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The Implications of a Cost of Revenue Accounting Model in Ecommerce

  
05 October 2016
  

The Implications of a Cost of Sale Accounting Model in Ecommerce

Ecommerce in the mid-market is often conducted by companies that have started with an alternative selling channel, such as retail, and have had to move into ecommerce due to the disruption created by the online channel.

As such, the strategies used can often be eye opening. Mistakes that simply could never happen in any other channel are regular occurrences in the online channel. Sales go up, sales go down and mid-market companies often have no real understanding of why.

And in the world of ecommerce where there are no degrees or charterships, companies generally do not know where authoritative opinions should come from.

At IRP Commerce, we align ourselves completely with companies in a pure form. We exist for two reasons:

  • To increase online sales;
  • To decrease costs through operational efficiency.

Using the anonymised data that flows around the IRP World system, we can understand online markets very clearly from a numbers point of view. Key to this understanding is benchmarking — what costs should be, what sales should be, and who should provide a particular service.

The Cost of Revenue Model versus the Overhead Model

There are some basics in ecommerce that, if a company cannot grasp them, they may be better not to participate in online selling at all.

The primary point to grasp is that online marketing should be seen and evaluated as a Cost of Revenue and not an overhead. Accountants need to remember the difference between the two when taking decisions — if they want a successful online operation they will have to back a Cost of Revenue model one hundred per cent.

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: online sales increase by 100% from the same month last year. Costs of the PPC channel also increase — to make the maths easy let’s say this is also by 100%. Finance flag that “overheads” are up 100% and that they need to be reduced. The Ecommerce Manager then cuts the PPC budget and sales evaporate. Then the circle begins again.

Let’s look at some basic accounting maths.

DATE ONLINE SALES PROFIT MARGIN GROSS PROFIT ONLINE MARKETING SPEND COST PER ACQUISITION % GROSS PROFIT AFTER ONLINE MARKETING SPEND
July 2015 Online Sales £100,000 15% £15,000 £5,000 5% £10,000
July 2016 Online Sales £200,000 15% £30,000 £10,000 5% £20,000

Online marketing spend as an overhead is traditionally how Finance 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 do not pull the plug on the channel because you sold £100,000 on eBay and it cost £12,000. It is 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.

Blunders that would not happen in a tangible selling channel are everyday occurrences for many companies in the online channel — and they are often not even noticed. If a company cannot adopt a Cost of Revenue model for online marketing, the long-term prospects are not good. They can expect their competition to take their business.

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