Variable Costs Explained: Why They Matter and How to Calculate Them

As an ecommerce business scales and order volume grows, costs inevitably rise in lockstep with revenue. While some expenses, like website hosting or office rent, stay relatively constant from month to month, others increase or decrease directly with sales. These are known as variable costs, and getting a firm handle on what they are, how they behave, and the role they play in profitability is essential for any online seller looking to thrive over the long run.

In this comprehensive guide, we‘ll unpack everything you need to know about variable costs, from basic definitions and formulas to real-world examples, benchmarks, and optimization strategies. Whether you‘re a solopreneur just starting to see sales take off or a seasoned ecommerce executive looking to fine-tune your unit economics, the insights and tactics you‘ll find here will help you make smarter, more profitable decisions. Let‘s dive in!

What Are Variable Costs?

At the most fundamental level, variable costs are business expenses that fluctuate depending on sales volume. The more products you sell, the higher these costs will be. Some common variable costs for ecommerce businesses include:

• Cost of goods sold (COGS) – what you pay your supplier/manufacturer for inventory
• Packaging materials like boxes, envelopes, tape, labels, air pillows, etc.
• Shipping costs to get orders to customers (postage, fees to carriers like UPS/FedEx)
• Transaction fees charged by payment processors (Stripe, PayPal, etc.)
• Sales commissions paid to affiliates or influencers
• Advertising spend on Facebook, Google, etc. to acquire customers

The key distinguishing factor is that these costs increase or decrease proportionally with order volume. If you sell 100 units this month, your shipping and transaction fees will be roughly double what they were when you sold 50 last month. Fixed costs, by contrast, stay the same regardless of sales. Think expenses like web hosting, subscriptions to ecommerce software, rent for warehouse space, salaries for full-time staff, etc.

It‘s important to note that some costs can be semi-variable, with both a fixed baseline component and a variable component that scales with order volume. An example would be customer service. You likely need a certain staffing level to handle a baseline amount of inquiries, but may need to hire additional temporary reps during peak periods.

Why Variable Costs Matter for Ecommerce

For online sellers, getting variable costs under control is absolutely critical for long-term success and profitability. Here are a few key reasons why:

Contribution Margin

Your contribution margin is the difference between your selling price and variable costs per unit. It represents the incremental profit you earn on each sale after accounting for the costs that change with volume. The higher your contribution margin, the more quickly you cover fixed costs and start generating net profit.

Let‘s look at a simple example. Say you sell a widget for $100 with the following variable costs:

• COGS: $50
• Shipping: $10
• Payment processing: $3
• Total = $63

Your contribution margin is $37 ($100 – $63). So for every widget sold, you earn $37 to put toward fixed expenses and net income. If your fixed costs are $1,000 per month, you‘ll need to sell 27 widgets ($1,000 / $37) to break even.

Now imagine your supplier raises prices, so your COGS increases to $60 per unit. Your contribution margin falls to $27 and your break-even volume rises to 37 units. As you can see, even small changes in variable costs can have a big impact on profitability.

Scaling Efficiently

Keeping variable costs in check is key to scaling profitably. Many ecommerce businesses actually see contribution margins shrink as they grow due to rising variable costs. Common culprits include:

• Shipping carriers raising rates (sometimes unexpectedly)
• Having to switch to a pricier 3PL to handle higher order volume
• Customers in more distant shipping zones as you expand geographically
• Advertising costs rising as you scale spend and reach new audiences
• Chargebacks and payment fraud increasing in tandem with order volume
• COGS increasing as you launch premium products with pricier inputs

If these variable costs rise faster than your average order value, contribution margin will decline and you‘ll have to sell more units to generate the same profit. So while top-line revenue is rising, actual profit may stagnate or even decline.

The key is to proactively monitor and optimize variable costs as you grow. That could mean:

• Renegotiating rates with key suppliers as order volume hits new tiers
• Optimizing shipping (packaging, carriers, zones, etc.) to lower costs
• Implementing fraud prevention best practices to minimize chargebacks
• Testing new advertising channels and audience targeting to improve ROI
• Adjusting pricing and discounting strategy to protect margins

Inventory Planning

For ecommerce brands, inventory is often the largest variable cost. Ordering too much stock ties up precious capital and leads to high carrying costs. Ordering too little means lost sales and unhappy customers. Finding the right balance requires a keen understanding of variable costs.

Consider how inventory impacts other variable expenses too. The more inventory you hold, the more you‘ll pay for storage space, labor to receive/pick/pack orders, shipping materials, and so on. Excess stock can also lead to higher obsolescence and damage costs down the line.

Effective inventory planning demands a granular view of variable costs at the SKU level. You need to know the true landed costs of each product (COGS + inbound shipping + customs, etc.), holding costs per unit, and velocity metrics to make smart decisions about reorder points, safety stock levels, and more.

Calculating Variable Costs for Your Ecommerce Business

Accurately measuring variable costs is essential for making informed pricing, marketing, and operational decisions. Here are the key metrics and formulas to know:

Variable Cost Per Unit

This figure represents the variable expenses incurred to sell one unit of a product. To calculate, divide total variable costs by the number of units sold.

Variable Cost Per Unit = Total Variable Costs / Units Sold

For example, if your total COGS, shipping, and payment processing fees for a product are $5,000 and you sold 250 units, your variable cost per unit is $20 ($5,000 / 250).

Average Variable Cost

Average variable cost is simply another way to look at variable cost per unit. You calculate it the same way: take your total variable costs over a given period and divide by the number of units sold.

Total Variable Cost

To calculate your total variable costs, multiply the variable cost per unit by the number of units sold.

Total Variable Cost = Variable Cost Per Unit x Units Sold

Going back to the example above, if your variable cost per unit is $20 and you sold 250 units, your total variable cost is $5,000 ($20 x 250).

It‘s important to track total variable costs on a regular basis (monthly, quarterly, etc.) and compare to prior periods and forecasts. Significant changes could signal the need to dig into certain line items and look for savings opportunities.

Contribution Margin

As noted earlier, contribution margin is the difference between selling price and variable costs. It‘s typically expressed on a per-unit basis and as a percent of revenue.

Contribution Margin Per Unit = Selling Price – Variable Cost Per Unit
Contribution Margin Percent = (Selling Price – Variable Cost Per Unit) / Selling Price

So if you sell a product for $50 and the variable cost per unit is $20, your contribution margin is $30 per unit and 60% of revenue.

Contribution margin is a critical metric for ecommerce businesses. It shows how much each incremental sale contributes to covering fixed expenses and reaching profitability. Generally, products with higher contribution margins are more profitable and should be prioritized in merchandising and marketing.

Here‘s an example of how two products with the same selling price can have very different profitability due to variable costs:

Product	Selling Price	Variable Cost	Contribution Margin	Margin %
A	$100	$60	$40	40%
B	$100	$80	$20	20%

Product A earns twice as much margin per unit as Product B. You‘d need to sell two units of B to generate the same incremental profit as one unit of A. This type of analysis is essential for optimizing your product mix, pricing strategy, and promotional calendar.

Break-Even Analysis

Your break-even point is the sales volume needed to cover both variable and fixed costs. Calculating it requires knowing your fixed costs, selling price, and variable cost per unit. Here‘s the formula:

Break-Even Volume in Units = Fixed Costs / (Selling Price – Variable Cost Per Unit)

Say you have $10,000 in fixed costs per month, your average selling price is $50, and your variable cost per unit is $30.

Break-Even = $10,000 / ($50 – $30) = 500 units

At 500 units sold, your total revenue ($25,000) will equal your total costs ($10,000 fixed + $15,000 variable). To turn a profit, you‘ll need to sell more than 500 units per month.

Break-even analysis is a helpful tool for setting sales targets, evaluating new products, and stress-testing your business model. By understanding how different price points, cost structures, and sales volumes impact profitability, you can make more informed decisions.

Benchmarking Your Ecommerce Variable Costs

Wondering how your variable costs stack up to other online sellers? While every business is unique, looking at industry benchmarks can provide helpful context and surface areas for improvement.

According to a study of 350 merchants by Shipbob:

• The average Cost of Goods Sold as a percentage of revenue was 34%
• Blended shipping costs averaged 16% of revenue
• Merchant fees (payment processing, marketplace commissions, etc.) averaged 7% of revenue

Of course, these figures vary widely by vertical, business model, average order value, and other factors. But in general, many ecommerce brands spend 50-60% of each sales dollar on variable costs.

If your variable costs are significantly higher than these benchmarks, it could be a sign that you need to optimize certain areas like shipping, payment processing, or COGS. That said, having higher costs isn‘t necessarily bad if they‘re driving faster growth (e.g. spending more on ads to acquire customers more quickly). It‘s all about striking the right balance for your business.

Strategies for Optimizing Ecommerce Variable Costs

Improving your bottom line isn‘t just about driving more sales. Often, the most impactful lever is lowering your variable costs. Even small optimizations can have an outsized impact on profitability, especially as you grow. Here are a few proven tactics to try:

Negotiate with suppliers

Don‘t be afraid to ask for better pricing, payment terms, or volume discounts, especially as your order quantities rise. Remember, your success is your suppliers‘ success too. Many will be willing to work with you to find a mutually beneficial arrangement.

Optimize inventory management

Reducing stock-outs and excess inventory can have a major impact on variable costs like COGS, shipping, and fulfillment. Make sure you‘re using accurate demand forecasting models, setting appropriate reorder points, and keeping a close eye on inventory turnover.

Streamline your supply chain

Look for ways to shorten lead times, consolidate shipments, and optimize routes to lower inbound shipping and carrying costs. Consider diversifying your supplier network to mitigate risk and take advantage of geographical cost advantages.

Automate fulfillment

Shipping is one of the largest variable costs for ecommerce brands. Finding ways to streamline the process through automation, bulk shipping rates, and more efficient packaging can translate to meaningful margin gains. Many fast-growing brands partner with a tech-enabled 3PL to realize these efficiencies.

Strengthen your reverse logistics

Processing returns is costly and eats into contribution margin. While you can‘t eliminate returns completely, you can reduce them by providing detailed product information, sizing guides, and setting clear expectations. Optimize your returns process to get products back in stock ASAP.

Stay on top of payment processing costs

Transaction fees and chargebacks add up quickly as order volume scales. Make sure you‘re using a modern payment gateway with competitive rates. Implement fraud detection tools and best practices to minimize illegitimate chargebacks. Monitor processing fees regularly and don‘t hesitate to switch providers if needed.

Test free shipping thresholds

Offering free shipping is a great way to boost conversion rates, but it also eats into margins. Consider testing different minimum order thresholds for free shipping to find the sweet spot. Many brands find that a slightly higher threshold actually increases average order value enough to offset the cost.

Focus on high-margin products

Not all products are created equal when it comes to profitability. Double down on marketing and merchandising high-margin SKUs that contribute outsized profits. Consider bundling low-margin products with high-margin ones to improve overall margins.

Use data to drive decisions

The key to optimizing variable costs is having granular, real-time data on your cost drivers. Make sure you‘re using robust ecommerce analytics tools to track COGS, shipping, advertising, and other key metrics at the SKU level. Pay attention to trends and anomalies that could signal cost-saving or revenue-boosting opportunities.

The Bottom Line

For ecommerce brands, keeping a laser focus on variable costs is non-negotiable for long-term success. These costs have a direct impact on your contribution margin, profitability, and ability to scale efficiently. By understanding what they are, how to measure them, and most importantly, how to optimize them, you‘ll be well on your way to building a thriving, profitable online business.

The key is to stay disciplined, data-driven, and proactive. Don‘t wait until margins are eroding to take action. Constantly monitor your key cost drivers, look for opportunities to optimize, and make decisions based on hard numbers, not gut feelings. With the right approach, you can keep variable costs under control and set your brand up for sustainable growth.