Friday, June 22, 2012

E-Commerce for Dummies Part 2 Q&A

…In which I just “phone it in” for another week. During the high summer I'm just too busy with real life to do more than caretaker work for Curio City.
These questions refer to this post.

Q: Based on how the dollar is broken up within an e-business. What is the most vital mistake one can make, in regards to finances when starting an e-business? What were the obstacles that you encountered when you first started up Curio City? How did you dissect the issues and find solutions?

A: The biggest danger is to overextend yourself based on optimistic projections. It’s tempting to spend as much as you can afford on as many products as possible in the belief that you’ll turn them over before the bills come due. But it takes time for a new business to attain its expected turn rate. (Turn rate = the number of times in a year that your inventory turns over: If $20,000 worth of stock produces $60,000 in sales, your turn rate is three…which, btw, is at the low end of acceptable.) If you don’t attain the turns that you expect, you’ll tie up inventory dollars in merchandise that’s just trickling out. I’ve said before that cash flow is the lifeblood of a business. Think of your inventory as a pile of frozen cash. Eighty percent of your sales are going to come from 20% of your merchandise, and only experience will teach you which products are in that magic 20%. Until you learn, don’t push your budget to the edge. Keep a cash cushion.

On a closely related note, don’t think that if you build it, they will come. Have a marketing plan in place before you turn your cash into inventory and infrastructure. Marketing is one area where you do want to max out your budget, and your budget needs to be bigger than you would probably like it to be (I initially planned to spend 5% on advertising). Undervaluing marketing was my single biggest mistake.

Finally, don’t count on drawing a reliable paycheck from your new business right away. You might have to skip a check now and then to pay the bills. Start your payroll budget as low as you can get away with and raise it as you gain experience and confidence. (Obviously, that’s hard to do if you have employees.) Have some personal savings or a spouse’s income that you can fall back upon.

Obstacles? Getting noticed! Having awesome products at great prices gets you nowhere if nobody knows about them. Yup, marketing again. The solution, inasmuch as I ever found one, was to read up on basic principles of pay-per-click advertising and search engine optimization. Today, social media marketing might play an equal role.

Q: How do you manage to sustain your profit margin? Which are the strategies to increase profit margin in spite of increasing operating and other costs?

A: Buy low and sell high. :) Seriously, you want to mark your products up to the highest price the marketplace will accept, and reduce your controllable costs as much as possible.

Look for products with better markups than keystone, because you’re going to end up taking a loss on some portion of your inventory. My overall margin is 50.5%. Most of my bestsellers deliver higher margins. The Mini-Briefcase is marked up 53% and the optional gift bag that you can get with it carries a 64% markup. Panther Vision cap margins range from 49-55%, and the optional batteries that one can add are marked up 66% (wholesale batteries are ridiculously cheap, btw; profits are high in the battery business). The 80% of my stock that sells slowly (or not at all) brings the average down as I discount it to clear it out. Keeping that average markup above keystone is mostly about wise product selection and appealing presentation. You can sometimes gain a couple of extra margin points by taking advantage of special offers from vendors, buying closeout merchandise, etc.

Many of my costs are scalable – they rise and fall with sales. Payment processing is a percentage of sales. So is payroll (as long as you’re the only employee, that is; hired help won’t regard their paychecks as flexible). Advertising doesn’t scale, but it’s at least partially controllable. I try not to spend more than 50% of net sales on merchandise each month, which is a very crude and simple way of calculating an open-to-buy budget. Finally, almost everything that I spend goes on two credit cards – an Amex for operating expenses and a Mastercard for inventory. I am fanatical about paying them both off in full every month, but in a cash flow emergency I would be able to carry a balance, effectively writing myself a high-interest loan. Of course, credit card interest would quickly eat into my already thin profit margin, so that’s a last resort.

Q: I've got a few questions on this lecture, one of which is just a point of clarification: You write that $0.23 goes to you and to taxes, and that $0.04 goes to profit. Does that mean that the $0.23 is your salary (in a sense), and that that is the money you earn to pay yourself for your labor, and then the profit is gravy?

The other question: I know you decided to bootstrap the business, but would you ever consider using credit to expand the business? I ask because I was told in a financial management class that credit is the lifeblood of growth. That said, some very successful companies have bootstrapped themselves (CSN stores, for example). Why or why not? How do you see the future of your business?

Also, how long did it take you to become profitable? What were some of the early impediments to profitability?

A: $0.20 is my salary and $0.03 is payroll tax. Profit is indeed gravy – whatever’s left after all expenses are paid. Assuming that there is a profit, Kraken Enterprises pays me a nice Christmas bonus at the end of the year, as the law stipulates that S Corporations must do. Incidentally, corporate profit distributions are not subject to payroll taxes (although they are taxed as ordinary income – it’s not a Romney-scale tax dodge). From a tax perspective, it would make sense to minimize my paychecks to plump up that end-of-year bonus. But the IRS stipulates that corporate officers must take a “reasonable” salary. Guess who decides what’s reasonable?

Being extremely debt-averse, I would only use credit if I was certain that the investment would yield more than enough new income to cover the debt. I’d also have to make sure that I wasn’t personally liable for my business’s debt – business credit cards require personal indemnification, and banks require collateral. People think that being a corporation insulates you from personal liability, but that’s not quite true.

Credit is certainly crucial if you want to hang out with the big dogs. That’s never been my objective for Kraken Enterprises. I want it to provide me with a reliable living until I retire, and then be attractive enough to sell. It needs to double its current size to do that – challenging, yes, but not high finance.
I recently identified $15,000 worth of improvements that might kickstart double-digit growth again and I have not completely ruled out borrowing that much. But, like everyone else, I’d like more confidence that the economy’s not headed back into the crapper before I roll the dice. 

It took two years to show my first profit. The chief impediment was my own cluelessness about online retailing in general and the direction of Curio City in particular. 

Q: I was intrigued by the link in the first section of your lecture regarding rejecting becoming an Amazon seller. The link unfortunately didn't lead to a post so I was unable to further research that particular topic. I'm curious as to why you rejected becoming an Amazon seller and if it had anything to do with the amount of money it would take off your profitability. The organization I work for recently became an Amazon seller in order to expand their offerings through the Amazon Marketplace. So far it has paid off really well for us. We are a much larger corporation than Curio City and have the capital to take on the added costs associated with becoming an Amazon seller but I can see how this could be a risky move for a smaller, personally run business like yours. Could you expand some more on your choice here?

A: Sorry for the bad link. Here’s the first time I rejected the idea, and here’s the second.  Bonus: Internet Retailer magazine’s take on it.

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