Amazon’s process for getting the buyer to spend more goes something like this. When you add an item you are interested in to your shopping cart, Amazon gives you a couple of options. One is to proceed to checkout. The other option is typically to click and add something else to the cart that is highly recommended for you.
For example, I added the Amazon Echo (2nd Generation) to my shopping cart. This is a $99 product. Amazon immediately presented the option to add 2-year accident protection for $14.99.
In addition, Amazon also shows you “Recommended For Your Device” options. These ranged, in this example, from a $14.99 “Outlet Shelf For Echo Devices” to a $29.99 “Alexa Voice Remote.”
If many people visited the same page, some customers would opt in on the additional offers. Amazon was capable of boosting the average order value in this example from $99 to potentially as high as $130 or more.
What Is Average Order Value
In simple terms, average order value is the mean dollar value of each checkout that occurs in your online store.
Average Order Value is abbreviated as AOV. To calculate AOV for your store, use the following formula:
AOV = Revenue / Total Number of Orders
Let’s suppose that Timo runs an online clothing store and his monthly revenue is around $180,000. On analyzing his checkout metrics, he confirms that his store processes around 3,000 orders per month. Dividing total revenue by the total number of orders, he discovers that his AOV is around $60.00.
E-commerce average order value is one of the core metrics for analyzing the financial performance of your e-commerce store. It forms part of an important set of closely related metrics which include:
- Gross Profit Margin – Gross profit margins typically improve when your AOV increases, but this is not necessarily the case. These are two metrics you want to optimize in the upward direction.
- Customer Acquisition Cost (CAC) – When your AOV is higher, you can typically afford to pay a higher customer acquisition cost. This is because each order is worth more to your business. However, there will still be a limit to how high your CAC can go.
Why Average Order Value Matters
A higher AOV can bring many benefits for your ecommerce business. The first way this helps you is in the profitability of your store. The correlation between AOV and Gross Profit Margin is important in this regard.
If your AOV is very low, typically your profit per product after shipping and fulfillment costs is low as well. So to make a decent profit, you need a high amount of orders. And that means either high repeat purchases from your customers or acquiring lots of customers. Since your margin is low, you don’t have much budget for customer acquisition costs.
However, when your AOV is higher, it means your total gross margin per order is higher too, even if the gross margin rate is the same. To see why, let’s suppose you have a 50% gross profit margin rate across your e-commerce store.
If your average order value is $100, that means you make a gross profit of $50 per order. That might be pretty good, but notice what happens if you are able to increase your average order value. When you raise your average order value and it goes up to $200, now things get even better. Even though your 50% gross profit margin rate stays the same, your gross profit per order is now $100. The gross profit you make per order has gone up from $50 to $100 just because the typical order you get is now bigger.
With that higher gross profit also comes margin for a higher Customer Acquisition Cost. As your margin is higher, the budget you can spend to acquire an additional customer and remain profitable goes up. Since you make more revenue and gross profit per customer, you can comfortably pay more for traffic in your ad campaigns and outbid your competition.
Where revenue is a vanity metric that does not give you much valuable insights, Average Order Value – especially in combination with Gross Margin rate and Customer Acquisition Costs – gives you insight in the financial and strategic health of your business.
According to MailMunch, settling for too low an AOV is, in fact, one of the most common e-commerce mistakes.
Keep In Mind
While it is important to optimize for a higher AOV, keep in mind that it is not the “holy grail” of e-commerce finances. Taken in isolation, a higher AOV might not be optimal for your store. You have to look at the store’s entire financial situation and optimize for overall financial health.
A related metric that factors into the effectiveness of the AOV is the rate of repeat purchase. This measures the percentage of your customers who return to your store for repeat purchases. It indicates how well your store performs in the important area of customer retention.
Having a high AOV might not help you as much if the bulk of your customers are one time buyers only. On the other hand, a lower AOV with a very high rate of repeat purchases would build your business sustainably over time. This is because you achieve a higher customer lifetime value (LTV). Since you know that customers stay with your store over time, you can afford to spend more on customer acquisition. You can even afford to sell certain products at a loss to acquire new customers because you make that money back over time.
In addition, you should be aware that having a few high priced items among a range of low cost items might skew your AOV high. As an average metric, AOV gives a much better picture if there is a normal distribution of prices in the store. Seasonality may also skew your AOV at different times of the year. If most of your sales occur over the holidays, your overall AOV may be much higher than you experience in off-season times.
AOV also varies widely depending on the industry and types of products you sell. A high end store selling premium products will tend to have a high AOV. On the other hand, a discount store selling low priced items will tend to have a low AOV.
Klaviyo did a study of e-commerce benchmarks across industries ranging from fashion and home goods to pet care. They found that the average AOV across e-commerce stores was around $86.07.
How To Improve E-Commerce Average Order Value
There are multiple approaches that work for improving your store’s e-commerce average order value. You will need to consider your store’s situation carefully to determine which of these options will work best for you.
The first approach is to increase prices. This straightforward method will directly boost the dollar value of each order, thus raising your AOV. But, as one of the most basic laws in economics holds true – at higher prices, there may be lower demand. Depending on your niche, customers may flock away to alternatives.
A better approach would be to use upsells. An upsell is when you offer a customer an upgrade of a product that they are buying or just bought. You already know the customer is interested in that kind of product, but maybe he or she was not aware of a better quality of that kind of product you have. Upsells tend to work well with customers who want a premium product or experience.
The third way to improve AOV is to use cross-sells. Cross sells work by recommending complementary products based on what the customer is interested in. For example, if a buyer just bought the Echo I mentioned earlier, you could offer insurance or accessories. These could include outlet shelves, extra chargers, and other related products.
With modern e-commerce platforms, setting up cross sells and upsells is incredibly easy. There are upsell and cross sell plugins for platforms like WooCommerce, Shopify and others that you can use.
5 Indirect Ways To Increase Average Order Value
There are indirect ways to improve average order value as well. These can encourage your customers to spend more with you:
- Flexible return policy – Take away the buyer’s risk by offering flexible returns. This will also encourage customers to buy in bulk since they can return the goods if they don’t like them.
- Free shipping for orders above a threshold value – Offer customers the benefit of free shipping for orders above a certain minimum value, for example $50. This will tend to nudge customers to spend more to take advantage of free shipping.
- Volume discounts (e.g. buy 3 and get 20% off) – Give volume discounts on popular items in your store to encourage shoppers to buy more of them.
- Offer gift wrap option – This is one tactic that can get buyers to spend more since they want their gifts to be well received. You can use this for holiday and birthday related products.
- Product recommendations – Using add-ons for your ecommerce platform, you can implement product recommendations similar to what Amazon does. These can encourage customers to buy related items and increase your AOV.
How We Can Help
For ecommerce entrepreneurs, optimizing average order value can solve many of the issues that online stores struggle with. Getting your AOV high enough can lead to improved cash flow, revenue, and overall store profitability.
A CFO will set your business on the sound path to fast and sustainable growth. At Insight Matters, we help entrepreneurs like you grow their businesses while avoiding the mistakes that slow things down. Reach out today to set up a call with us and get the help your business needs.SCHEDULE A FREE CONSULTATION