Why most ecommerce businesses stop growing.

Today’s guest blog post is from Michael Ross, Co-Founder and Director, eCommera and one of the lead authors of the Trading Intelligence Quarterly. Drop us a line if you want to run a guest blog. We would love to hear from awesome people with great things to share!

Michael will be speaking at the ecommerce Networking Forum, (#eCloud), London 1st November. This is a by-invitation forum for key executives from the multi-channel retail community to meet, discuss issues of common interest with their peers, exchange ideas, and do business. If you are a CIO, CTO, CFO or Director of ecommerce you should give some serious thought to getting there too.

Most retailers want to grow. Whether driven by ambitious entrepreneurs or expectant shareholders, growth has become totemic of success. But whilst the growth model in physical retail is well understood, the growth of online retail is not. As a result, there have been big winners and losers online (see figure 1).

Figure 1: Winners and losers*

* “Bad” are well known online retailers who shall remain anonymous to protect their dignity

Asos, Net-a-porter and Wiggle have sustained exponential growth. For each of them, there are tens of online retailers or divisions of multichannel retailers that have quietly stopped growing, leaving customers for their competitors.

Moreover, whilst online represents a small percentage of overall sales, any excess stock bought for online can be managed. But as online becomes an increasing share of sales, failure to understand the underlying drivers of growth can have a catastrophic impact on stock turn, margin and cashflow.

Many retailers enjoyed ‘easy’ growth in the first decade of online retail; it was hard NOT to grow at exponential rates as customers moved purchases online.

In particular, high street retailers saw rapid growth when they went online driven by:

  • Channel shifting (with some cannibalisation of store sales)
  • Increased sales to loyal customers
  • Access to latent demand beyond a store catchment area.

For many, the real challenge now is how to retain this early momentum which requires a real understanding of the growth model of online retail. This article sheds some light on:

  • Traditional growth models: How do physical retailers and brand owners grow?
  • The online growth model: What drives growth in online retail?
  • The challenge: Why do most online retailers stop growing?

Traditional growth models

The growth models for physical retailers and brand owners are tried and tested and there are many successful players to emulate and learn from. However, the tactics and reasons for success for a physical retailer are completely different to those of a brand owner. Surprisingly, the growth dynamic of an online business is more similar to that of brand owners, than a physical retailer.

a) How physical retailers grow

Retailers’ growth is driven by like-for-likes and new stores. This is a growth model honed over the last 150 years – and the largest retailers in the world have a lot of stores (see figure 2). The ability of these stores to succeed is based on consumer insight around range, price, convenience and service – the core elements of a store format. Each store then gives access to new customers.

Figure 2: How many?

Source: Wikipedia – 2010/2011 data

b) How brand owners grow

The growth of brand owner (consumer goods) businesses, selling products such as baked beans, toothpaste and shampoo, is based on building a loyal customer base. Brand owners carefully manage the transition of consumers from trialists to repeaters to loyalists. Lots of people can be encouraged to try something based on promotions, marketing and shelf positioning. Some percentage go on to repeat and some of those then become loyal. Only if the ‘percentages’ work does the brand owner roll-out.

The mathematics of this transition was worked out in the 1960s/70s by the likes of Eskin, Kalwani and Silk. It was fuelled by the roll-out of barcode scanning which, for the first time, allowed the large scale tracking of individual consumers’ behaviour. They discovered that the transition from trialist to loyalist is predictable. This enabled the successful FMCG companies to get very large (see figure 3).

Figure 3: How big?

The online growth model: what drives growth?

Online retail growth – at its most fundamental – is similarly driven by customers. Customers do or do not purchase for a first time, and then do or do not come back. This rhythm of customer acquisition and retention is the starting point, and everything a retailer does will affect the rate of acquisition or retention.

While growing retailers will have achieved some combination of an increase in traffic, conversion and average order value, it is important to recognise that these are outcomes rather than business inputs. Similarly, increasing stock (whether breadth or depth) can be a critical driver of growth but will not necessarily drive growth in and of itself.

Adding new products or increasing cover can simply lead to cannibalisation or a reduction in stock turn. Improving delivery on promise is never a bad thing but it may be uneconomic if it doesn’t drive customer retention.

It is important to note that whilst customer loyalty is an outcome (of great products and service), the challenge for retailers online is to understand the relationship between inputs and customers. In the offline world, this requires experience and instinct; in the online world, it requires good analysis. Only by understanding the impact on customers can the right decisions be made.

Cohort analysis explains this growth dynamic. It is probably the single most important analysis an online retailer can do, and it is the heartbeat of their business. There are four elements of a cohort analysis:

  • How customers transition from new to loyal
  • How long it takes to make this transition
  • How it gets better/worse over time
  • The spend pattern of a loyal customer.

This data is what’s needed to predict growth – it tells you what growth rate is achievable given a marketing spend, or what marketing spend is required to deliver a target growth rate. And it is the baseline against which all other initiatives can be evaluated.

The challenge: why do most online retailers stop growing?

Implicit in this picture is customer churn: an annoying number of customers will buy once (or twice) and never come back – exactly like the trialists for a consumer goods brand. The simple reason for slowing growth is that once your new customer acquisition is equal to the churn of your customer base, you will stop growing.

The solution is equally simple: you either need to get more new customers or you need to reduce churn. Many multichannel retailers (who don’t break out online) have been satisfied with growth benchmarked against like-for-likes – if their web store is growing faster than the physical stores that’s OK. Unfortunately, it is an unhelpful comparison given the lack of constraints of the online store and the hypergrowth of the global eCommerce opportunity. Failure to take advantage of it is simply leaving customers for your competitors.

Many – maybe most – online plans today are based on modelling: marketing channels, categories or simple extrapolations of traffic, conversion and average order value. Some plans are just by CEO diktat (see ‘Using data to deliver online targets’). This is dangerous – the stock/margin exposure of getting a growth rate off by 10 to 20 percentage points is typically a lot more than the cost of building a good model.

Navigating this new customer data is challenging: many retailers do not have a customer database, and customer analysis is – at best – an ad hoc activity. Understanding an individual customer’s purchases is a new world for retailers who have built successful businesses on inference and gut feel.

Michael will be speaking at the eCommerce Networking Forum, (#eCloud), London 1st November. This is a by-invitation forum for key executives from the multi-channel retail community to meet, discuss issues of common interest with their peers, exchange ideas, and do business. If you are a CIO, CTO, CFO or Director of ecommerce you should give some serious thought to getting there too.