So You Want to Start an E-Commerce Business?

September 9, 2016  by Jane Chero in Industry, Internet   

By Richard Sexton

With online sales continuing to be the primary driver of growth within the home furnishing sector (and all other sectors, for that matter), it's a natural inclination for single or multi-store retailers to aggressively expand into e-commerce or, if they are already online (and who isn't?), to contemplate a significant capital investment in upgrading their virtual presence.

The purpose of this article is not to discourage anyone from e-commerce. Like a well-balanced portfolio, online sales of your home furnishings business should be an important part of your overall growth strategy, especially considering the downside risk of not being in this channel.

However, far too many businesses rush to enter this channel, operating in panic mode, and wind up investing hard-earned capital for negative returns. Even more common is the decision to pull the plug on an e-commerce venture when it is not profitable within the first few months of operation, the most critical time for reinvesting in a new e-commerce launch.

In my 20-year experience as a home furnishings independent retailer, which evolved into a healthy e-commerce business, and in my role as a consultant to other businesses across retail and professional services sectors, some very clear and consistent metrics regularly manifest themselves. I will review some of these critical components of e-commerce and their impact on net margin. Importantly, none of these metrics are specific to a particular business that I've been involved with, which is why the numbers are so compelling. You see them across businesses using different strategies and different capital expenditure plans, yet most arrive at the same conclusion: "We had no idea.”  Following are some areas for consideration.
 

Are You Prepared To Make 5% at Best Over the Long Run?
If you are pressed for time and cannot read this article in full, then simply answer the above question. If the answer is "No", then you are finished reading. If the answer is "Yes," then understand that getting to 5% will take a concerted, disciplined approach that requires nerves of steel during downturns and champagne for the upturns!

The Talent You'll Need For Success
For a long-term, viable e-commerce business, here are the functional roles you will need filled:

• Platform development team: This technical team includes integrations with third party platforms, user experience (U/X), navigation, taxonomy (how the categories are arranged) and platform optimization.
• Content team: Using your manufacturers’ images and text will get you nowhere fast, since you will get dinged by Google for duplicate content and you will be offering nothing new to the consumer. You'll need to have a team to customize product descriptions, take new photos if possible, and add unique product attributes.
• Search Engine Optimization (SEO) expert: Google is doing its best to eliminate organic "free" search results.  The value of organic traffic is questionable, but its appearance high in the available non-paid space of the search page is still important. I recommend this is done in-house since nobody knows your business like you do. Write in a natural language for SEO and the chips will fall where they may.
• Search Engine Marketing (SEM) expert: Paid search is your best channel for online visibility, but you can burn through your budget in a day if you have not strategically chosen keywords and key phrases to describe your business, products, or services. This is a functional area that can be outsourced to third parties or agencies, but you'll need to be very specific about your budget, your conversion objectives, and your business strategy (brand awareness, defensive positions, campaign enhancement, product sell-through)
• Social media integration: While this is often relegated to a non-critical path, remember that as many e-commerce searches collectively occur on social channels as on the search engines themselves (if you include YouTube as social, which is the second-most popular search property). Social is not just about Facebook posts, it's about usable content such as videos, instructions, reviews, gamification, loyalty programs, and other digital touch points. Social channels are usually the most neglected in the home furnishings sector. This is regrettable since there is so much rich content to be pushed out to potential stakeholders.
• Analytics team: The one engagement discipline more neglected than social media is analytics.  This is ironic since your e-commerce business needs to have established metrics and benchmarks for success (otherwise, you are flying blind). You wouldn't have started your brick-and-mortar business without establishing your objectives early on. You had a target revenue/square foot, a target gross/net profit margin and ROI, etc. The digital world allows us to measure all these metrics and many more.  With the proper tracking code and tags, every interaction can be tracked, reported, and improved upon. Finding and building on that analytics expertise is challenging (even for a company such as AAA, where I work now). Fortunately, there is a plethora of online training available from Google, Bing, and many other third parties, and this training can be accessed in a sequential learning process.
• Sales team: Fortunately, this is one area that is completely scalable and already takes advantage of in-house expertise. Your sales staff should already be adept at omni-channel sales, transitioning easily from in-store to phone. An e-commerce business will add to the volume, with a lower conversion rate due to the price-shopping nature of online selling. Therefore, you will need to account for the lower close ratio in your sales commission plan. One additional responsibility for your sales staff could be online chat. No fully fleshed e-commerce site should be without chat, especially considering all of the robust functionality that chat brings (drag and drop images, room planning, etc). Whether chat is assigned to sales staff or routed to customer service is an internal decision, but consider that you want chat to act as a value-add, not just a price quoting vehicle, which can backfire on you as a retailer.
• Customer service team: Customer service capabilities will have to ramp up with your new e-commerce business because of the more problematic nature of shipping your orders, as opposed to in-store pickup or local delivery. The margin impact of having a white-glove delivery fulfillment service is considerable, possibly a deal-killer for many, but even so, the e-trailer needs to have resources aligned to the incoming volume of calls that result from fulfillment issues, such as scheduling, shipping damage, product variances and returns. Collectively, shipping and fulfillment issues define the largest chunk of unanticipated costs in a home-furnishings e-commerce business (see "Breaking it Down", below).
• Shipping and logistics team: Most e-commerce models typically consist of a blended fulfillment process consisting of direct-from-warehouse and drop shipment. In the furniture world in particular, "drop shipping" can mean several different operations, depending on the manufacturer. Some are perfectly willing to receive and order and ship it anywhere in the country, while I have experienced others who ship only within a retailers predefined market area.  At the extreme end, some manufacturers will allow dock pickup only and simply don't want to know where the order is going. The successful e-tailer needs a shipping and logistics team capable of managing inventory onsite or at a third party warehouse.  This team also needs to be flexible enough to work around the vagaries of manufacturer sales and distribution policies.
• Management: In addition to the aforementioned talent, entering the hyper-competitive world of e-commerce requires an agile management team that can simultaneously deal with irate online customers, cut-throat competitors, disgruntled manufacturers, and Amazon. Of course you'll never beat Amazon, but you can sell on product expertise and leverage, other core competencies.

Breaking It Down

Let's get down to business and see how much your e-commerce venture is going to make, given the requirements above. We'll start with the assumption that the furniture e-tailer is selling online at some sort of minimum internet price structure (sometimes expressed as "MAP"). These pricing guidelines are released by the manufacturers quarterly, annually, or timed with furniture market dates. They are issued as the manufacturers’ minimum online pricing expectation, and, although there is legal language specifying the voluntary nature of the pricing, the e-commerce business should take them as fact. In our example, we'll start with an MAP of 2.0, about average for the furniture industry. (I have seen a range of 1.6 to 3.0).

Our all-wood handcrafted cocktail table has a MAP of $800 and is sold online with free shipping. To be completely realistic, products sold at MAP are not competitive unless shipping is given away free. You won't even be close to Wayfair or Amazon if this is not the case.

Analysis and Summary
In this example, I've used conservative estimates. Advertising, in the form of paid search, runs from 8% to 12% of revenue, sometimes higher. I used 8% in this scenario. Management costs are also conservative, using a managers' salary of $100k on a $5m business. Importantly, I've not included physical overhead, such as the cost of showrooms, warehouses, and office space. Given the conservative nature of this calculation, you could logically ask "why bother". It's a valid question and one that you need to carefully consider before investing hundreds of thousands of dollars into a nascent e-commerce venture. It's not all doom and gloom, however. Following are four considerations that could move the needle from red to black.

Keys To Making E-commerce Profitable

You game your online business to higher average order values (AOV): Our model doesn't look so good for an $800 sale, but for a $2,500 sale, we are profitable. Why? Because we are always going to be paying a much higher proportional freight cost on lower ticket items. Our shipping to Texas on this new theoretical order would probably be only twice as much as our $800 order, with a CGS of $1,250. That small difference is all it takes to make this sale worthwhile.
2. You leverage existing resources: Your business already has a sales team, customer service team, and delivery staff. You may even have employees with the bandwidth and skill sets to handle other tasks such as social and analytics. This may well work in the short run as you get your business launched, but long-term you'll need dedicated expertise.
3. You sell based on discounts: Another tactic is to take advantage of manufacturers' closeouts and discontinuations. These are usually sold at 25% to 50% off wholesale with no pricing restrictions. Such opportunity purchases can add to your overall margin, but may require that you purchase and warehouse the product in advance.
4. You leverage your brand: One clear advantage most furniture retailers possess is their own longevity and physical presence. If your retail business is still around after the last tumultuous decade, chances are you are an established presence with some brand equity. By leveraging your brand throughout your store and across channels, particularly social, you may substitute this visibility for paid advertising.
5. Accept lower margins: When all is said and done, in the best case scenario, expect net profit of 5% or less. Of course, the net contribution of 5% on a $20m business is significant, as opposed to the higher margins you enjoy in your smaller brick and mortar business, so it's all a matter of perspective. It's a volume-driven business that requires both patience and capital to grow.

You need to carefully consider the strategic implications of launching an online business with the opportunities it presents and the pitfalls and challenges you will encounter. The ever-changing digital retail environment has paid off big for many, but the road is strewn with remains of businesses that did not carefully plan their resources.  Consider the performance of Wayfair shown in the following graphic.  It’s been a long road.