5 Insights on the Future of E-Commerce

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Guest post by Naithan Jones, founder and CEO of AgLocal. The views expressed here are solely those of the author, and do not reflect the views of Food+Tech Connect.

1. E-commerce for future markets

I hold a strong belief that the biggest opportunity in new firm and new value creation globally, exists in e-commerce, with the rise of what I call “full stack e-commerce” companies. Internet first companies that also utilize physical infrastructure but do so much more inexpensively than traditional brick and mortar due to the in house automation of space, materials, and labor via protected software. These more mature versions of their predecessors will pop up and scale specifically with new technology-enabled retail brands and on demand services. They will be more difficult to build than last generation e-commerce companies and they will also be harder to replace or implode. I believe Andy Dunn is building one such a company at Bonobos for example. Why is today the day for full stack e-commerce? Friction between silo’d horizontal business lines in retail is causing many of them to identify but not be able to react to the emergence of “super niches” driven by the first generation of consumers that have been raised entirely on the internet. The newer brands that are early winners for the attention of this generation are 360 degree brands (brands that offer not only products, but context for them via blogs, videos, and multi-media interaction).  Add the emergence of crypto-currencies, which can extend participation to consumers in third world countries in ways not previously possible, and you have the beginnings of a very large global e-commerce opportunity. I believe in the next five years that major upheaval is coming to every category of physical retail, and that internet first brands are going to be the winners by focusing on openness, sharing and global participation.

I do not believe that the current generation of internet retail, in which the simple repackaging of CPG items and usage of the internet merely for marketing and sales takes full advantage of the opportunity that is emerging. The emerging opportunity is to innovate throughout the entire supply chain stack, with sales and marketing as just one layer in the stack.

For example,we see AgLocal as the first “internet label for meat,” and we plan to do a few things not yet done. We plan to define and build extremely high brand value via openness and accessibility for farms. We plan to expand consumers choice through multiple online channel partnerships. We plan to replace the labeling system of the USDA with an experience that is rich, immersive, human and educational. We will do this by merging online sales with offline fulfillment innovation (key), and this will dramatically expand market accessibility and product availability.

The long term benefit of our existence is that we will vertically integrate the production and supply chain for meat producing farms with an open access to the middle of market.

AgLocal, from the outside, probably seems like a very difficult and unsexy problem to work on, and this is exactly why we are working on it. It seems highly unlikely a startup can re-create the cold supply chain for meat. Without understanding the underlying problem it is pretty difficult to get the output value until you understand this.

If you’re going to follow us and try your hands at an e-commerce startup or tech enabled retailer, consider the following points below before proceeding further. Plan the business this way and raise capital from investors that understand the following points, and not from those that don’t (again, if you have such a luxury).

2. E-Commerce and private capital

I believe that due to the cost of inventory, operations and other factors it is very difficult to bootstrap e-commerce, which is especially the case with physical products versus services. Any founder wishing to startup a physical product or technology enabled retailer should know that early on they will need to consider outside capital more so than someone building a messaging or consumer SaaS product.

As such, I also believe that the approach taken by outside capital towards e-commerce is a little back to front (a neophytes opinion). A lot of e-commerce businesses are raising gigantic later stage growth capital rounds from venture capital before profitability has been reached. My opinion is that treating profitability as an afterthought this late in a companies life will kill a lot of these companies that would have otherwise ascended to Amazonian heights.

Ironically, I believe that e-commerce companies in particular, versus all other mobile or internet based startups, uniquely face intensely high startup costs to get their engine cold started. A great many excellent market opportunities are suffocated in the crib due to the true capital requirements not being understood entirely by the founders and investors. As such not enough capital is raised early. For founders that are blessed to have traction in an early round, I would advise that you raise as much as possible and do not worry about dilution. I repeat do not concern yourself with dilution early. Get that value back later when you have built something great. I would advise you to try and make a case to your investors that they should not to compare your capital requirements to other types of non e-commerce startups that are raising stage similar rounds.

The problem is that no one knows which squeaky wheel actually needs all of the grease and which one doesn’t in e-commerce, so they spread the grease amongst all of them to see which one works out. This strategy has led to many opportunities left improperly explored and poorly assumed as dead markets. If I were assessing or building (We are), I would not look at early sales and marketing ability as a leading indicator of ultimate success, as a competitor can hire the commoditized knowledge of marketing and sales. I also would not focus so much on the consumer facing part of the technology and who is building that.

I would look behind the scenes at the operational roadmap and the operations talent creating that roadmap. I would also look heavily at the software roadmap and the focus on innovating deep into the retail stack in the fulfillment and supply chain, as this will be the real long term value and competitive advantage of the company. This is the advantage that a new competitor will not be able to overcome, not an initial sales bump. Sales spikes do not last. Product availability, platform lock-in of industry participants and cash are what will outlast the ups and downs of sales. Remaking retail categories is a marathon and likely can’t be pegged as success or failure in the same ways that explosive consumer tech hits can early on.

3. How do we price? (Actual Dollars > High Margins)

Investors and founders love to understand the macro and micro profit margins of the business. I, like many of them, thought the magic 30% margin rule you always hear about was the holy grail of e-commerce. Margin measurement is, of course, helpful to know, but in and of itself it is very incomplete. Adhering to that rule early created arbitrary limitations and headaches of stress when pricing our high sticker products.

What would be more enlightening in terms of understanding the business? The actual dollars that each sold unit contributes to the business. The contribution profile. The better of these being the dollar contributions per unit that we collect after accounting for COGS (cost of goods sold). In physical product e-commerce business the COGS are the product inventory, assembly and fulfillment costs, in a SaaS business this is the cost of software engineering.

If I am selling a low sticker item, then yes, I need those juicy higher margins to provide a contribution that feeds a timely pace towards profitability (profitability defined as: the ability to cover the monthly bills and then some with net profits), but conversely, if I am selling high sticker items, then the margin pressure is much lower and can be lower because the overall dollars contributed to the bottom line are still healthy. 2% margin on a high ticket items could be damn great if the item in question is a high priced item that contributes the dollars we need combined with acquisition growth rate that paces us to self sustainability. It comes down to the dollars contributed to cover the cost of COGS required per unit and then some, along with new buyer growth. If an average sale of an item produces enough net profit per unit to beat the clock (the time line to self sustainability vs cash out) then does it matter what margin got us to that point?

As with everything that the Wu-Tang Clan was right about, cash does indeed rule everything around me. Not metrics.

So, where does CAC/CPA come in to this equation? You can count or discount CAC/CPA in COGS if you’d like. But as I will explain below, I don’t actually think counting them against the cash early on tells you anything meaningful about whether you have a product that can scale profitably. A lot of founders assume they have a loser on their hands far too early, making this mistake

Caution: This does not mean that you are off the hook to find profitability, quite the opposite.

4. Pre Product Market Fit (Growth – Churn  >   LTV – CPA/CAC)

This is purely my opinion, but in the first six months of a products availability, and maybe for the first year, it is entirely unhelpful to treat LTV, CPA, Margins and Churn as equals. Metrics that don’t consider stage ultimately lie to the person using them. The standard e-commerce metrics are most assuredly not equally important from stage to stage and attempts to twist and contort these stats into place leads to dreadful assessments of an e-commerce businesses future viability. I actually believe CAC/CPA and LTV should be entirely discounted as a sign of whether or not the product or service being offered shows the vital signs of health and scalability during the first year. Notice I didn’t say that CPA/CAC and LTV shouldn’t be measured and understood from day one. They absolutely should. Re-emphasizing: these metrics should not drive the business strategy in the early stages or inform those running the business of the likely future trajectory. My opinion again, is that what is better to understand early on is churn. Paired with a growth rate double its size and a healthy contribution of dollars per unit, it can tell a much clearer story, if I’m an early team member or early investor. Why?

A. Early CPA/CAC and LTV is a phantom metric that will likely be all over the place as channels and tactics are experimented with, and that’s IF we are being honest with how we are tracking these. The methods used to determine how long an unchurned user will ultimately stay around, amount to crystal ball wizardry in my opinion. Early experiments can lie to you very easily and need to be controlled over time to truly understand how each is performing. Time? Something we do not have.

B. Early CAC/CPA numbers too often end up being the big lie that founders tell investors and then once investors get excited about it, start to believe the lie themselves. This causes a deleterious effect on e-commerce companies, especially as they assume what they are doing is working and fail to experiment as broadly as they would have without this assumption. There seems to be too much of a rush to say “Eureka, we have found gold in these hills”. It’s human nature. Why does this happen? Because there is undue pressure to know this number early and for some very weird reason, this number is paired with LTV as a snapshot that tells founders and investors about how profitable the business is and will be.

This snapshot is a bad one to hold up as equal to growth and dollars for two reasons. Firstly, the real cost can be, and typically is, easily gamed and obscured from investors’ due diligence, by hiding non traditional costs that cannot be detected during due diligence. And secondly, because it does not take into account fluctuations from competitors, seasonality, and rising platform costs. I think that any investor that holds up a companies CAC and LTV as the reason they invested or passed, is looking at fools gold and falling into a trap of conventional wisdom. It’s a ballsy thing for a founder to say, but its my opinion.

C. Churn and growth rate, along with actual dollars collected are very hard metrics to game and tell you something concrete, mainly, what the true profitability window likely is. Low churn and high growth (when paired with a great contribution of dollars per unit) tells me a few things. First, that we priced this either just right, or maybe even too low (great news!). Secondly, that the pain people are switching from and to our product is real because they are continuing to pay this price to have our product/service. And finally, that our users are telling other people about what they have found and those people agree.

D. Cash and user growth can also lie. Beware of stopping at the demand validation. There is another side to the coin. There are numbers and earmarks of future success that I believe are not even tracked by most. For starters, how do I know that we are building a future market that is enabled by backend tech that provides a competitive advantage that cannot be overcome by mere sales one-upsmanship, PR cleverness, or growth hacks. Am I building the new way and creating lock in? Look at Uber, for example. Their competitive advantage is their driver dispatch technology. Taxi drivers cannot overcome this advantage unless they switch to Uber and participate. And they are. They have created a monopoly on supply, and have replaced the entire taxi dispatching system in America. That is the real value of the company. Going back to Amazon for a minute, they are also obvious in how they have innovated in the supply chain stack. But where is it popular to see supplier activation, lock in, and chain innovation tracked in most things written about e-commerce? Not many places in my experience. I think that will change as time goes on and we learn more about what is cause such success for the next generation of full stack e-commerce platforms.

5. Product Market Fit 

My theory on product market fit is that it will look different than it did in previous generations of e-commerce. I believe Amazon will remain the unchallenged king of e-commerce even in the post-Amazon era, and that it will be very difficult to topple them, much like a new search attempting to topple Google. I don’t see their overall e-commerce dominance changing any time soon, but I also believe that due to the aforementioned conditions there is an opportunity to dominate huge multi-billion dollar “super niche” categories and create $1b + companies, due to the requirement of a singular laser focus to pull off these super niche category remakes. The ability to predict a winner by yesterdays Amazon standard, will not pass muster in tomorrow’s post-Amazon world.

I believe the first signs of product market fit will not in fact be identified as before, by strictly looking at the growth curve of profitable sales to consumers, but moreso in suppliers switching and loyalty to the new system. This in my opinion will be a significant marker that a new and better world is being created for suppliers. This will enabled a rich getting richer super network effect of monopolized supply.

Summary:

In closing, I believe that e-commerce and technology enabled retail is a gigantic opportunity globally. This is especially true because it is possible for founders without engineering backgrounds to start one and succeed, due to the conditions around the commoditization of retail infrastructure and the emergence of global cypto-currencies which open up market opportunities in third world countries.

Any company that endeavors to own entire retail categories from procurement and assembly to sales and fulfillment are the real opportunities for the next wave of $1b plus valued companies. A very good early sign that your e-commerce company has potential to reach those lofty heights is that you are making real cash, spinning that cash up in such a way that you are tracking to cover your monthly burn with net profits within 18 months of the availability of your products.

You will have to stay tuned to see if AgLocal can cross the chasm. I think we will.

This post originally appeared on Fits and Starts on July 10, 2014.