E-commerce fulfilment cost allocation: practical best practices to reveal product-level profitability

The Foundation: Why Fulfillment Costs Belong in COGS

Your revenue is climbing, but your net profit feels stagnant. You look at your product margins, and they seem healthy, yet cash flow remains tight. This common frustration for e-commerce founders often points to a single, overlooked area: fulfillment costs. When every pick, pack, and shipping fee is pooled into a general operating expense line item, you lose sight of which products are truly profitable and which are silently draining your resources. Learning how to allocate fulfillment costs in ecommerce is not just an accounting exercise. It’s a critical step toward making smarter decisions on pricing, marketing spend, and inventory management.

For many early-stage businesses, all fulfillment-related expenses from a 3PL or carrier are booked under Selling, General, and Administrative expenses (SG&A). This is simple, but it can be misleading. Fulfillment cost allocation is the process of moving these direct and variable costs from SG&A into the Cost of Goods Sold (COGS). This fundamentally changes how you view your profitability and is a key part of effective logistics cost management.

This shift allows you to distinguish between a Contribution Margin (revenue minus all variable costs) and a true Gross Margin (revenue minus COGS). A true Gross Margin that includes product-level fulfillment costs is what investors scrutinize and what you should use to guide strategy. Why does this matter? If a popular but heavy-to-ship product has its fulfillment costs hidden in SG&A, its gross margin looks artificially high. You might invest more in marketing it, only to find you’re losing money on every unit shipped. Moving fulfillment into COGS provides an honest, SKU-level view of profitability, which is essential for building strong, defensible unit economics that stand up to investor diligence.

Step 1: Deconstruct Your Invoices for an Accurate Order Processing Cost Breakdown

Before you can allocate costs, you need to understand what you are being charged for. Your 3PL and carrier invoices are often complex, but the fees generally fall into three categories. The first step in any order processing cost breakdown is to segment these expenses. Work with your fulfillment partner to get detailed reports, as this data is the foundation of your entire analysis.

1. Direct Per-Order Costs: These are the most straightforward to link to a specific customer order. They include fees for picking items from shelves, packing them into boxes, the cost of the shipping label itself, and any packaging materials like boxes or mailers. A common structure is a base fee plus a per-item charge. For example, you might see a fee of $1.50 per order plus $0.30 per additional item. These are the easiest to assign directly to a SKU or order.
2. Indirect (Shared) Costs: These are costs associated with running the warehouse that are not tied to a single order. This bucket includes monthly storage fees, often calculated by pallet, bin, or cubic foot. It also covers receiving fees for inbound inventory and any fixed monthly account management fees. Allocating these requires a logical model, such as distributing them based on the storage volume each SKU occupies or the number of units sold per month.
3. Variable and Exception Costs: This category covers everything else, including fees for handling customer returns, which might be a flat rate like $3.00 per return inspection. It also includes costs for special projects like kitting (bundling multiple SKUs together) and unexpected carrier surcharges for fuel, residential delivery, or peak season volumes. It is important to track these, as indirect and variable fees can add up to 20-30% of your total fulfillment expense.

Step 2: Choose Your Allocation Model for Effective SKU Cost Allocation

Once you have bucketed your costs, the next step is to choose a method for warehouse expense tracking and SKU cost allocation. The right model depends on your company's scale, product diversity, and operational complexity. The reality for most startups is more pragmatic: start simple and add sophistication as you grow.

Good: Blended Cost Per Order (for Brands Under $1M ARR)

This is the simplest starting point. You calculate a single, average fulfillment cost by dividing your total monthly fulfillment expenses by the number of orders shipped. If your total costs were $5,000 and you shipped 500 orders, your blended cost is $10 per order. This model is sufficient when you are just starting out and your product catalog is relatively uniform in size and weight. Its main weakness is that it treats all products equally. This can hide unprofitability in certain SKUs, leading you to promote products that are actually losing you money.

Better: Tiered or Weighted Allocation (the Sweet Spot for $1M - $10M ARR)

As your product mix diversifies, a blended model breaks down. Tiered allocation is a practical and highly effective step for most brands hitting the $1M revenue mark. In this model, you group SKUs into tiers based on attributes like size, weight, or packaging complexity. This method provides a much more accurate product-level fulfillment analysis without requiring expensive software.

Consider a brand selling a small, lightweight jewelry box and a large, heavy winter coat. A blended rate of $10 per order would significantly overstate the jewelry's true shipping cost and dramatically understate the coat's. This leads to mispricing the jewelry and losing money on every coat sold. With a tiered model, you might create three tiers based on historical data: 'Small' ($6), 'Medium' ($12), and 'Large' ($20). You then assign each SKU to a tier, achieving a far more accurate view of product-level profitability. This approach provides a strong balance between accuracy and effort.

Best: Activity-Based Costing (for Brands at $10M+ ARR)

This is the most precise method. Here, you attempt to trace every single cost, from the labor time to pick an item to the specific box used, to an individual order. Activity-Based Costing (ABC) provides unparalleled accuracy but requires significant investment. This level of detail typically demands dedicated software that integrates with your 3PL and accounting systems. For businesses operating at significant scale with complex logistics, the investment can be worthwhile. The thresholds for allocation model sophistication are clear: an 'Under $1M ARR' brand will find a blended model sufficient, a '$1M - $10M ARR' brand is in the tiered/weighted model sweet spot, and a '$10M+ ARR' company should evaluate activity-based costing software.

Step 3: Implementation Mechanics for Warehouse Expense Tracking

With a model chosen, the final step is implementation. For most startups using QuickBooks or Xero, this involves a combination of a spreadsheet for calculation and a journal entry for reclassification in your accounting system. This process addresses the pain point of integrating complex 3PL invoices without expensive automation.

Building Your Allocation Engine

A simple spreadsheet is a perfect tool to serve as your allocation engine. Each month, you will export your order data from Shopify or your e-commerce platform and combine it with your fulfillment invoice data. The structure is straightforward:

• Column A: Order ID
• Column B: SKU(s) in Order
• Column C: Allocation Tier (e.g., 'Small,' 'Medium,' 'Heavy,' based on your chosen model)
• Column D: Tiered Fulfillment Cost (a lookup from your model's rates)
• Column E: Actual Shipping Cost (if available per order from your carrier)
• Column F: Total Allocated Cost (sum of direct costs like D and E)
• Column G: Share of Indirect Costs (your monthly indirect costs distributed across orders, perhaps pro-rata by order value or item count)

While effective, be aware that manual spreadsheets become more prone to error as order volume increases. This can potentially distort the financial statements you rely on for key decisions and investor reporting.

Making the Accounting Entry

After running these calculations, you will have a total fulfillment cost that you now need to move into COGS. This is done with a journal entry. You are not creating a new expense, but simply reclassifying it. In your accounting software, you will post an entry to debit (increase) an expense account like 'COGS: Fulfillment Costs' and credit (decrease) the original expense account, such as 'SG&A: Shipping & Fulfillment.' This correctly moves the cost for reporting purposes, providing a true Gross Margin.

We strongly advise consulting with your accountant or fractional CFO before posting your first journal entry. They can ensure it aligns with your specific chart of accounts and reporting needs, whether you are following US GAAP in the US or FRS 102 in the UK.

The Strategic Payoff: From Cost Allocation to Smarter Growth

Successfully implementing a fulfillment cost allocation process is a significant step toward financial maturity. It resolves the ambiguity that prevents founders from understanding true, product-level profitability. The goal is clarity, not perfect precision at first. Start with a model that matches your current scale and complexity.

What founders find actually works is evolving their approach over time. Begin with a blended rate when you are small. As you cross the $1 million revenue mark and your product mix expands, graduate to a tiered model. This is the stage where you unlock significant strategic advantages by moving these costs to COGS, allowing you to:

• Price products intelligently: Ensure every SKU is priced to cover its full landed cost, including its specific shipping and handling profile.
• Optimize marketing spend: Confidently invest marketing dollars in campaigns for products that you know have healthy, sustainable margins after all fulfillment costs.
• Manage inventory effectively: Make data-driven decisions about which products to reorder, feature, or discontinue based on their true profitability.

Your immediate next step is simple: take your last 3PL invoice and begin categorizing the costs into the three buckets of direct, indirect, and variable. This initial analysis is the foundation for building a more accurate and insightful financial picture of your e-commerce business.

See the Inventory & Fulfillment Cost Accounting hub for related guides.

Frequently Asked Questions

Q: How often should I review my fulfillment cost allocation model?

A: Review your model quarterly or whenever a significant change occurs. This includes major carrier rate hikes, adding a new product line with a different size or weight profile, or changing your packaging. Keeping your model current ensures your product-level profitability data remains accurate.

Q: What is the biggest mistake to avoid when allocating fulfillment costs?

A: The most common mistake is sticking with a simple blended-cost model for too long. Once your product catalog diversifies in size, weight, or complexity, a blended rate will hide unprofitable SKUs. Evolving to a tiered model is critical for sustainable growth.

Q: Can my 3PL provider help me with ecommerce shipping costs and allocation?

A: Your 3PL is the source of the raw data. They can provide detailed invoices and reports breaking down charges for picking, packing, storage, and shipping. While some offer advanced reporting, the responsibility for choosing an allocation model and making the accounting entries rests with you.

Q: How does this process change if I handle fulfillment in-house?

A: The principles of warehouse expense tracking remain the same, but the data sources change. Instead of a 3PL invoice, you must track internal costs like warehouse staff wages, a portion of your facility's rent and utilities, and the cost of shipping supplies and boxes to perform your SKU cost allocation.