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Think Big. Move Fast.

Since my earlier post on “Three ways to build an online media business to $50m in revenues” was well received, I thought I’d examine the e-commerce industry as well.

The margin structure in most (physical) ecommerce businesses is dramatically different from that of online media businesses. Whereas online media businesses can enjoy gross margins of upwards of 90%, and net margins (at scale) of 50% or higher, many ecommerce businesses have gross margins in the 20-40% range and net margins (at scale) in the 5-10% range. As a result, ecommerce companies have to grow to a much bigger top line to achieve the same value. We’ll target $500m in revenue to get to net income in the same range as a $50m revenue online media business.

There are three ways that an ecommerce company can get to this scale:

1. Build up $500m in sales in a single vertical. You’ll need to ensure that the vertical that you’re addressing is large enough in online sales to accommodate your size – books, music, consumer electronics, shoes and groceries are all good examples. You’ll likely need to be number one in your category, which implies industry leading cost structures. You’ll probably be holding inventory and operating multiple distribution centers, dealing with returns and generally operating a very large scale business that gives you certain margin advantages because you’re one of the largest retail channels for your suppliers.

You’re probably able to spend on building a brand (vs performance based marketing only) and you likely think about customer lifetime value. Hence you may be willing to pay more to acquire a customer than you’ll realize from your first transaction since you sell a product that is bought frequently. As a result, you obsess over customer service because you need your customers to have a great experience and have confidence and recall to buy from you again in the future – ideally by typing your URL in directly into their browser.

$500m in a single category is a lot. In 2005, according to Internet Retailer, only four pureplay ecommerce companies exceeded $500m in online revenues (Amazon, Newegg), Overstock and Netflix. The remaining 22 companies who had sales over $500m online were very large multi-channel retailers like Office Depot, Gap, Dell, Circuit City and Walmart.

Other companies who likely have already reached this revenue level since then, or will soon, include companies like Zappos, Freshdirect, Drugstore.com and Buy.com

2. Build up $50-100m in sales across each of 10-5 verticals. This could be by being a smaller player in a larger category (such as the verticals discussed above), but you’re likely number one in a smaller category. Say Ski gear, nutirtional supplements, autoparts or power tools; smaller categories than books or shoes, but still pretty big. (Note – the links are to examples of companies that are at or could get to $100m in sales, but they are not parts of companies with multiple verticals each doing $100m in sales).

Since in many cases there are not that many synergies across categories (little or no ability to leverage supplier relationships for example) you may be a result of a rollup to get to critical scale. You may see some ability to leverage your distribution infrastructure, but in many cases the pick, pack and ship needs of different products are quite different and may not support shared infrastructure (small vials of pills looks very different from aftermarket auto parts). You likely hold inventory and operate your own distribution centers, but if you are in a category with large and unwieldy items that often get built to order, you may be able to dropship from your manufacturers.

In 2005, according to Internet Retailer, only 155 companies exceeded $50m in online revenues, and only 45 were pure play etailers, including Blue Nile, Redenvelope.com, Shoebuy and Furniture.com. However, there are a number of companies who are taking this approach, including Musician’s Friend, Provide Commerce/ Liberty Media, and Blue Lava

3. Build up less than $5m in sales in each of 100+ categories.
According to Internet Retailer, there were 479 ecommerce companies with sales over $5m in 2005, including Batteries.com, Junonia (plus sized activewear for women), iGourmet, artbeads.com and thinkgeek.com. As you can see, even relatively small niches can sustain $5m in sales. You may be able to rely on your manufacturers to drop ship, and you may need lower levels of dedicated resources against each category with less depth of industry merchandising expertise.

Rather than building a brand, you can rely more on performance based marketing, particularly paid and organic search and shopping engines. You may not even need to be number one in your verticals – if they are big enough you can still win some share of the market to get to $5m.

What is hard is getting to this level of sales across so many verticals. To be able to do this you need a level of shared technology and processes that can be applied across many stores. Winning becomes less about any one store, and more about applying best practices across all the stores. The challenge is in being able to enter a category cost effectively, and to run a store against low volume in a very low cost way. Processes and cost control become paramount because any sub optimal practices get magnified across 100 stores. Although no one has hit $500m in revenues through this approach yet, there are a number of companies who are taking a shot at this approach, including Mercantila (a Lightspeed portfolio company)CSN Stores, Netshops, Niche Retail, and others.

All these models are viable. As in most cases, the first $20m in revenues are the hardest! I’d love to hear from people on any of these paths.

  • BT

    Jeremy-

    Great article, very interesting. I am curious as to what kind of valuations are typically assigned to $50M online media businesses versus $500M e-commerce businesses (such as Zappos) given the assumptions in your example above?

  • http://blog.blendah.com Blendah Tom

    Jeremy,

    What about an Online Copycats of “Sams Club” “Costco” etc… Our new startup is trying to incorporate this business model combined w/ a low monthly option as well… How many more Netflix models will regular e-tailers switch to in the future i.e lower their margins but gaining a recurring fee that is much more viral in nature… The cost to acquire and keep customers now are getting out of hand..

    Thanks,
    Tom

  • http://lsvp.wordpress.com jeremyliew

    BT – valuations really depend on growth rates. It looks like the public markets are giving a 12x EBITDA multiple on ecommerce companies and 17x EBITDA multiple on online media companies, but these are just averages. (using Pacific Crest March comparisons as my source)

    Blendah – I think there are lots of ways to make money online – the analysis above is just for ecommerce companies and isn’t meant to imply that that is the only way

  • David Yancey

    As a numbers exercise, the post is useful, but, as I’m sure Jeremy would acknowledge, this sky-high level of overview doesn’t get into the specifics that real marketers and interactive business planner/developers can learn from. I won’t plow into these details here, since Jeremy’s post isn’t about the realities of actually designing and building a break-out business model; I’ll say only that all should remember that a very substantial portion of what turn out to be the most successful (by size) businesses begin in sectors where the odds seem to favor the established big Berthas.

    The most fundamental flaw in the post’s analysis is the missing time-frame for the interactive economy (which, as you all know, is only the fastest-growing economy, and most massive economic disruption in business history). While intended to give a real-world, realistic assessment of the very substantial challenge of building a seriously large online-based business, the post ignores the real-world time scale: building any such venture today from scratch is at least a five year undertaking, and in five years, the interactive economy will be a radically different one in many sectors.

    *A well-designed business-model, plan, and interactive marketing concept will successfully envision the likely coming changes and take them into account.* The net effect is that such ventures can, I predict, to a surprising degree, simply do an end-run around many of the competitors who, looking solely at today’s interactive business models, probably appear to the conventional portfolio-management mentality to be unbeatable.

    I can provide at least five detailed projections in five different industry categories where this sort of sector-disruptive end-running is likely to occur, but that is for another discussion.

    More immediately relevant here, Jeremy bases his analysis on just three kinds of business model, or paths-to-scale, and thus ignores what promises to be for at least some new ventures a fourth path to the half-billion US$ annual revenue level.

    Few so far have apparently grasped the ramifications of this “fourth way”, a truly vertical model in the maturing interactive economy. For this radically new path, some details may therefore be illuminating.

    Wonderfully demonstrating the adage that there is nothing really all that new under the online sun, these “fourth way” businesses hearken back to the very first massively-disrupting distribution revolution, more than a century past: they are starting up as truly vertical enterprises. They not only maximize the cheap channels and wide distribution reach of the Internet, but also make or control the manufacture of their own branded goods. If, as in our new “true vertical” venture, such a business deploys a make-to-*pre*-paid order model, coupled with just-in-time methods to tightly control inventory expense, it can quickly become one of the low-cost producers in its sector. If the business obsesses, as Jeremy says, over quality and customer care, it can build WOMpact, customer retention and staying power with a viral speed that traditional competitors could not imagine.

    By controlling its own designs, such a business can control quality and costs, as well as copyright and uniqueness. Even more important, the business can offer a range of style and color options to its online customers that *no bricks-housed retail competitor can even begin to match.* It can offer new items nationally or globally in as little as three days from product sketch to massive audience reach. Such a business drives an eighteen-wheeler cyber truck at true light speed right through the seasonality or other shelf-life problems of conventional businesses.

    Jeremy’s post does mention the new potential online for rapid brand-building, and we agree that here is possibly the biggest potential edge a “true vertical” like ours can have.

    We envision a multi-brand management model, with (potentially) dozens of super-targeted “micro brands”, each with its own brandable domain name and mini-site replete with search-friendly content; each with its own online community (assuming a core niche audience adopts the mini-brand as their own); and each with its own specifically co-targeted network of affiliated sales partner sites. The operational key is that all these brands share one super-efficient, low per-order cost, design, supplier-control, manufacturing, fulfillment, and customer service machine. The goal is to exploit viral, search-based prospect acquisition, affiliate-networking, and other native interactive advantages, with a whole assault team of micro-brands that can collectively scale very rapidly.

    This scaling and targeted marketing concept naturally lends itself to killer roll-out speed: we’ve launched over six micro-brands in under a year, and will add at least two dozen more over the next 6 to 10 quarters. While some of these have the potential of becoming niche category leaders, perhaps half will merely prove to be also rans. But in our model, the losers can be killed in a day, with almost zero cost. Even better, a single person can manage a $10 to $25 million brand, from product development to channel management to number-crunching. In fact, we plan to launch some micro-brands primarily as training platforms for our future product management superstars.

    If such a tightly focused, operationally efficient business has a practical plan for extending its reach into the physical distribution channel, US$500 million does not seem so intimidating all of a sudden. Again citing our plan as an example, we envision rolling out circa year 3 a new kind of interactive physical store to extend the penetration of the bigger winners among our brand family.

    If the targeted sector is big, and/or the primary sector competitors are slow-footed or fragmented, then reaching a level of US$500 million seems very realistic. In our sector, for example, annual revenues globally exceed US$ 30 billion, and are amazingly fragmented. In about five years, we estimate the sector will be at roughly $40 billion; achieving a 1.25% share, given all the advantages of a new-era “true vertical” model, seems pretty conservative, actually.

    Consider: what I describe above is simply what, say, an Ikea might have come up with had they begun in the interactive era. It’s not such a stretch, then, to imagine that same process being repeated many times, especially in an economy in such turmoil. Surely, we are not the only team thinking this way.

    The point of all the above is that, while copy-cat ecommerce companies do have a very big set of barriers blocking them from reaching the US$ 500 million level, companies with the ability to make their own products such as ours, businesses that design and plan for the new interactive economy from the get-go, have a *much* better shot than Jeremy’s high-level portrayal would suggest.

  • http://lsvp.wordpress.com jeremyliew

    David,

    This list of ways to get to $500m in revenues is far from exhaustive. Thanks for sharings some of the details of your approach.

    Finally, I’m a venture capitalist – I fundamentally DO believe that companies can create massive enterprise value over short periods of time – those are the ones we want to hear from and invest in!

  • William T

    Ecommerce businesses should really be broken out into 2 types for analysis, those that act as internet store fronts for products which must then be shipped, and those that provide subscriptions to online content, for which there is no marginal cost. The margins in these two types of ecommerce businesses are vastly different.

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  • Jean Paul

    Price comparison sites can also scale up quickly by providing qualified shopping leads to retailers such as the ones mentioned above.
    An interesting new player who grows very fast is http://www.cubalaya.com.

    J. P.

  • http://www.advertisespace.com chad

    To me this post is a bit silly. It’s like saying: 3 ways to make a million dollars. Make a $250,000 a year for 4 years, make $500,000 a year for 2 years or make a million in one year and save everything you make. There you go, you are now a millionaire!!!

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  • Amisare Waswere

    Chad fails to distinguish between feasibility of concurrency vs sequentiality in execution or in Critical Path Network parlance, parellel vs serial programming .

    The Oxford English Dictionary (OED) second edition contains the following:

    Number of words in entire text: 59 million
    Number of printed characters: 350 million
    Number of different typographical characters used in text: approx.: 750 (660 special plus approx. 90 on regular keyboard)

    Equivalent person years used to ‘key in’ text to convert to machine-readable form: 120
    Equivalent person years to proof-read text: 60

    But it didn’t take 120 years to key in nor 60 years to proof read as the work was done by teams of people.

    The OED (2nd ed.) was published in 1989 in 20 volumes, and consists of 21,730 pages
    .

    See http://oed.com/about/facts.html

  • http://e-commerceinfo.blogspot.com/ susan

    Nice article,

    I have gone through your article. it’s very cool. information about e-commerce is very nice.

    Thanks.

  • http://www.handlesdirect.co.uk Katie

    Thanks for posting this, it’s very interesting and something that i’ll be looking into further

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  • http://www.absolutelynew.com Henry Lo

    Jeremy:
    We incubate great ideas. But our ideas come from independent inventors with patents. And instead of building whole companies around them, we add them to our product lines. We’re a rapidly emerging VC-backed consumer products company with a huge proprietary invention database, and a management team that has launched hundreds of successful products. The beauty of our business model is that unique products are bought, not sold. We utilize our business development relationships (ie: HD, OFD, SPLS) as our product selectors. Coupled with subsidized development from our inventors, we have a compelling business model whereby we’re focused on improving the odds in our favor that we will find a “hit” product sooner and it will “cost us less to find it” and we can charge “premium margins” for it. I think this is pretty darn close to the fourth way, with the exception of going to the consumer directly.

  • http://www.tradehandles.co.uk Handle

    This is a very useful article thanks!

    We will certainly put your advice to good use on our kitchen door handle website.

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  • http://buyitnowfurniture.com bar stools furniture

    Very good article on building your e commerce business up. Like to know how these company’s are doing today.

  • http://callingpost.com/ Voice Broadcasting Services

    E-commerce article like this is very informative. Thanks for sharing Jeremy.

  • S.T

    Great read.

    Does anyone know of any company names for European companies taking the multi-niche, 100 sites @ $5m, approach. I know Hayneedle and CSN do this in the States, but I can’t find any in Europe. I know they’re out there.

    Thanks.

  • http://www.sarafis.pl buty reebok

    The beauty of our business model is that unique products are bought, not sold. We utilize our business development relationships (ie: HD, OFD, SPLS) as our product selectors.

  • http://www.centrumwitek.pl/oferta_centrum sofy

    Very good article on building your e commerce business up. Like to know how these company’s are doing today. Chad fails to distinguish between feasibility of concurrency vs sequentiality in execution or in Critical Path Network parlance, parellel vs serial programming .trategy analysis, there are no magic bullet secret formulas revealed. But i

  • http://sghealthaffiliateprogram.com Health Affiliate Program

    Yes great article however you are talking about the top percentage of ecommerce businesses. the other 95% could never hope of reaching those figures in sales. There are also other business models other than traditional e-commerce sites to sell physical products online including free information marketing with follow up product offers.

  • Jonathan

    Well this is unusual a post that started 2007 & still comment 2010 Quality. I picked the tread up from http://www.thecoffeeshopsofmayfair.com/ My comment was: I note some leading financial models in North America and now the UK are using première keyword verticals to expand the brand offering to new customer segments.This (IMO) is a smart move that ticks all the seo boxes when each offering is authoritative stand alone. The fact that the financial markets are simple online transactions makes this a very smart strategy that will be replicated.
    http://www.insidermedia.com/insider/midlands/42395-moneysupermarket-buys-online-rival/

  • Tom Andrews

    Update
    Recently Amazon bought Zappos which was doing over 1 Billion in sales, but only 5% profit. The sale price was 1 Billion dollars as well. Along with that Amazon recently bought Diapers.com (also owns Soap.com). It looks like Amazon in interested in these different types of companies. I wonder what is next maybe the third type. Maybe they will buy a company like Halloween Costumes (Which also owns T-shirts).

  • http://europolitan.pl hurtownia odzieży używanej

    Very good article on building your e commerce business up. Like to know how these company’s are doing today. The beauty of our business model is that unique products are bought, not sold. We utilize our business development relationships (ie: HD, OFD, SPLS) as our product selectors.

  • http://www.voicebroadcastingpros.com Voice Broadcasting Service

    I do agree with most of what is said here.

    However, one factor that is left out, a lot, in the progressive growth of a company is the current buyers/client/subscriber lists.

    Most companies don’t value their current list enough to let that list do the ‘growing’ for you.

    It’s something that’s always bothered me when watching a company not focus on them.

    But, solid info here.

  • http://www.purecostumes.com Karen D

    Found your article via google on ecommerce related topic. I think there are good ideas here but a lot have changed since 2007. I am curious what concept will work in the always changing, fast pace etailing business.

  • http://grossmanfurniture.com Grossman Furniture

    Internet businesses should be split up into types for analysis. There are the types of busniesses that process and ship product, and others that drop ship or are really just a shell. There is a huge difference in costs between the two.

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