Friday, May 18, 2012

E-Commerce for Dummies Part 2: The Buck Doesn't Stop Here

This is the second of three ideas for my online e-commerce “lecture” (about 700 words).
Curio City’s gross sales look like a decent living wage. Alas, I can only pocket a fraction of them; most of my revenue enriches other people. (Regular readers might recognize this topic from when I rejected becoming an Amazon seller.) So who got how much of every dollar that came in last year?

$0.495 buys the stock, including inbound freight and some other fiddly little things that constitute “Cost of Goods Sold”, or COGS. “Keystone” is the rule in retail, and it simply means doubling your cost: Paying more than 50% of retail is bad and paying less than 50% is good. Some things (like clothing) are marked up by as much as 400% to a benchmark price that only the ignorant and affluent ever really pay, then sold at semi-permanent discounts that still deliver bloated margins (the difference between cost and selling price). This deceptive pricing technique is so common that Massachusetts requires retailers to occasionally display clothing at its nominal retail price to justify calling it “regular price.” Other things (like books) deliver margins as low as 20%. Retailers can affect this cost by sourcing their merchandise and setting prices…but 50% is the general goal.

Rent would typically be a merchant's second-largest expense. As a home business, I only have to rent a UPS Store box and web server space, which fit comfortably into "miscellaneous". One could ascribe a percentage of our mortgage payment to a business expense – that is, if Curio City takes up 25% of our house, then 25% of our mortgage could be considered business rent. But for this discussion let’s just simplify “rent” to zero.

$0.20 goes into my pocket and another $0.032 goes to federal and state payroll taxes. If I had to offer basic employee benefits, payroll and associated expenses would rise to about 30 cents from each dollar.

Shipping costs would come next if shipping fees didn't cancel them out. Small shippers (fewer than 200,000 parcels a year; Curio City ships about 1,500) pay the same retail rates to UPS and USPS that you pay. Medium-sized shippers hire freight consolidators who pass along their volume discounts but charge their clients for warehousing and labor; ideally, the discounted postage plus service fees are roughly the same as small shippers pay to do it ourselves. The biggest players, of course, get very attractive bulk rates that enable them to offer free shipping. Anyway, Curio City spends almost exactly 14 cents per dollar on postage, but I’m treating it as another zero for this expense breakdown.

$0.119 goes to advertising. It would be nice if sales rose and fell predictably with advertising outlays, but they do not. This line item is chronically over budget, and cutting it without harming sales is an ongoing challenge -- I’d like it to run under 10%. Google AdWords gets about three quarters of this money, with Microsoft AdSense taking the rest.

Debt payments are another potential budget-buster that varies according to each company's circumstances. I started Curio City with my own money and then grew it slowly from its own revenues (called "bootstrapping"). Being debt-free is obviously good from a cash flow standpoint -- and remember from my previous post that cash flow miscalculations are the most frequent cause of business failure. Loan payments are non-negotiable costs that (along with rent) often kill companies whose revenues don't meet expectations. I could easily invest $10,000 or $15,000 in improvements (a website redesign, new merchandise, and some contracted marketing services) that would probably kick sales up by five or 10 percent. I could borrow that much from the credit cards that cover my operating expenses. But if the additional revenue that I project doesn't materialize, or if sales fizzle from uncontrollable circumstances like another global recession, I'd have a new monthly demand on my already-fragile cash flow. Being a debt-averse person by nature, I've kept debt to zero. The tradeoff for staying debt-free, of course, is lack of capital for expansion. Most companies borrow enough money to reach their expected potential all at once. The impact of debt service on their balance sheets depends on how much they borrowed as a percentage of their income. Listing it here, after advertising, is arbitrary, but probably accurate for most small businesses.     
$0.063 goes into discounting – markdowns, coupons, quantity discounts, and Customer Rewards. This is one cost over which I have almost complete control. 

Bricks-and-mortar retailers have to budget 2-5% to cover shoplifting and damages (“shrink”). That’s another expense that e-tailers escape almost entirely. The lost and damaged shipments that impart a small amount of shrink fit within "miscellaneous".

$0.042 goes to PayPal, Google Checkout, and credit card processing. Large enterprises pay lower rates, and the largest of all do their own in-house payment processing. But for the small players, bankers take a cut right off the top of every dollar.
That leaves $0.055 to cover everything else – office supplies, shipping supplies, licenses, taxes and fees, professional services, Internet access, telephone, etc. Last year those miscellaneous expenses ate up $0.013, leaving 4.2 cents for profit. An S Corporation’s profit is owned entirely by its shareholders, who pay the income taxes on it. As the sole shareholder, I pay myself 75% of it as a year-end bonus and let the company keep the rest, but I have to pay taxes on the whole thing.
To summarize, one dollar breaks down like this:

•    0.495 to vendors
•    0.232 to me and the government
•    0.119 to marketing, mostly Google
•    0.057 to discounts
•    0.042 to banks
•    0.013 for miscellaneous
•    0.042 for profit (shareholders, a.k.a. me)

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