Ecommerce Myth Debunked: 3 Reasons Why (Indonesian) Startups Fall
Riot-y times no?
Multiply falls, Zalora is pulling a Joker, Rakuten Indonesia got divorced, Plasa in limbo, and many others victims as well as triumphs.
With so many to cover, I’m picking at the newest dude in the hood. IMHO, multiply did not close because of not being profitable, but because there’s not enough historical growth PLUS it has sustained negative cashflow for a while.
First, investors want growth. If there’s not enough growth, they’d better put their money with some fund managers who can grow their money at 30-150% annually, so that’s your benchmark. They want hyper growth company that can beat their fund managers. If they can’t get it from you, they’re going conventional. They’re not ruthless, that’s just how the world works.
But remember, however beautiful a hockey-stick growth is, if historical and projected cashflow is bad, you’re eventually going down. We can break down cashflow problem into 3 interrelated critical factors:
- cashflow = LTV - CAC > 0
- psychological anchoring
- twisted business strategy: misconception of deflationary economics
What follows is the story of how they interrelate.
Cashflow = LTV - CAC > 0
If you’re in ecommerce, you better know your LTV and CAC like you know the location of your birthmark. Any sustainable business operates on 1 condition: cashflow > 0. It is not different with startups.
What is LTV?
LTV is Lifetime Value. Basically, this is a metric that calculates how much income a customer generates for you as long as they become your customer. This is mostly affected by your gross margin and your product retention rate.
This is what killed ecomom when they focused on the top line and went daily deals frenzy. Low gross margin (if positive, at all) and low retention rate (daily deals users are not the most loyal of all. That is, the collective LTV from these customers does not justify the CAC.
So if an ecommerce consistently gives discount, that should be a red flag for any investor or journalists alike. #kode
What is CAC?
CAC is Customer Acquisition Cost. Basically, this is a metric that calculates how much do you spend per customer. The simplest way to calculate:
CAC = marketing spend / # of users
This metric is mostly affected by how good your online marketing team is and the marketing gimmicks that they run. Any marketing expenditure will accumulate into CAC.
Positive means money going into your business, negative means money going out of your business. And this is where many ecommerce startups in Indonesia fails. Let’s break it down:
Cashflow = LTV - CAC = f(retention rate, gross margin) - g(marketing spend, customers obtained)
- Retention rate: How long does it take for customers to buy the n+1th time?
- Gross margin: How much do you make in a given period? How much do you keep?
- Marketing spend: how much do you spend to market your product within a given period. Include any gimmick subsidy cost (e.g. free shipping, free transfer cost, etc)
- Customers obtained: how many customers to you gain with that budget within that period?
Using the above metrics, I’ll rate a few startups from what I see, assuming the following overly simplified mathematics:
- f(retention rate, gross margin) = gross margin x retention rate
- g(marketing spend, customers obtained) = marketing spend / customers obtained
The rating value will be relative and out of 5. This is not meant to be objective and bias does take into account:
Berrybenka: retention rate (1.5), gross margin (2), spend (2), customers (1.5) = 2.25
Belowcepek: 1.5, 1, 0, 1 = 1.5
Maskoolin: 1, 1.5, 0.5, 1 = 1
Zalora: 1.5, 1.5, 5, 1.5 = (1.5 x 1.5) - (5/2.5) = 2.25 - 3.33 = -1.08 (!)
It’s overly simplified but I’m pretty confident it aptly reflects their current condition. And just to be blatantly obvious, yes I am saying that I believe Zalora is most likely at negative cashflow for every transaction they make.
Now you can easily rate any ecommerce startups with these 4 questions. Investors to-be, dig deep and do your homework. Ecommerce startup owners, look at yourself in the mirror and stop fooling yourselves.
At the moment, my most favorite ecommerce startup is tiket.com. I’m not saying they’ll end up with the highest net worth or they’ll have the most extravagant exit, but they’re likely the most sustainable ecommerce startup currently. I like building sustainable companies, so I’m inherently biased :)
Another of a rising star for me is burufly.com. Their team is solid and their product roadmap seems great. Their first priority is validating their business model but once that’s taken care of, they should take off. (Disclaimer: I was a part-time consultant for burufly.)
It’s a very simple concept: a novel establishment sets an internal threshold that we will be pre-disposed to when similar happenstance re-occur.
Suppose you are doing consulting and your first ecommerce client is willing to pay you $5000 for 5 hours of consultation. Would you do consulting for another for $2500 for 5 hours? Most likely not, because now you have established the belief that your consulting rate is $1000/hour. Why would you want to do it for half less?
Take this concept to e-commerce: if an ecommerce startup has regularly given discounts to their existing customers, what do you think will happen to their retention rate once they reduce/remove discounts?
For some startups, this has become a dug-hole-too-deep-now-i’m-fucked situation which stems from:
Twisted business strategy
Have you ever wondered how can some startups keep giving discounts left and right and most importantly, why do they do it? These startups have to subsidize the burden in order to get attract first-time buyer and repeat buyer to their site. The strategy behind this commonly used tactic is to make their customers belief that the startup can give them the biggest bang for their buck; the startup gives them whatever they want (feature, fashion items, whatever) at the (close to) lowest price in industry.
This idea is the origin of a concept Mark Suster calls “deflationary economics”. However, this idea does not and should not entail having negative cashflow. What startups all over the world recklessly do is embedding deflationary economics onto their startup without regard to their cashflow plus establishing psychological anchoring on top of it.
They have too small margin, they give extra discounts that makes their cashflow implode and by doing that, they’re implicitly telling their customers that “we’re cheap, come buy some more”. Now do you see how some Indonesian ecommerce startups have essentially shot themselves in the foot, tumbled over into a river and got carried into a falls?
These days ecommerce have low barrier of entry, but it does not necessarily mean it’s easy to execute profitably, let alone remain profitable while having rapid growth. Here are 3 small lessons that I think every startup, not just ecommerce, needs live and breath by:
Pick 1: growth or profitability. But know the limit and do balance things out. If you pick growth, make sure you don’t set traps for yourself along the road. Also make sure that you know, with a great degree of certainty, when are you going to start being profitable. You can’t simply state that ecommerce startup generally takes a long time to show its value. I call that being ignorant & irresponsible because you can prove your startup’s value 6 months into operation. Know your payback period and segment it into cohorts.
Becareful with your marketing gimmicks. At first, they may create a rosy perception that your business is doing really well, your metrics are over the top, you get that hockey stick growth you’ve always dreamt of. But in the long run, they can put you into a hole so deep you can never get out of because now you have installed a habit and a predisposition so hard to erase from your customers expectation.
Lastly, learn from online gaming. I have quite a bit of experience in this industry and I have to say that this is probably the best online business in Indonesia. Inventory in bits means gross margin is approaching infinity, built in viral mechanism means CAC is approaching 0, and built-in retention rate, what more can you ask for? No wonder VCs flock to these guys. Figure out if you can figuratively (pun intended) integrate aspects in online gaming that make it such a lucrative business into yours.
learn from the deaths of your industry fellows. The news may not say so, but 99% of the time there are good, rock-solid reasons behind it. If you don’t, you will be the next to fall.
Caveat: You may ask: “how did you get the number in your cashflow calculation rating?” The short answer is: I infer. The longer asnwer is just as short: I have had experience in many different startups involving LTV and CAC, so I can confidently infer.