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Cost of Revenue – Ecommerce's Dark Secret

Ecommerce is going through exceptional growth, but what is lurking beneath the surface of this rise and how can companies navigate these choppy waters?
5 min read

2020, what a year. There's no point in covering off what happened – we all lived it, we all experienced it. And though the year has come and gone, the pandemic's effects live on.

COVID-19 and the various responses to it around the world have created a seismic shift in our lives and our economy. One of the few winners from this event was ecommerce. Some of the statistics we have seen truly show a global industry in huge growth:

  • 56% of consumers have tried a new retailer during the pandemic (Narvar).
  • Ecommerce sales are forecasted to have increased 32.4% in 2020 with brick-and-mortar forecasted to fall 3.2% (eMarketer).
  • Amazon saw 39.1% year-over-year sales growth in 2020 (eMarketer).
  • IRP YOY average growth of 78% (IRP Trading Data).

A great year for ecommerce

A recent report from IBM put forward the proposition that the ecommerce landscape has shifted five years forward thanks to the pandemic in only six months. IRP Trading Data shows similar traits:

  • Overall average IRP client sales increased by 78%.
  • November 2020 saw an increase of 180% YOY in some cases with a much more solid buying pattern across most industries.
  • Conversion rates increased by 15%.
  • CPA decreased from 6.98% to 6.85%, a percentage change of 1.8%.

A good year. A great year. But non-IRP clients soon realised the ultimate ecommerce pitfall when they looked at their bottom lines on Jan 1st 2021. Sales are great, they are the lifeblood of a business and an increase in sales is always met with a euphoric glee in the boardroom. The Financial Director though will always note the key metric – how much it cost to get those sales. To that end, how much profit was made?

We don't need to have gone to Harvard Business School to know that the bottom line speaks loudest in business, but in the words of one of their foremost business and economics professors, Michael Porter:

“If your goal is anything but profitability – if it's to be big, or to grow fast, or to become a technology leader – you'll hit problems.”

We believe that to be a true partner to a business looking to succeed in ecommerce, you must be a partner in profit. As their supplier, we believe that we must have a shared goal and indeed a shared risk based on maximising the profit of their ecommerce store.


Online marketing is a cost of revenue and not an overhead

Growth is achieved by utilising various marketing channels to send customers to your store. Importantly, the successful company is the one that believes that online marketing should be seen and evaluated as a cost of revenue and not an overhead.

Once appreciated as a core element of the process, the right ecosystem can maintain control of the target CPA while still facilitating growth.

A real-life example that we have seen repeatedly in this area will help draw out the implications of not adopting a cost of revenue model: an online company's Google PPC channel starts to deliver on results and the following sequence of events ensues:

  1. Online sales increase by 100% from the same month last year.
  2. Costs of the PPC channel also increase – to make the maths easy let's say this is also by 100%.
  3. The Finance Department flags that 'overheads' are up 100% and that they need to be reduced.
  4. The Ecommerce Manager then cuts the PPC budget.
  5. Sales evaporate.
  6. The circle begins again.
  Mar 2019 Online Sales Mar 2020 Online Sales
Online sales £100,000 £200,000
Product margin 40% 40%
Gross profit £40,000 £80,000
Online marketing spend £5,000 £10,000
Cost per acquisition % 5% 5%
Gross profit after online marketing spend £35,000 £70,000

Online marketing spend as an overhead is traditionally how a Finance Department would have viewed their online operation. In the above example, when sales drop again from £200,000 to £100,000 when the budget is cut, the real issue can be missed and the drop can be ascribed to any number of causes. Perhaps the SEO was responsible …

Obviously a cost of revenue model should be adopted for many selling channels, including by anyone selling on eBay or Amazon. You don't pull the plug on the channel because you sold £100,000 on eBay and it cost £12,000.

It's exactly the same with a company's own direct-selling website, only the cost of revenue will be less if they run a tight ship.


IRP is built on the foundation of controlling cost of revenue

So why do IRP clients continue to grow at exponential rates without having to cut back? Because our IRP Commerce Cloud platform is built on the foundation of controlling cost of revenue.

Our platform focuses on helping companies perform to their maximum growth whilst all the time ensuring a tight adherence to the cost of revenue targets set at the start of each year.

Our unique structure combines state-of-the-art technology, unparalleled, data-driven insights and IRP World – an ecosystem of account managers and service providers all of whom are dedicated to helping our clients reach their target revenues at the target cost per acquisition.

This is really the key ingredient in a successful ecommerce strategy: alignment on combating the dark secret of ecommerce – the cost of revenue. When your entire ecosystem is driven and designed to maximise your profits, success follows.

Our ecosystem is built on providing clear data with powerful insights, all controlled by an array of aligned suppliers monitored in a competitive marketplace and focussed on the delivery of maximum growth at target CPA. The result is high growth, high profits and happy clients.

The key trap to avoid is that lack of control. When you cannot control your costs, your growth (even the growth fuelled by lockdowns) is meaningless. In fact, it is dangerous.

The dark secret isn't fought with black magic. It's a simple process of delivering target revenue and target CPA in order to create a controlled profit machine.

Anonymous - The fact no one straight out talks about Net Profit as the key ecommerce metric says a lot.
14 Jan 2021 17:09
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