eCommerce Business Model 101

I've been answering a number of emails lately from business owners that request that I look at their website and offer my suggestions as to why their website isn't generating more sales. I've also been asked about eBay listing strategies, shipping strategies and finally marketing questions. By "reading between the lines" I've determined that there are a few concepts about the ecommerce business model that seem to be confusing or just not understood clearly by these business owners.

My goal here is to impart some logic to the ecommerce business model.

First, let's define a few basic concepts:

Margin = The money you receive when you sell an item to a customer minus the money you pay to your dropshipper or wholesaler to get that item. This number is usually defined in percentage. (i.e. You purchase a necklace for $5 and sell it for $10. Your margin is 50%)

Variable Costs = The percentage of your sale spent on three items: Shipping, Marketing, and credit card processing

Fixed Costs = Any expense that will occur regardless of whether you have any sales or not. An example of a fixed cost would be a lease on a warehouse.

Obviously the goal is to make positive margin on every individual transaction, and then do enough transactions to cover your fixed costs. Any amount above and beyond this is your profit. (by the way, profit is a good thing and so is paying some taxes. It's the government's way of rewarding you for being successful!)

As an illustration of a successful business model I'll write out the plan for my website, JustGolfBags.com

I price my products to gather an average margin of 40%.

My Marketing costs are around 7.5% of sales

My Shipping expense is about 11% of sales (I offer free shipping on many orders)

My credit card processing is about 3% of sales

Add all of my variable expenses together and my Net Margin per Sale is about 18.5% (40% margin less 21.5% variable expenses).

This translates to say that for every $100 golf bag that I sell I am putting $18.50 in my business checking account. Then, I need to sell enough of golf bags to cover my Fixed Costs such as Rent, Utilities, Phone, Supplies, and Payroll. Whatever is left over becomes the profit for my business. Easy, right?

Ok, so how does this effect me you ask? The truth is I don't know enough about every product being sold to tell you what the correct business model is for your business. What I can tell you is that you should look at each number independently, then pull them all together to see if your business will make money.

The first place to start is by figuring out how much margin the products that you sell will generate. Obviously the higher the margin, the better. Try to stay away from product categories that offer less than 20% margin, it's just too hard to make any profit.

Next, determine how much marketing you'll want to spend to generate traffic and sales. I personally try to keep this number under 10% of my total revenue.

Then, figure out what your credit card processing rate is. I would guess it's between 3.5% and 5% depending on your volume. As your business grows you'll be able to lower this rate because of your business volume and a lower risk of default.

Finally, determine your shipping strategy. This is where I see the majority of the small website owners get stuck. They are trying to charge too much for shipping and people visiting their site are buying elsewhere from a site offering a better rate! Shipping in my business is 11% of my total expense structure for a couple of reasons. First of all, it's expensive to ship golf bags, but more importantly the market conditions almost mandate that I offer free shipping. It's what my competition does so I pretty much need to do the same to remain competitive. Especially since we all are selling similar products as similar pricing.

To really gain an understanding of how all of this works, build a spreadsheet with the some example scenarios. Play with the numbers until you have a plan that makes sense from a financial perspective and is realistic to implement. The great thing about ecommerce is that you can play with the variables until you determine the perfect solution. Is it by offering free shipping? Maybe it's just subsidizing shipping by charging a low flat rate to your customers. The answer might be to sell at a lower margin by offering products inexpensively. Or, maybe the answer is just more marketing?

Sample Business Model
Revenue	A	B	C
Target Margin	30%	45%	60%
Expenses
Credit Card Processing	3.50%	3.50%	3.50%
Marketing	7.50%	10%	25%
Shipping	5%	10%	15%
Net Profit Margin	14%	21.50%	16.50%

I truly wish I had the perfect solution to every business's quest for more sales but since I don't, just follow the simplicity of the above model and you'll be well on your way to building an ecommerce empire!