Photo used from Pexels by Karolina Grabowska 

It's amazing how many untapped niches there are. However, before pursuing a prospective niche, you must first determine its profitability. In order to figure out the profitability of your niche, you need to know what to look for. There are a few crucial metrics for every niche that will make or break its success. You'll need to conduct research on your rivals' products and services, as well as what their customers have to say about them.

It is imperative that you know what your business will be lucrative before you devote your valuable time and money to it. Here are a few pointers for figuring out whether an eCommerce niche is profitable or not.

Look into the production cost

For both a retailer and an e-commerce entrepreneur, the question of the cost of production versus potential profit is a crucial consideration when determining whether to stock or sell a particular product. Any number of factors can influence the price at which a manufacturer will sell a product to retailers, as well as on the price at which retailers may then mark up those products for sale to consumers.

Running a business comes with several possible costs, including, but not limited to:

• Property and equipment leases
• Loan repayments
• Utilities
• Salaries/wages/commissions of employees
• The inventory itself

After you have a handle on all of these costs, determine the average price that you can sell your product for. This number should be based on market research and awareness. You may be surprised to learn that there is a cost associated with every sale, even if you are selling digital goods. For example, if your website sells eBooks, you will incur some costs whenever someone clicks on a "buy now" button. These costs could be website hosting fees, transaction fees, and taxes.

Other things to consider when calculating the profit margin include:

• Markdowns
• Unanticipated shortages
• Inventory damage
• Shrinkage (– for example shoplifting)
• Employee discounts

Now even after a product has been "produced," the cost of delivering it from one location to another must also be considered. Even a seller who employs the drop-shipping services of a third-party distributor might still struggle with the expenses of shipping.

It’s a little challenging to calculate profitability especially when we know that all of the factors above can change at any time. Overhead and transportation expenses are likely to rise in the future. Employees can (and will) request pay increases or renegotiate their contracts. But arguably the most significant source of change will be found in the nature of the market you have entered.

You need to know the differences between fixed and variable expenditures if you want a clear understanding of your expenses.

Understand your margins

Now that you more or less have an idea about the true production cost, the next best way to determine whether your eCommerce business can turn a profit is to understand profit margins. The higher the profit margin, the more likely you are to turn a profit.

A profit margin is simply the percentage of profit you keep from a sale. A $100 product with a 20% profit margin equates to $20 net income. That same product with a 10% margin only gives you $10 in income. You’re doing the same amount of work, but you’re making half as much money.

Profitability metrics can be broken down into two categories: gross profit margin and operating profit margin (OPM). The gross profit margin is calculated by subtracting the cost of goods sold from revenue and dividing that number by revenue.

Operating profit margin is determined by subtracting operating expenses from gross profits, then dividing that number by revenue. Operating expenses include all other costs associated with running your business, including rent, insurance, and inventory management software fees.

Test the market

Finding out what customers are ready to pay for a product on the open market might help you assess if your target niche is lucrative. You can accomplish this by testing the demand and price point on Amazon, eBay, and other marketplaces, or by building a sales page on your website.

Launching a simple landing page that describes the product and collects emails from interested customers can be helpful in validating your concept. Dollar Shave Club uses this strategy to great effect. Within 48 hours of launching their explainer video and an initial sign-up page, they had 12,000 people register their interest.

Properly evaluating the market is work that demands you to study the prices of items as determined by your rivals. On the low end, an Amazon marketplace seller may simply need to check at marketplace listings for a certain product to get an instant feel of how it's priced, from highest to lowest.

For some products, you'll have to do some further research or perhaps make a few phone calls. You may not even know the names of your rivals without first performing an investigation.

Continue to test the market by performing larger-scale research. Pay a visit to new shops in your area that sell similar items.  and take notice of what is being stocked on the shelves and the corresponding costs. Check out the pricing of the same or similar items on the web using online research for eCommerce products.

Know how much you can afford to acquire customers

If you want to know whether your prospect niche is profitable, one of the easiest ways to calculate that is by determining the cost of acquiring customers or CAC. You can calculate the Cost of Acquiring Customers (CAC) by dividing your total amount spent on sales and marketing (including the price of advertising such as PPC, Facebook ads, content marketing, etc) by the number of new customers. The cost should be less than what each customer brings in so you don't lose money. If it's more, then you need to find out why and adjust accordingly.

 If your CAC is too high, it means you’re spending too much money on acquiring each customer. This can lead to problems later on when margins are low or nonexistent.

If your CAC is $100 and the average profit per customer is $30, then you can't spend more than $70 per customer on sales and marketing because that would put you at a loss.

Let's say you spend $1,000 per month on your marketing efforts and acquire 50 new customers during that time frame.

Your CAC is $20 ($1,000/50).

Now let's say each of those 50 customers spends an average of $100 per year with you. After subtracting the initial $20 in marketing expenses from each customer's value, you're left with an average lifetime value of $80 per customer.

When generating revenue for your business, it's always a good idea to benchmark against competitors' numbers as well as industry standards. Remember that these numbers will vary widely depending on the type of business model you're in.

Questions to ask yourself and determine profitability

Apart from the metrics above, you might want to ask yourself the following questions to determine if this is the right niche for you:

1. Do your products solve a problem or spark an emotion? Customers have problems, you and your products need to be the answer. Whatever it is you’re selling, you must do so in a way that solves a problem or evokes emotion.
2. How many people search for your niche/products? Keep tabs on how many people are looking for items similar to yours. Although you want to choose a market where there isn't a lot of competition, it doesn't mean that you should go for a niche that no one is searching for.
3. Did you find any proof that your product is popular online? Apart from the daily searches for your items, you should uncover evidence that your product has an online audience via blogs, e-books, social media, and forums, among other places. If there is no online discussion about your products and the solutions they offer, you may not have a platform of people to sell to.
4. Are there individuals who are willing to pay for the product? Just because something is Googled a thousand times a day does not guarantee that consumers would spend money on a product associated with it. Establish a profile of the customers to whom you will market and determine if they are motivated and capable of making the purchase.
5. How easy is it to rank for the keywords you want? You should ensure that you will be able to use the most precise keywords possible in order to attract the most qualified website visitors. Spend some time to examine the top-ranking rival websites for your keywords, and assess how your products match up to theirs.

Because no two niches are the same, you should consider all of the aforementioned criteria before making a selection. Create a scoring system and assess how many of the criteria each of your niche ideas meet out of a possible ten

Main takeaways…

The profitability of an e-commerce business is never a given, even for the largest and most successful brands. There will always be risks involved in any business venture, especially one that relies heavily on technology. This is why it's so important to look at every possible angle before deciding whether or not to open an e-commerce business. There are many aspects to consider, including market trends and the various expenses that a business is likely to encounter.

While this list is hardly exhaustive, it provides you with a solid jump off point to help you determine the profitability of your eCommerce website. And since this is a process that should—ideally—be ongoing, it's worth putting some time and effort into determining these costs as early on in the development cycle as possible. After all, you'll be able to better anticipate potential problems down the line if you know where your earnings and losses are taking place in the short term.

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