A Micropreneur’s Perspective: Selling Physical Products vs. Digital Products

A recent discussion in the Micropreneur Academy surrounded the topic of starting an online business selling physical products as opposed to software. Since I’ve worked on both sides of the fence I have a lot to say on the subject.

I’m asked pretty regularly about the best way to start a physical product e-commerce site, or whether that’s a good way to get started selling online.

One major benefit of selling a physical product is you don’t have to build anything; the work is all in finding a supplier and putting up a site. This is great because you avoid the 200-400 hours to build something.

But there are two downfalls of selling physical products compared to software:

1. Unless you manufacture something yourself you are a commodity, which means price is a major issue. No matter where you go, any supplier you find will already be in use by someone else. If they aren’t, within 6 months of your success you’ll likely see someone else selling the same product on eBay for less.

2. As a result, margins are tight. If you want to stock products yourself (I am vehemently against this), you will need a garage or other large space, thousands of dollars in up-front inventory, and you will spend hours packing boxes and running to the post office…this is not work for a Micropreneur. The better route is to find a drop-shipper who will ship directly to your customers once you’ve made the sale. Which is great, except at that point your margins are slim…think 20-40% gross profit.

As a developer you have the ability to build/hire out/buy applications and websites, where the margin is huge and you have something unique. Whether you’re selling invoicing software or performance management software your gross margin is going to be close to 100%.

But with sunglasses, paper lanterns and beach towels the margin is much smaller.

Case Study – JustBeachTowels.com

Using JustBeachTowels.com as as an example, I purchased the site because of the #6 Google ranking for the term “beach towels” and because it was priced way below its potential. I added a shopping cart and found a beach towel dropshipper (surprisingly hard to find), and sales were around $100-200 per month. Gross margin was about 30%, which meant a whopping $30-$60 per month in my pocket.

So I spent time honing PPC, SEO, a new design, a new cart, finding more dropshippers…and I finally hit on the big low price guarantee revelation I wrote about in my blog. Sales shot up starting the next day and that month sales were in the low four-figures. I was pleased to say the least.

Except that four-figures in sales resulted in just a few hundred dollars in net profit after cost of goods sold.

Not bad…except I took in nearly 100 hundred orders to attain that number and I either had to place all of those orders myself or have a Virtual Assistant (VA) handle the order processing. The dropshippers are not very high-tech and don’t have a way to integrate programatically with their ordering system so every order has to be placed manually.

And even at $6/hour for the VA, the cost to place 100 orders manually through a shopping cart was close to $200. No big deal, I still made a few hundred bucks, right?

Except the shopping cart (shopify.com – awesome hosted cart) charged a percentage of sales that wound up totaling about $80. And credit card processing fees took another 3%, which left me with a net profit of around 10% of my gross revenue.

From a blockbuster month of sales I made just over 10% net profit.

Why Digital Products Are Superior

This was a big lesson for me. I had spent a lot of time coddling and growing this website and all I got was a lousy 10%? This was compared to my digital product sites like DotNetInvoice, where an increase in sales results in darn near 100% of the money hitting my bottom line as profit.

It was that moment I decided to focus my effort on digital products exclusively given the huge difference in profitability.

I sold justbeachtowels.com in January of 2009 and made a great return on my investment with the goal of investing the funds into my next digital product site. Though I haven’t acquired anything yet (I have my eye on a few), the return on those funds will be much higher with a software product or SaaS website.

This is not to say that you should never go into physical products; I’m sure there are exceptions to my experience, and if you stumble on a crazy deal as I did you would be foolish not to acquire something below market price. But to build a physical product e-commerce website from scratch would require much more time than it’s worth given that we can build and sell software at higher margins and with less competition.

And I didn’t even mention returns and lost shipments…

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#1 CVOS man on 05.04.09 at 9:50 pm

Selling online is a lot like comedy: success comes with lots of testing and perfect timing.

#2 recession marketing monkey on 05.05.09 at 6:01 am

Great post! I just sell via an affilliate link on one of my sites.. Although I have no administration overheads, it does suck only getting 2.5% commission.. look forward to reading more!

#3 Daily Digest for May 5th « Flow on 05.05.09 at 7:24 am

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#4 iWeb Blog » Nouvelles Techno iWeb: marketing web, f.lux, micro-entrepreneuriat on 05.05.09 at 8:00 am

[…] les leçons apprises par un micro-entrepreneur: Vendre des produits physiques vs vendre des produits digitaux […]

#5 iWeb Blog » iWeb Tech News Highlights: web marketing, F.lux, micropreneurs on 05.05.09 at 9:58 am

[…] a micropreneur’s perspective: Selling physical products vs digital products […]

#6 Jannik on 05.06.09 at 5:33 am

Hey Rob,

I was just wondering – where/how do you look for decent acquisitions? Was justbeachtowels.com officially up for sale?

#7 Rob on 05.07.09 at 4:22 pm

@Jannik – Check out the comments on http://www.softwarebyrob.com/2008/10/03/should-you-build-or-buy-your-micro-isv/ for some info about this. And yes, it was for sale – I purchased it at auction.

BTW, the Micropreneur Academy I mentioned (www.sixfiguresoftware.com) goes in-depth on the issue of buying a product, including how to re-vamp it and increase traffic/sales since that’s the key to a sustainable increase in value.

There are a lot of pitfalls to avoid so I wouldn’t recommend going to the site and making an offer on the first site you see. It took me a couple years and many bad purchases before I figured out how to screen sites, handle purchase transactions, and how to re-vamp and ultimately profit through increased recurring income or selling the site at a higher value.

#8 C.S. Hsia on 07.31.09 at 2:38 am

My startup, which has expanded into language based service, online community debugging, and an open ID provider, are all software based products. We’re firm believers in digital products and online based services (not ad based). However, it all still depends on the audience. Selling our VOIP service without a “physical CD” proves very hard in education. Whereas we got some big names interested in Pay4bugs very early, just with SEO.

#9 Jeremy on 08.11.09 at 3:16 pm

Part of the problem with the beach towel site was the choice of product:

1. Low margins
2. It was an item someone can buy at a store
3. Little opportunity for upsells (buy a bigger towel?!?)
4. Little value in the list of customers
5. No or little repeat/continuity business

If you can find a high margin, not-available-in-stores, continuity product with the possibility for upsells, then you have a winner.