For the last few years, buyers have been purchasing a type of website that, left unchanged, is almost always doomed to fail. The worst part is, it’s probably one of the most popular types of site being sold.
This is part of a series of guest posts by Justin Gilchrist the cofounder of Centurica, a company that provides due diligence and website assessments to people who buy web based businesses.
I’d like to show you how you can avoid the same fate. More importantly, I’ll take you through a strategy that’s been working for over 8 years now, turning these problem sites in huge profits for buyers.
A few months before writing this I sat opposite a lady on a flight and we had one those really awkward cross-aisle conversations. The type that happens when the other person sees Google Analytics on your screen and realizes you also have an internet business, but neither of you know if the other person really wants to talk.
Originally, she said she ran an ‘ecommerce company’. Five minutes in, it was actually a farming supplies store in the British countryside that happened to have a website … where about 5% of all their transactions happened, compared to the other 95% that happened in store. Her website was three months old and she was very proud of it. I didn’t have the heart to tell her otherwise.
I guess running an ecommerce company sounds so much cooler than “I run a small shop” but that wouldn’t be the first time I’ve heard ‘ecommerce’ used for all the wrong reasons. People’s definition of ecommerce varies depending on who you speak to.
We frequently work with buyers at Centurica where someone wants to purchase an ‘ecommerce business’. Sometimes, they want an online store. Sometimes, they’re just referring to any business that transacts on the internet – like a content site.
Both are technically ecommerce, but not the online store we usually mean.
Ecommerce can be split up into
Physical Ecommerce (PSE) – an online store selling a physical product that is either warehoused and dispatched by the owner, or warehoused by a third party fulfillment center such as Amazon FBA or ShipWire.
Drop-ship Ecommerce (DSE) – an online store that also sells physical products, but these are dispatched directly from the manufacturer or wholesaler.
Digital Ecommerce – is a website that sells one or more digital information products where the transaction happens on the site. If this were an Affiliate site, the user would be sent elsewhere to make their purchase. If the user is taken to a third party hosted page to make payment (like many shopping carts do) then it still counts as Digital Commerce, providing the site owner also owns that cart transaction.
Knowing the difference is pretty important.
One of those three models comes almost doomed to failure unless you’re able to do something about it. Can you guess which one? Pretend for a minute that you didn’t already read the title.
Here’s the problem with drop-ship
In my opinion, drop-ship ecommerce (DSE) holds the least value out of all three of those types of business.
And to clarify, the ‘bad’ kind of drop-ship are those stores that sell generic products that are easy to source. The kind where you type ‘drop-ship directory’ into Google and your supplier pops up. If you have a site with a distribution agreement, or products that are difficult for competitors to find elsewhere, then the rules change.
New buyers tend to see DSE as being extremely low maintenance. After all, you’re just sitting watching the orders come in while someone else does all the hard work right? If you’ve been around for a few years you’ll probably know anything that seems like easy money on the internet is a problem waiting to happen! Less work means far less reward and whole host of other issues, but we’ll get to those soon.
In reality, Digital Product Ecommerce tends to be the lowest maintenance of the three different types. Outside of customers being unable to open a zip file (yes … it happens), and people asking for a refund, there’s very little maintenance that you need to do providing the product itself is evergreen.
Meanwhile, drop-shipping (which everyone assumes is the easy option), is probably tied second with Physical Ecommerce (PSE), often to people’s surprise. This is providing you have a PSE store where you:
1) Use a fulfillment center to warehouse and dispatch your goods, and a shopping cart that automates most tasks for you, like sending the orders to that fulfillment center when they come in.
2) Outsource or hire someone for basic customer support and
3) Set up triggers with your suppliers for automatic reordering whenever stock runs low. Again, this is something most modern shopping carts will automate.
You’re likely to spend about the same amount of time maintaining a physical ecommerce store (with fulfillment) as you would with a drop-ship one, so the argument about maintenance becomes redundant.
But you promised ‘hate’ in the title …
Being ‘comparatively not as low maintenance as everyone thinks it is’ is hardly a crime or a reason to loathe drop-ship ecommerce. The maintenance issue was merely making a point that DSE’s biggest perceived benefit actually isn’t that much of a game changer.
My personal vendetta against drop-ship ecommerce is that the business model is seriously flawed. When you sell goods on a drop-ship basis, you will always have the smallest margins in the supply chain. UPS will often make more than you do on a typical transaction.
DSE margins are usually so slim there’s not enough left to run paid traffic campaigns. And love or hate paid traffic, most new buyers soon learn this is the ONLY reliable and consistent way to grow an ecommerce business.
Look at it this way – organic traffic is nice, but difficult when you sell a generic product with the same description as everyone else and very few genuine product reviews. You could start a blog and you will get traffic, but most of that traffic will read the article and bounce. Ecommerce blogs typically have low conversion to sales, even with remarketing. Social marketing works well in niches where people care enough to share their love for the products you sell, but what if that product is a lawnmower … or worse still a pubic hair trimmer? Suddenly, your only source for new customers are those where you have to pay to reach them.
Based on the average conversion in your niche, and the cost to buy one click (which is dictated by the other advertisers who all have bigger margins if they’re supplying direct), the amount you would spend to get a sale usually doesn’t generate enough gross profit to make buying clicks sustainable. I’m sure there are exceptions or sites that convert so well, they buck the trend but you’ll find this isn’t the case for the majority of drop-ship sites that you look at.
This why most drop-ship stores rely on Organic Search traffic.
The owners try paid traffic and quickly give up. But we all know that an ecommerce store without paid traffic is like a goldfish in a shark tank right? Besides never being able to hit scale that matters, you’re stuck in a market dominated by competitors who can and will spend whatever it takes to steal your market share, and you’ll be defenseless to do anything about it.
If that wasn’t bad enough, you might also be competing against your own suppliers, who can offer lower prices if need be and spend more to advertise than you ever could.
In short, DSE is a flawed model that SHOULD never scale. It sometimes does, but it’s usually short-lived. Buy at the wrong time and you’ll be left paying for the seller’s mistakes.
So wait, I should never purchase a drop-ship Store?
Not quite. Drop-ship purchases have been some of the most profitable ones I’ve ever made. The problem comes from purchasing a drop-ship store and leaving it that way, expecting untold riches and a place on the Inc 500.
If you buy DSE, do so with a healthy dose of reality. You could keep it as is, but chances are you’ll find it difficult to grow and scale, and often struggle to just maintain your current position.
A more effective strategy for renovating drop-ship sites is to see it for what it really is – an opportunity to acquire customers cheaply and build a more sustainable system around what is already there.
Take this example
You purchase a store that sells stationery and office supplies to businesses that order online. Currently, they drop-ship directly from the manufacturer and have an average of 100 orders each month. The site generates a profit of $10 on a $100 average order size.
Most of the traffic comes from organic search and the seller has told you PPC is too expensive and doesn’t work. When he tried it, he experienced a conversion rate of 2% and an average cost per click of $0.80
Your first step would be to look at the most popular 20% of products that account for the majority of revenue. In this case, it’s pens, staples and paper. You can order these products directly from the manufacturer in bulk and pay a wholesale rate. On stationery, the margins are significantly higher when you buy wholesale as it’s a commodity item dominated by low cost Turkish and Chinese imports.
Next, you setup an account with a fulfillment provider like Shipwire. They handle all of your warehousing and shipping just for these new products. After Shipwire’s costs have been considered, let’s assume you’re now making an average profit of $70 on each $100 order that you dispatch from the fulfillment centre. All the other long-tail products like lamination machines or laser toners are still drop-shipped as it makes no sense to keep inventory just for the occasional purchase.
Your profit on a sale now averages $60 on a $100 order. This is an average of the majority of products where you earn $70 and few drop shipped items where you still earn $10.
With increased profit per transaction, paid marketing is now back on the table.
Based on the figures above, 100 clicks would cost $80 and generate 2 sales. Previously, this equaled $20 profit (a $60 loss after marketing costs are removed) whereas now, it’s $120 (i.e. a $40 profit after marketing costs). If a campaign works on Google Adwords, then it’s highly likely it will work well with retargeting platforms and paid social too (e.g. Facebook or Twitter Ads), often at a fraction of the acquisition cost of Google.
You now have a system that’s scalable and gives you far more defense against new competitors. You’ve also increased the value of what you purchased several times over before even thinking about recruiting an extra visitor. Any kind of strategy that doesn’t involve the ever-vague “doing SEO” instantly gets my vote.
So on reflection, hate was a little strong.
If you own or you’re thinking of buying an ecommerce store, then you should think twice before diving head first into drop-shipping as a model.
That said, you can turn a negative to your advantage and acquire drop-ship ecommerce sites, providing you intend to change the model, and you’re able to do so quickly.
In Digitally Wed, I go into some depth about how to avoid the type of purchases that appear great on the surface, but deliver mediocre results because of a flawed business model. You can download or order a copy really soon from Flippa – with a special price just for Flippa members. Stay tuned for my next post to get this deal.
E-commerce websites are popular here at Flippa. Wouldn’t it be nice if you could buy a profitable dropshipping site for cheap and travel the world as it earns you a healthy amount every month?
Unless you’re extremely efficient and experienced, it would be hard to replicate the results you hear about from Tim Ferriss and other 4-hour workweek advocates. That doesn’t mean it can’t happen, it just might take some time to get there.
Of course, the entire reason you’re buying an e-commerce site is to get there faster. You don’t have to go through the entire process of setting it up and finding suppliers because someone has already done it for you.
On the other hand, you don’t want to invest a whole lot of money to buy an e-commerce site only to find out that that it doesn’t generate enough money, or that it takes up all your time. So to protect you from making a bad investment, here are five things to look out for when buying an e-commerce website.
You want to make sure that the site you found has a good niche with acceptable demand and low competition.
There are lots of e-commerce sites selling popular electronics, but these are very broad markets and you are competing with thousands of others. Unless the site has some extremely obvious USP (Unique Selling Proposition), this business will end up taking all your time and will force you to drive down profits to compete.
Now, there’s no such thing as the perfect niche, but there are profitable niches around. These niches usually have the same or similar characteristics.
You need to find something that you’re interested in and that you can add value to. This means you have some expertise in your niche and that you’re able to write good content for your site. If the product being sold has multiple components and complex installations, you can add your expertise by creating a free manual to go along with the product, thus giving you an edge over Amazon and allowing you to charge a premium.
Products that are difficult to find at a local brick-and-mortar store, that have a lot of accessories, are small and have low turnovers are usually good products to sell online. Disposable products mean that people will be coming back to your site often and you can build a regular customer base.
When it comes to suppliers, you want to ask yourself a few important questions:
- Are the suppliers any good? Do you want them to stay on?
- Where are they located? Where do they ship?
- Are they wholesalers, manufacturers, or middlemen?
- Are they offering a good wholesale price?
You certainly don’t want to take on a business with unreliable suppliers. If they mess up on orders, not only can that cost you financially, you also have to deal with irate customers, and you don’t want that.
The best way to determine if you want to keep the supplier is to meet with them in person. A face-to-face meeting is always the best way to build trust, and that’s exactly what you’ll need to ensure your store runs smoothly.
You may want to start by creating a few test orders to make sure your supplier is reliable and easy to work with. Also, when starting out with a new supplier, and this applies even if you aren’t buying an established store, you need to set your expectations from the start. Miscommunication is one of the leading causes for problems in business.
3. Website Design and Marketing
Marketing is what brings customers to your site, but design is what convinces them to purchase.
When buying a new site you want to see what it actually looks like. Look at the design with a critical eye and see if it inspires you to buy any product. Click through to see if the shopping cart is user friendly. Poor design means you might have to redesign the site, which might cost, so keep that in mind.
Next, take a look at the site traffic. Specifically, look at the organic traffic, because paid traffic means a further monthly cost, which will reduce your margins. Regular traffic with returning customers is a good sign. Sometimes you might see sellers claiming high average traffic caused primarily due to irregular traffic spikes from some one-off marketing push, but if it drops back to a low level it clearly means people aren’t interested in visiting again. For better performance, remember to keep track of the key metrics for your website.
After that, research the SEO and backlinking work done on the site. Then, use Open Site Explorer to see what work has been done on the site. Remember, poor backlinks means Google will penalize you. Other factors that affect Google rankings are domain age and page rank. Bigger numbers mean better rankings and site quality. Buying a brand new e-store that was set up a week ago won’t give you any added advantage on the marketing front than if you set it up yourself from scratch.
If you’re stuck on this stage, make sure to follow these 12 smart SEO tips to keep you moving forward.
Revenue is all well and good but what matters more is profitability and margins. Low margins means low profits. And if you have to spend money each month on a marketing strategy, you might end up making a loss no matter what your revenue is.
Get detailed income statements from the seller and analyze them yourself. Income statements might sound a bit intimidating, but you should be able to figure them out easily. What you really want to look for are trends over the past five years or so of the business. Are margins rising or falling? What about revenues? Are there any sudden spikes in costs?
5. Sale Price and Valuation
After having gone through the previous steps, if you have determined that this is indeed a good business, with strong financials, you will want to figure out if the seller is selling the site for a premium or a discount.
This is where the concept of multiples comes into play. Sellers will obviously try to sell the site for a premium, claiming that they invested so much in design and marketing. However, you need to figure out whether it is worth it for you, regardless of the investments the previous owner made.
Usually, multiples for an e-commerce business would be in the 1x to 3x range. That means the sale price of the store would be 1 to 3 times the yearly profit. Of course, this isn’t taking into account all the other factors previously mentioned. At the end of the day, each business is different. If you feel like you can take the site and increase sales and profitability, you might want to seriously consider anything less than a 2x multiple.
Buying an e-commerce store has some obvious advantages over starting from scratch. To begin with, it’s already an established business with a website, suppliers and customers so that saves a lot of work right off the bat. However, in some cases, it just might make more sense to start one from scratch if an existing business seems to have too many problems. It really all depends on how much time you’re willing to spend on the site and how much money you have to set aside for it.
Have you bought any e-commerce websites lately? What are your tips and thoughts? Please share your experiences in the comments…
P.S. Did you like this article? Make sure to check out 5 Simple Rules for Running E-commerce Sites.
Photo credit: VintageDept