious work. You will use antiquated tools like Excel, type each product data, URL to it, and search for sales data—you will do so many things that you will find yourself overwhelmed.

And then what happens? You quit.    

At best, get a tool like Tradelle and only pay $29.99 per month. You will save a ton of time and effort in your dropshipping activities, so that you can now give more focus on what really matters – your marketing campaigns. Instead of doing manual work, you will do real management work. The best part is that you do not need to hire an employee to do these—the system will do it for you automatically!

What Is The Ideal Gross Profit Margin In E-commerce?

The ideal profit margin is what will keep your business afloat. In my opinion, there is no such thing as an ideal profit percentage or value for profit margins.

Your business has expenses that others do not incur. As such, you must price your products appropriately, regardless of what “experts” say out there.

But since it is a legitimate question, allow me to provide stats based on benchmarks:

• 10% is the average profit margin for e-Commerce
• 20% is what we can consider high
• 5% is low

The profit margin percentages here refer to net profit margins. The formula for net profit margin is this: Net Profit Margin = Net Income / Revenue x 100

Let us do a sample calculation. Let us say that your gross revenue for the month is $14,000. If your total expenses amount to $11,000, you still have $3,000 left.

• Therefore, your profit margin is $3,000 / $14,000 = 0.214285714
• Multiply this by 100 and you get: 21.43%

Your net profit margin is 21.43%. This money is what you get to keep. But wait, will you keep the $3,000 for yourself, or set it aside to pay your other business expenses if your sales are low? I would go for the latter.

The higher profit margin you have, the more likely you are going to be profitable over the long term. Later, in the succeeding sections, we will discuss how to price your products and subsequently how you can increase your profit margins.

Pricing Strategies For Dropshipping: Common Ways To Price Products

Should you add $10 to your capital cost? How about $15? What should you do? In this section, I will provide you with several effective pricing strategies that will help you manage your own dropshipping fees, costs and profit margins.

1. Price Skimming

Price skimming is a pricing model where you sell your item at the highest possible price because it is new. Companies do this all the time when they introduce a new product in the market.

For example, it is not unusual to pay $700 for a new computer processor. Years later, this same processor will only sell for $150.

You can do the same for dropshipping, but it works best if you get a chance to sell a product at the start of a trend. That is why I encourage you to use a tool like Tradelle, as it gives you data about ongoing trends. You can pick a product that is about to explode, and capitalize on it because you are one of the first people who sold it.

If you hit the jackpot, you can sell a cheap item for four or five times its actual worth, giving you a good profit margin percentage, of more than 400%. After some time, the demand and prices for this product will go down. Despite that, you already made a huge profit before and during this product boom.

2. Cost-Plus Pricing

Cost-plus pricing is a strategy that we commonly apply to our selling price. In this strategy, you base your prices on your target gross margin and add that dollar value to it.

For example, if a drone costs $50 from your supplier, and your target profit margin is 50%, you will add $25 to $50 because $25 is 50% of $50.

As such, you will sell this item for $75, and it is up to you if you want to give free shipping on that or if you will charge shipping fees separately.

This method does not work if your product is low-cost. For example, if you are selling hair ribbons whose capital cost is $1, applying a profit margin of 50% does not make sense. You will sell that ribbon for $1.50, with a profit of $0.50 per piece.

In this case, I suggest that you price your products by adding a straightforward dollar value to them. For example, sell the ribbon for $5, regardless of your target profit margin.

The cost-plus pricing works great and is easy to implement, provided that you checked the market for your competition, which takes us to the competitive pricing model.

3. Competitive Pricing

In this pricing model, you want to check the prices of your competitors in the same niche. What you want to do here is to price your product close to their prices, so you remain competitive.

Take a look at this example:

The supplier’s price for this vacuum adapter is $9.25. Knowing this, how much should we price it in our dropshipping store? What I did was do a reverse image search to find online stores selling the same thing.

Here are two screenshots:

On eBay, the toy sells for $39.99. On Amazon, the toy sells for $49.99.

From here, you can price this product anywhere between $40 and $50, but not more than $50. A price between the range I mentioned is what I call the sweet spot.

4. Promotional Pricing

The last pricing strategy that I recommend is promotional pricing. It is a method where you sell your items at a low price to entice buyers to make the purchase now. Typically, you would need a sale plug-in or app to do this if your e-commerce platform does not have it yet.

In this strategy, you have to indicate the original price and the sale price. You also have to indicate a promotional period—like the price is only until the end of the month.

Usually, you use this pricing method during special seasons or occasions, like Father’s Day, Mother’s Day, Thanksgiving, the Holidays, etc.

You do not need to wait for a special occasion to do this. Right off the gate, you can offer promotional pricing the day you open your store.

The buyer psychology here is what we call FOMO or fear of missing out. People tend to make impulsive purchases because they do not want to miss out on a good deal.

How To Increase Your Profit Margin

In this section, I will show several ways to increase your profit margins. It is an entrepreneurial principle because your business will only survive if you increase your profit margin. The higher it is, the more cash reserve you get to keep. While the default mindset is to increase prices, it does not always work because of two things: economy and competition.

Here are my recommendations:

1. Reduce your expenses
2. Avoid mistakes that cost you money
3. Increase your average order value
4. Encourage repeat purchases

Let us discuss these approaches one by one.

1. Reduce Your Expenses

The most obvious way to increase your profit margin is by reducing your operating expenses. Take a look at this example:

SCENARIO A			SCENARIO B
AREA	COST		AREA	COST
Total Revenue	$500		Total Revenue	$500
EXPENSES			EXPENSES
Shopify	$25		Shopify	$25
Tradelle	$30		Tradelle	$30
Other Apps	$145		–	–
TOTAL EXPENSES	$200		TOTAL EXPENSES	$55
PROFIT	$300		PROFIT	$445
PROFIT MARGIN	60.00%		PROFIT MARGIN	89.00%

As you can see, the second scenario has a 29% higher profit margin than the first one, and all it took was to stop paying for apps that you do not need.

Once you start a dropshipping store, I can tell you right now that you will see so many apps in the market. Marketers position these apps to make you believe that you will increase your sales.

But no. All these are merely bells and whistles that make your website look better, but they have no direct relationship with increasing your sales, in most cases. If you are merely beginning, avoid these apps like a plague.

2. Avoid Mistakes That Cost You Money

Another way to increase your profit margins is to avoid mistakes that have a cost. For example, make it a point to set customer expectations to avoid refunds. Or, make sure your dropshipping suppliers are reliable.

Supposing that you sold a product that cost you $50 to buy from the supplier, plus $10 for shipping. Your total cost is $60. You sold this for $100 and offered free shipping. Your profit margin is $40.

Now imagine the supplier ships the wrong item. What do you think is going to happen?

You have to give the customer back $100. You paid the supplier $60, right? It will be a hustle to demand the money back for shipping from the supplier. Now, you are negative $10. In addition, the customer may even demand that you pay for the shipping of the item back to your supplier.

Another mistake you can make is rushing to advertise. Social media and Google advertising are different beasts that are hard to tackle. Before spending thousands of dollars on ads, I implore you to spend only a little.

Advertise with a small budget, then learn from the results. From here, you can move forward and create better copy, better videos and images, and earn from your ads rather than lose money in advertisements.

3. Increase Your Average Order Value

Average order value or AOV refers to the average amount of money a customer spends in a transaction. The higher it is, the higher your revenue is going to be. You may need to cut down on the profit, but you will have more money coming in.

Increasing AOV is a common practice in businesses—a good example is the bundled meal at McDonald’s. You can do the same for dropshipping.

Here is how you calculate AOV:

• Customer 1 – spent $400 for a jacket
• Customer 2 – spent $250 for a pair of pants
• Customer 3 – spent $300 for a shirt

The average order value is the sum of all three transactions divided by three transactions = $316.67. What we want is to increase it, so our revenue is also bigger, yet our operating costs and expenses remain the same.

Here is an example of increasing AOV by using a bundle promotion:

ITEM	CAPITAL	CUSTOMER PAID	PROFIT
Jacket	$250	$400	$150
Pants	$200	$250	$50
Shirt	$250	$300	$50

Your profit from three separate customers is $250. Now, what if you create a bundle for these three products, and sell the bundle for $800?

If you do this, your profit for each bundle is only $100. However, you can expect more people to buy. Instead of the customers paying the full price of $950, they only pay $800, which gives them a savings of $150.

Now, it takes only three customers to spend $800 each, and your average order value is $800, not $316.

Also, you have a profit of $300 (total for the three transactions), not $250. As you can see, for the same number of customers, you made more money if you bundled your products than if you didn’t.

4. Encourage Repeat Purchases

The last method I can share to increase your profit margins is to encourage repeat purchases. It is also why I recommend that you sell things that people will buy repeatedly, such as lipsticks and make-up.  

In business, it is always better to sell to repeat customers than to have to acquire new ones. For example, if you spend $100 on ads and it results in two customers buying, your acquisition cost is $50 for each customer.

The problem is that these customers will not buy again. On the other hand, if you sell a product that they will buy again, your acquisition cost is still $50, but the same two customers will buy the same product in a few months; you do not have to spend money on ads to acquire new customers.

What does this mean? It means you do not have to spend so much money on marketing to make sales. All you have to do is to sell products that customers will buy repeatedly, and give them a reason to buy again and again from you.

FAQ: How To Calculate A Dropshipping Profit Margin

What is the profit ratio for dropshipping?

The profitability ratio refers to many types of calculations, including gross profit margin, EBITDA, net profit margin, etc.

How do I calculate my profit margin?

The formula is revenue – all expenses = profit. Divide the profit by the revenue then multiply by 100, and you will get your profit margin percentage.

How to calculate the dropshipping price?

The most straightforward way to calculate the dropshipping price is through straight dollar pricing where you add a specific dollar amount to your capital cost.

What is the average profit of a dropshipping store?

Industry experts say that it is between 15% and 20%. However, do not be misguided with this info—you are in control of your profit margins in your business.

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Final Thoughts

The trick here is to list down all your potential expenses and then set a target number of net sales or units per month. From here, you can identify how much profit you need to add to each item to break even or become profitable.

I also encourage you to try out Tradelle, and see how much time and money it can save you from doing manual work. It is free to sign up for an account!