Wednesday, January 5, 2011

A simple business plan for online retail startups

I've been doing some reading about successful online retail startups and talking to some other people in the space and it seems that what follows is the basic path that they all take:

1. Develop the product concept
2. Scale the offer
3. Measure and increase the lifetime value of a customer
4. Acquire customers at scale

To look at each of these steps in detail:

1. Develop the product concept
The first step if you're interested in starting an online retail business is to develop your product concept. What's your value proposition? Why are people going to shop with you? Why are you different to other retailers? It's important to start with a good concept, but getting it right can also take some tweaking.

Amazon's concept is to offer an incredibly large range of products at very good prices with fast, well priced shipping. Zappo's (recently acquired by Amazing for US$1.2B) offer extraordinary customer service which includes customer support team members going above and beyond the call of duty, free shipping, free upgrades to overnight shipping for some repeat customers and 365 day returns with free shipping on the returns. (recently acquired by Amazon for US$540m) provide diapers and related products at incredibly low prices with very fast shipping. While not in the same league as these retailers, our product concept at Shoes of Prey is to allow women to design their own shoes which we hand make and deliver to them.

Once you've developed what you think is a good product concept it's important to test it in the market, evaluate it and tweak it where required. You want to ensure you are providing the right offer before you move on to step 2 and work out how to make it scale. Zappo's didn't start out with all the amazing customer service activities they now have, these were gradual changes they made based on feedback from customers. They also had a lot of early success with search engine marketing. Search engine marketing didn't really exist when the business was founded in 1999, so this was also something they tweaked with their model after they started which helped them to scale.

A key part of this step is to launch your product concept quickly and cheaply in case your product isn't something people want. If your business is going to fail it's best this happen sooner rather than later, and if it's going to succeed there is no better way to tweak and optimise it than to be getting feedback from real, live customers. So don't wait until everything is perfect to launch, better to get feedback early and perfect the product concept after launch using customer feedback.

Developing our product concept is exactly what we've done over the past 14 months with Shoes of Prey. We've made some changes to our model since our launch, in particular tweaking our range adding Italian silk, ballet flats and ankle boots, and also redesigning our website based on feedback from our customers.

2. Scale the offer
Once you have developed the product concept, the next step is to work out how to make it scale so that you're able to supply more and more product as your customer base grows. Amazon had to work out how to do this and achieved it with their amazing warehouses and supply chain.

Zappo's took the time to develop a strong and effective company culture so that the same high level of customer service could be provided by 100's of employees that was originally being provided by only a small number. Similar to Amazon, had to develop incredibly efficient supply chain processes to be able to offer their low prices, on low margin products at scale. Check out their robotic pickers in this video!

At Shoes of Prey we need to ensure we can hand make and ship a large number of shoes with high consistent quality and within our 5 week promised delivery time.

3. Measure and increase the lifetime value of a customer
Once you've worked out how to scale your offer the next step is to be able to measure the lifetime value of a customer, then work on increasing it.

The lifetime value (LTV) of a customer can be described by the following forumula:

LTV = Expected Life x Avg. Revenue per User x Gross Margin

This formula highlights 3 levers a business like Shoes of Prey can pull to increase LTV.

Expected Life or the number of shoes each customer purchases from us. How can we offer better value to encourage single visit customers to make repeat purchases from us?

Avg. Revenue per User or the $ value of each sale we make. Can we sell complimentary products to our existing customer to increase the value of their basket each time they purchase? Can we upsell them from our cheaper ballet flats to our more expensive ankle boots? Can we encourage people to buy a higher value gift certificate for their friends and loved ones?

Gross Margin. How can we reduce our cost base to increase our gross margin without having to raise our prices? Can we introduce new, higher margin products into our range?

These are all things we need to work on to increase the lifetime value of our customers. For a great post describing how to measure the lifetime value of your customers have a read of this blog post from the Venture Capital from Lightspeed Venture Partners.

4. Acquire customers at scale
The final step is to work out how to acquire customers at scale for a cost that is lower than their lifetime value. If a customer is worth $200 over their lifetime and you can acquire a million customers in a year at $100 each, you've got a business that's going to generate $100m in profit.

This is obviously much easier said than done! You'll need to test different marketing channels to find out what works best. Is it TV advertising, print media, PR, YouTube, social media, search engine optimisation, search engine marketing or a mix of all of these that works best for your business? What marketing tactics and campaigns within these channels help you acquire customers at a low cost and at scale?

Once you have a business concept that people want, an offer that can scale and you can acquire lots of customers at a cost below their lifetime value you'll have built yourself a very successful online retail business. These 4 steps are not simple to achieve, but they provide a good framework to work from if you're setting out to start an online retail or eCommerce business.

Cross posted to the Nett magazine blog.


  1. Great article again guys, and love some of the concepts in here. For you though, I'd throw in a co-efficient for the formula around the lifetime value of a customer...because with each satisfied customer, your brand image and brand value grows as that person wears their shoes and shares their story. Whilst this is hard to measure, I don't think you can ignore the impact of positive word of mouth as your customer matures through your lifecycle. Knowing how a customer navigates through these phases (initial concept, purchase decision, receipt of goods, wearing, caring, sharing...2nd concept) and how their requirements and experiences differ at each stage, would provide some interesting insights for your marketing efforts.

    Additionally, I'd be fascinated to know how the formula for cost of retaining or even worse, cost or acquiring maps onto this expected life. You'd probably end up with some kind of BCG style matrix of customers?

    Once again, great read.

  2. MFN - Cheers for the feedback and great thoughts on the additional brand value coming from each new customer. I guess ideally that would be something that's good to include in the lifetime value of the original customer, though that's getting very hard to measure so probably not possible. Good to keep in mind.

  3. good stuff. When you test your concept, you don't necessarily have to have a ready product to go. To simply and cheaply test an idea, you need to just have a way for people to show their interest, whether it is a purchase button which leads to coming soon page etc. You can track the interest this way and then decide whether it is worth making the product.

    Also, have you guys tried playing with your guarantee terms. You might want to A/B test a few different guarantee offers (30-day, 60-day and more). I'd assume that this is probably one of the most influencing factors when someone makes a decision to purchase. It could increase your purchase rate.

  4. Hi Michael,

    I really loved this post. As always the content is useful but what I really liked was the three videos you chose to include. They had great relevance to the business I currently work in (Brady Australia) as we have an extensive warehouse and logistics operation with a large product range (around 40,000 SKU’s).

    I forwarded the link to your blog post to our Operations Director who was so impressed that he sent the following email to our Leadership and Operations Team.

    “Hi Team

    just reviewed this email and article Lisa Mulligan sent me. "WOW"

    Not sure if she sent copies to other team members but if not I
    personally think there is value in the viewing for everyone.

    Especially with our strategy refresh reviews starting this week, this
    is the time and place to investigate new opportunities that could
    enhance our market share and profitability.

    I watched all the videos and each one had some little pearls of wisdom
    that could be relevant to our business.

    Happy viewing”

  5. Hi Libor, it can definitely be good to test in the way you describe. I'd almost put that as a preliminary to step 1 though as I think it's important to properly test the concept, in market for a solid period of time (in our case over a year) before moving on to step 2. Along the lines of what you describe we ran a beta test amongst friends and had them design their shoes from pictures at a discounted price. The feedback was fantastic for working out details like the best way to determine a customer's shoe size etc. Great idea for the A/B test too. We actually honour our returns policy much longer than 30 days anyway, so we might just change it on the site rather than worrying about testing. Cheers.

    Lisa, thanks so much for passing the post on to your colleagues and for the great feedback. So nice to hear when people find the posts useful and are "WOW"ed! :) 40,000 SKU's at Brady would make for a very large and complex warehouse and logistics operation.

  6. In your scenario (shoes), expected life of a customer can be high. A shoe can last for one year. You don't expect the same customer to buy more and more shoes any soon. However for a bulk discount site that offers discount coupons on movies, spas, music, restaurant etc., expected life of a customer will be small. In that scenario how do you justify the same formula? Or does the formula work well with group discount sites? such as Snap Deal?

  7. Hi OBR, the expected life of our our customers will depend on how much they spend with us per transaction (are they buying our cheaper ballet flats or our more expensive ankle boots) and how often they come back and repurchase from us. It's the same for a daily deals site. Some of their customers will purchase cheap deals, some more expensive deals and the expected life of their customers will also be impacted by how often customers come back and repurchase from them. A daily deals side should arguably have a higher repurchase rate than we do because customers visit restaurants, spas, movies etc. more often than they purchase shoes, though the amount they spend on these things will be less than shoes.

  8. Thank you for the artickr and for your tips. I am starting my online women shoe boutique, and have started designing/customizing women's shoes. The way I test them is by collaborating with up and coming designers at their fashion shows and showcasing my shoes at their events. I get feedback, exposure, I network, and I'm able to tell if some changes need to be made to the designs as far as durability, and practicality of the shoe. On the topic of the expected life of the customer, you can't measure that as a shoe can last a year because how many women you know that buy a pair a year. Not many right? Lol.. I have customers that buy 2 or 3 a month. My prices are very reasonable and competitive with other shoe retailers, therefore that might just make it easier fr them to come back more often.
    Pls keep these articles coming.

    Best regards,
    Divina Moda