I have been a long-time fan of the e-commerce industry. As offline retailers were struggling to compete with online retailers, many large chains went out of business, and an increasing amount of consumer buying moved online. For a long time, e-commerce startups were printing money, in what felt like a “can’t lose” industry over the last couple decades. But, like with any “gold rush”, empowered by e-commerce platforms like Shopify that made it quick and inexpensive to get your online store up and running, e-commerce attracted a bunch of competitors trying to get their products discovered online.
But, what happens when millions of e-commerce stores are fighting to get discovered on only three primary websites (Amazon, Google and Facebook) where consumers are looking for potential shopping solutions? All hell breaks loose, wreaking havoc on your cost of customer acquisition and your bottom line profits. Which means the only long term winners in e-commerce are going to be Amazon, Google, and Facebook (“The Big Three”), who keep raking in all the highly-profitable advertising dollars, while the e-commerce businesses themselves are starting to struggle to make a profit. Allow me to explain.
The Growing E-commerce Industry
The e-commerce industry in the U.S. was approximately $500BN in size in 2018 and has been one of the fastest growing areas of the economy. This big market has been attracting tons of large retail corporations and startup entrepreneurs that have been trying to capture their piece of the pie. What started off as a handful of e-commerce sites in the infancy of the internet has grown to over one million e-commerce businesses in the U.S. alone (and growing daily), each competing for consumer attention.
The Rising Costs Of Getting Discovered
But, how to do you get consumer attention? In today’s market, that largely means The Big Three websites. But, there is a limited supply of positions on the first page of The Big Three’s website search results. Which means with limited supply and growing demand, the price of getting discovered keeps going up and up. Which means the cost of acquiring a new e-commerce customer is quickly increasing, eating into the profitability margins of those e-commerce businesses.
To me, it is quickly becoming a race to the bottom for the e-commerce businesses, many of which can no longer drive a profit on their first sale. They now must cross their fingers that they have a quick and frequent repeat sale cycle, to make their profits from the second and third transactions down the road. Which may work well for a consumable vitamin business, but doesn’t work so well for a non-consumable mattress business, as an example.
Google, Facebook and Amazon Capturing All the Profits
As costs keep going up and up for the e-commerce businesses, that means advertising revenues keep going up and up for The Big Three. Which means the only true long term winners in e-commerce will be The Big Three!! Said another way, if advertisers are willing to invest up to one-third of their revenues into consumer marketing efforts, that is over $150BN of largely free and clear profits for The Big Three to share between themselves. While at the same time, all the e-commerce businesses will simply struggle to break even as their marketing costs continue to soar to higher and higher levels. Pretty picture for The Big Three; ugly picture for the e-commerce businesses.
An iExplore Case Study—Costs Up 10X
Let me provide an example here. When I was running iExplore in the year 2000, I could buy a Google “adventure travel” search click for $0.25, competing against a handful of competitors. Those clicks would net me around a $200 cost of acquisition per new customer, or around 20% of my $1,000 gross profit margin. Resulting in a very healthy bottom line profit margin. Fast forward to today, that same click may cost $2.50 (10x more), as hundreds of competitors are now fighting for the top positions on those keywords. Which means my cost of customer acquisition has grown to $2,000 today. And, instead of driving an $800 profit on the first sale, I am now losing $1,000 on the first sale. A pretty grim reality, to say the least.
Making A Deal With The Devil (Amazon)
Google and Facebook clearly present their marketing challenges, but Amazon is even worse. Over half of all shopping searches start at Amazon. But, there is a price to pay for that distribution. Amazon charges around a 15% revenue share to get promoted on their website, assuming you do your own fulfillment (the fee rises to around 25% if you need Amazon to do the fulfillment). And, that is before Amazon has fully exploited their ambition of building a Google-like advertising marketplace to ensure your products get discovered on their platform. When you layer marketing costs on top of the distribution and fulfillment fees, there is going to be no profits left for anyone except Amazon. And, if you were hoping for repeat sales to drive your long term profits, good luck, as Amazon does not allow you to share in any of the customer records created. They are Amazon’s customers, not yours, and you are not allowed to repeat market to them anywhere except on Amazon. All in all, a great win for Amazon, and a strong kick in the gut for the e-commerce businesses.
Even if you are one of the lucky e-commerce businesses that are driving a healthy profit today. Enjoy it while it lasts. It is only a matter of time before new competitors learn of your success on The Big Three websites, and try to enter your market. We’ll see what your profits look like in a couple years after the flock of competitors starts fighting for position around your keywords. And, this will be the case in nearly every category of e-commerce, so it doesn’t really matter what products you sell.
So, for all you e-commerce lovers out there (myself included), I have these cautionary words of wisdom for you: think twice before getting into the e-commerce business. If you want to win long term in e-commerce, stop thinking about what products you are trying to sell, and think more about how you can profitability grow your business without relying on The Big Three websites (e.g., viral word of mouth, direct mail, smaller websites) with proprietary or patented products only found on your website. Or, better yet, think about how you are going to build a new fourth competitor to The Big Three, as that is where the real profits are long term, without having to deal with all the merchandising, warehousing, markdowns and other headaches that come with running an e-commerce business.