INTRODUCTION
The dot-com bubble is long behind us, but online commerce is finally red-hot again. In the late 1990s, the conventional wisdom was that the transformation from “bricks to clicks” for retailers would happen almost instantly. Yet over the past ten years, it’s become clear that the shift to the Web was not a two- to three- year revolution, but a 15-20 year evolution. According to comScore, non-travel/auto/gas/food e-commerce sales represented just 7.1% of total retail sales in the US in Q2 2010. But, significantly, online sales have grown at an annualized rate of 9.7% since 2006 (vs. the 2.3% annualized decline in total retail sales over that same period, which includes the Great Recession). Leading online retailers, like Amazon.com, are growing even faster—30% per year for the past several years. This growth in e-commerce should only accelerate. Companies like Zappos, Bessemer portfolio company Quidsi (operator of Diapers.com and Soap.com), Vente Privee, Netflix and others are creating new online-retail categories and pulling offline dollars onto the Web. But a lot has changed since the heady—and money- losing—days of eToys and Pets.com. Today’s successful e-commerce sites don’t just throw products up on a Web site and spend tens of millions of dollars on traditional brand advertising to promote them. The rules of the game today are much more complex and, in many ways, scientific: They involve astute use of targeted, direct-response advertising, for instance, and careful calculations about the lifetime value of each customer. Those leading the e-commerce pack today also display a laser-like focus on customer service, including offering fast and/or free product delivery. (Consider Zappos, which ships customers their shoes overnight.) At Bessemer, we’ve been lucky to have participated in each successive wave of retail innovation since the mid-1980s, starting with our investments in “big-box” retailers like Staples, The Sports Authority, Dick’s Sporting Goods and Eagle Hardware & Garden. In the late 1990s, we funded several first-generation Internet retailers. Some of these early-stage investments, like Blue Nile, became successful public companies and went on to embody the initial promise of online retail. Others, like eToys, burned brightly for a time but faded quickly in the face of the uneconomic (read: way-too-expensive) customer acquisition model that plagued many early Web pioneers. Together with the e-tail industry at large, we learned lots of hard lessons about building sustainable and valuable e-commerce businesses. That can only be done, in our view, by focusing on the smart development of a consumer brand through profitable customer acquisition and extraordinary customer service. Among today’s successes, according to those criteria: Quidsi (operator of Diapers.com and Soap.com), Delivery Agent and Onestop Internet. Moreover, we continue to invest in other types of category-leading companies that play in the e-commerce ecosystem, like Criteo and Convertro, which are becoming indispensible tools to help e-tailers exploit the increasing complex opportunities in online marketing So now, we offer our own rulebook for this dynamic and rapidly growing sector—Bessemer’s Top 10 Laws of E-Commerce. BESSEMER E-COMMERCE RULE #1: You must build a brand, but not through brand advertising The ultimate goal for any consumer offering–and the goal that will frame the remaining nine rules–is to build a brand. If your brand becomes synonymous with a particular category (e.g. books for Amazon, DVDs for Netflix) you gain tremendous leverage in your marketing spend. But exactly how you build a brand has changed a lot in the last decade. Forget sock puppets and pricey Super Bowl ads. So 1999! Brand strength today is built penny by penny (and order by order) with effective direct-response advertising that can be quantified and measured. In some categories your marketing campaign can attract customers for as little as $10 apiece. If your offering works (more on that later), those customers you snag will generate more than $10 (say, $30) of profit over their lifetimes. Then, you can reinvest that $30 in more online marketing. Rinse, lather, repeat. You have a growth (and profit) generation machine. Once you get big enough that you’re spending millions of dollars on direct-response advertising, you can think about more traditional brand advertising. When you can afford it, brand marketing will help you finally convert customers that you probably have touched before with your direct-response advertising but just need an extra nudge. Essentially, if done right, brand marketing becomes yet another form of direct response advertising. Consider this: Zappos, the online-shoe retailer scooped up by Amazon.com for $847 million last year, didn’t run its first television ad until 2008, even though it was founded in 1999. Clearly CEO Tony Hsieh and his crew knew how to build their company’s brand penny by penny. By the time Zappos went on TV, as many people in the U.S. were searching for Zappos by name on Google’s search engine as were searching for Adidas, a globally recognized brand.
Essentially, if you measure your marketing results on a multi-attribution basis (more on this in Rule #6), brand marketing becomes yet another form of direct response advertising. Measure your results. If you are not seeing enough of a lift in your word of mouth or direct “type in” traffic to justify the cost, then you should rethink your brand-advertising strategy. Another tip: Run lots of marketing experiments of at least $10,000-20,000 apiece. These might include using different marketing channels like certain comparison-shopping sites that you’ve never worked with, vertical-ad networks or even new advertising techniques like retargeting. Measure the results on a multi-attribution basis and invest in the ones that work well. You may be surprised where the best return-on-investment comes from. Certainly, monitor your ROI and tweak as necessary. Finally, it’s important to point out that penny-at-a-time advertising doesn’t guarantee you will actually succeed in building a brand. We touch on some of the critical elements of successful brand building in the remaining rules (especially Nos. 4, 5, 8 and 9). While there may not be a clear and concise formula for building a great brand, we’re certain about one thing: It’s virtually impossible to build a brand through excessive marketing. So don’t try it. All of your marketing should be measurable and profitable. If you follow the rest of our ten laws of e-commerce, and steadily increase your marketing expenditures in a profitable way, you’ll lure more and more consumers to your store–and eventually, your brand will emerge. If it doesn’t, you’ve almost certainly been ignoring several of our other rules.
BESSEMER E-COMMERCE RULE #2: Customer Lifetime Contribution (CLTC) is your new pulseAs you build your direct-response marketing campaign, remember to focus on the lifetime value of your customer, or how much profit that customer will generate during the course of your relationship.
The textbook definition of CLTC is the net present value (NPV) of the profit from a customer’s
purchases. Remember to include all the sales that result from a customer’s repeat visits, less
any associated costs to service the resulting orders (include variable costs like COGS, credit-card
processing fees, shipping, warehouse-order processing, etc). A profitable customer will have a
CLTC in excess of its customer acquisition cost (CAC). Treat these profitable customers well.
Once you have a good handle on this metric, you shouldn’t be afraid to spend until the marginal
CAC (your CAC to acquire the next customer) approaches the CLTC of your next incremental
customer, even if it costs more to acquire that new customer than you recoup on his or her first
purchase. Note: This doesn’t mean you should spend until the average CAC approaches your
CLTC. Rather, you want to spend to acquire customers until your marginal contribution (CLTC –
CAC for each new customer) equals zero.
Anything less is under-investing in your business. Obviously, this can be a very scary pill to
swallow, so make sure you really understand your CLTC before jumping in.
For early-stage companies, estimating a customer’s lifetime value can be more of an art than a
science. If you’re not fully confident you have a handle on this, instead spend right up to the
average, fully-loaded gross profit of a customer’s first order. Then you can focus on driving
repeat usage.
In the beginning, your average CLTC will be low because you won’t have scale. But as you grow,
you’ll start to see some of the benefits of scale, such as:
• Getting better terms from vendors, because you’re buying more (which drives up your
gross margins);
• The ability to offer your customers a broader selection of higher-margin, slower-moving
SKUs (which increases your average order value, your gross margins, and your customer
satisfaction);
• The data to offer better product recommendations (which also increases your average
order value and improves conversion rates); etc.
All of these things will increase your CLTC. This kicks off a virtuous cycle: CLTC goes up; you can
afford to spend more money on marketing; you start to grow faster; you get more scale —
and on and on and on.
It’s critical to calculate CLTC as accurately as possible, since it will drive much of your marketing
decision making. At scale, follow this rule of thumb: If your CLTC is at least two times the cost of
acquiring a new customer, with at least 1X coming in the first 12 months after acquisition,
you’re in great shape. If you’re doing any better than that, it’s irresponsible for you not to be
spending more aggressively on marketing. (And please, call us so we can invest in your
company!) If your CLTC/CAC ratio is less than two, then it’s worth reigning in your marketing
spend until you grow into it.