E-commerce is trending but what seems like a “low-investment-fast-growth” business idea to entrepreneurs might not be an accurate assumption. Treat this not as discouragement to start something new, but as a caution note from a person who has faced/seen people facing such problems. If you do have time and money, invest it into something everyone else is not doing. E-commerce is becoming cluttered very quickly and this creates only problems. Read on to understand the major pitfalls of e-commerce as it exists today. These simple points will help you understand the problems a novice entrepreneur or a retail will face when stepping into e-commerce.
1. Capital Intensive: E-commerce is retail in disguise. In fact, it is a bigger, hungrier form of physical retail and all the troubles like warehousing, inventory and supply chain come along. An e-commerce store is expected to have a larger range and as well as cheaper prices. Plus delivery times are always an issue so stocking inventory becomes a must in most cases – and here comes in the role of capital. So either start looking out for investors (which is not an easy task unless you’re a big-shot) or get ready to invest huge sums of your own money. But wait, if you have huge sums of money, why are you throwing it down the e-commerce drain? Buy some gold.
2. Low profit margin: This comes as a shock to anyone outside the e-commerce industry but is obvious to people inside – everyone in India (where I am from) is currently bleeding investor money. Everyone is making a loss. Even the biggest names you hear in the industry (yeah, all the karts, marts, hearts etc) are burning millions every month to acquire customers, reach a massive scale and waiting for others to die out before they can start making any profits. They’re taking returns, replacing products and pampering the consumer while bearing all these expenses just to become larger. There are several reasons why good profit margin is a far-fetched dream for companies:
a. Unit economics: The biggest mistake any uninformed entrepreneur could make is the negligence of contributions like payment gateway cost, packaging cost, shipping and handling cost and effective cataloging cost of articles to the overall margin. In e-commerce, the sourcing margins and effective margins are very different mostly because of these costs. Thus some articles are a better fit for e-commerce and some are not since even on very huge volumes, unit economics don’t work out to be positive. If the selling price of the item is low (and hence absolute sourcing margin is also low), the gateway charges, packaging, shipping and cataloging cost will easily overpower the margin and hence lead to a loss in the transaction.
To head one’s head around this, I coined a term called profit density defined as the ratio of sourcing margin to the additional e-commerce costs incurred in selling it (a major contribution of which is usually shipping cost). Profit densities are different for different categories of products. Books and beauty products have an extremely low profit density and real jewellery and apparel have a relatively high profit density. But since the universe has the habit of leveling things out, items with high profit densities are slow movers and harder to sell online and one’s with low densities are quicker and easier.
b. Cash on delivery: Since it has now become almost necessary to offer a cash on delivery service, it is very counter intuitive to know that all logistic companies actually charge to collect cash on your behalf. They actually charge a huge fixed amount (could vary from as Rs. 30 to Rs. 150 (that’s 0.5 to 2.5 USD) or sometimes even more per package depending on the provider, total volumes offered and also package value) to use your cash! This strongly degrades the unit economics.
Secondly, we all know how valuable cash is for a startup and in such an arrangement a lot of your cash-flow is stuck with the logistic company because they will take a certain amount of time to remit the money they’ve collected on your behalf.
Thirdly, almost always the logistic service provider will actually owe you more money (the cash they collected) than you owe them for delivery, thus making dealing with them a little more difficult (read hell).
Fourthly, customers are much more likely to return packages in cash on delivery cases since they haven’t paid for it. Post which the business has to incur double the shipping cost, lose out on precious inventory for a long time and still maybe end up with something that cannot be sold again, and a customer who will never buy again.
c. Lost, damaged articles: Business owners forget to take into account lost and damaged articles – which neither the service provider nor the customer will be liable for. Who else is left to bear the burden of lost/damaged inventory? This is especially harmful when you’re counting on low margins with huge volumes.
d. Competition: Consumers expect you to be the cheapest. Since you’re on the Internet, you save on the rent of a physical storefront and can pass on that benefit to the customer (very faulty premise which every customer carries in his/her mind). Moreover, pricing on the internet is very transparent so you have to keep a rock solid heart and offer the lowest margins humanly possible. In fact, cash rich competition will also sell at a loss just to drive you out of business. Competition will do everything – low prices, expensive advertisement, relaxed return policies, free shipping etc and these things start becoming must-haves instead of differentiators.
3. Logistics co-ordination and reconciliation: Since you cannot deliver everywhere all by yourself (at least initially), you will need to be dependent on logistic service providers. Fortunately or unfortunately, the performance of your service provider will determine the goodwill you create with your customer. It is certain that you will lose good and loyal customers due to a 3rd party’s poor performance and there is nothing you will be able to do about it. Customers will call your company and your operators will be recipients of heavy verbal abuse from disgruntled customers. Your operator will have no answer because they don’t know what has become of the package after it left your premises. Account reconciliation with service providers is also a similar harrowing experience wherein every kind of case and exception that can arise, will arise. Moreover, each provider will have its own format of reconciliation and reporting which you will need to adapt to.
4. Super strict IT requirements: If one of your founders is not a tech genius, quit right now. IT is the backbone of an e-commerce company and you will need it at every nook and corner of your business. The tech team will need to understand the entire business from end-to-end and develop technology to support every operation along the way. This is one section where mediocrity will fail you badly. An e-commerce company is not just “a website” which firms will make for a few thousand rupees. If you have any intention of making it big, don’t ever think of outsourcing this.
5. Marketing and SEO: Are you a marketing genius? Are you full of ideas on how to sell your product? Can you see how the current companies are doing it wrong? Think again. Marketing for an e-commerce company is a completely different ball game. It requires more of tech knowledge than anything else. You will hear terms like SEO, SEM, SMM floating around in the market and you might not understand them completely, but since you trust your marketing gut you’re brave enough to venture out into an unknown territory. The smarter choice is to keep someone who’s experienced in the field of online marketing close to you or of course to experience and learn yourself. The even smarter choice is to understand that it’s not the same as regular marketing! There are many ways of getting traffic and sales on your site, but they will require a lot of expertise, experimentation, analytics, research and dollars. Ranking #1 on google is like snatching flesh from a hungry lion – it’s hard!
In e-commerce marketing, there are only two aims to fulfill. Generate trust (by highlighting USPs and being persistent) and make yourself discoverable (bring traffic). The former will need time and effort, the latter needs money. In the competitive market out there today, advertising online has become so expensive recovering your spend seems utopian. Again, if you just started up without investor money you will face huge problems in this regard because today the online consumer has unlimited choices to buy from. If you already have raised investor money then there’s no point reading this – you can’t back out now.
6. Vendor management: If you’re thinking of sourcing from various vendors, you might be fine in the short term but this becomes a huge issue when the numbers increase. Every brand/manufacturer/distributor will have their own styles of packing, logistics, billing and measurement. Reconciling all of them is not insurmountable but a very cumbersome task. It is not possible to have everything in stock and usually you will end up accepting orders for items not in your inventory. Vendors in India will never be able to provide a synchronization system wherein you will be able to understand if item is actually in stock even with your supplier(s) for a long time to come. Moreover, manufacturing defects will then become your headache since you’re the seller and your goodwill is at stake now.
If you are a manufacturer and want to extend your physical store, this might not apply but the other problems still live unscathed. But even in that case since you cannot produce everything, you will ultimately end up sourcing from other suppliers. The better solution might be to become a vendor to already established e-commerce websites.
7. Distribution networks: If you want to sell grocery, pharmacy or other items wherein you plan to tie up with retailers, be aware that you will always end up with a very rough experience for the customer. The operations are hugely manual and hence cumbersome and delivery time is of utmost importance.
E-commerce is currently booming and everyone wants to start a website to sell stuff. What people miss are some subtle points that make e-commerce a difficult creature to rein. A genuine question that arises is that if no one is making profit, why are people continuing, why are investors investing and why are new e-shops opening everyday. The truth is everyone is playing the top-line game – not worrying about the bottom-lines at this moment. Companies want to increase their top-lines to a very large scale and rule their respective markets post which their marketing spend would decrease and a huge customer pool would have been accumulated. Beyond this point profitability would be possible but there would only be a handful survivors.
The only exit strategy that remains for e-commerce companies is either an acquisition or an IPO. Fire sales and shutdowns happen all the time but they’re not noticed by a lot of people – examples are Letsbuy and Taggle. So if you’re fully convinced that e-commerce is your life path, best of luck but be very cautious of the problems described above.
What’s your opinion?