0:00
[MUSIC PLAYING] Welcome to module 2, lesson 1, why e-commerce doesn't scale and what you can do about it. There are two articles every e-commerce entrepreneur should read. Andy Dunn CEO and founder of Bonobos wrote the first called E-commerce is a Bear. Josh Hannah, VC at Matrix Partners wrote the second called, That's a Nice Little 40 million E-commerce Company You Have There, Call Me When It Scales. Both authors say the same thing.
0:28
They talk about three reasons why it's so hard to scale up an e-commerce company. Reason number one is because most of us operate in niches. Now, niches are good because they help us get traction. It's easy to find opportunities, it's easy to find products, it's easy to find and acquire customers initially. But the downside is when we're in a niche, we're in a niche. We eventually tap out the demand, we've acquired all the cheap customers there are to acquire, our marginal cost of acquisition goes up and growth becomes unprofitable, plus any success invites competition.
1:02
Welcome to the niche commerce wall of death. So reason number two why it's hard to scale is that we have too many onetime buyers. I've worked with 20 to 30 different retailers, and for each I consistently see 80% one time buyers. What's the problem with a one time buyer? They come to a brand, they take up a lot of customer support time, they buy a low ALV product, they might return it, and they never come back again.
1:28
They represent a wide swath of buyers who are really just dead weight. And when they churn, it makes it harder for you to predict revenue and profit going forward. This table shows a breakdown of one time buyer economics. Most brands are spending up to acquire these customers hoping to make it up in ultimate lifetime value. But one time buyers just churn right away. Reason number three why e-commerce doesn't scale is that even if we're able to reacquire the one time buyers, if we're able to lure them back to buy again, we still have to pay to reacquire them.
2:02
The customer still must click on our ads or come through our content that we paid for. This is what our typical repeat order might look like in this case. We've lost money in the first order, but we've also lost it on the second order because we had to reacquire that customer. Those are the big three issues with e-commerce. You put all three of them together, and you realize if you really want to trigger growth, you need cheap reorders, cheap re-acquisition. You need people to come back and order again, but you need to be able to have that be a profitable transaction.
2:33
Put another way, you need your customer lifetime value higher than your customer acquisition costs. If you're in a niche where customer acquisition cost has risen to the point where it's equal to your lifetime value, you need to start working on that lifetime value. Only then will you achieve stable predictable cash flow. What's the use for cash flow? A few really important things. Number one, you could line your pockets. You can run your business as a cash flow machine and take money out every year, nothing wrong with that.
2:59
Number two, you could plow that cash right into our third multiplier, acquisition, and outspend your competition. You could seize market share at your competitors expense. There is a third benefit of cash flow that comes into play when you want to sell your business too. At that point, a potential acquirer typically values your business off of multiple of that cash flow. The higher the cash flow, the higher the valuation.
3:25
Now this depends on a million different things, but for most people in this program, e-commerce multiples might hover around three or four times owners discretionary cash flow. For the same size, Sas business, the multiples eight times. Why the difference? Because Sas has predictable revenue, cheap customer re-acquisition. It scales, e-commerce does not. That tells me that the more you dial in your retention, the higher multiple you can justify when you go to sell your business.
3:53
It's why multiplier one customer purchase frequency is critical. In the next lesson, I want to talk about how to engineer retention. How are we going to create a system that retains customers? And to recap this lesson, e-commerce is hard. Andy Dunn says it, Josh Hannah says it, and now I say it. But good retention can make it easier. [MUSIC PLAYING]
