E-commerce winners will focus on customer retention
E-commerce has exploded over the past 5–10 years. Global retail e-commerce sales hit $2.3 trillion in 2017, up from $1.3 trillion just three years earlier (link). Some $64 billion of venture capital was invested in the e-commerce space in 2013–2017 (link). This has led to an explosion in the number of e-commerce businesses competing for customers. Shopify, a leading e-commerce platform provider for small businesses, powers more than 500,000 online shops (link). Magento and WooCommerce, two other large providers, support hundreds of thousands of e-commerce sites each.
Despite this boom, there are rather few winners in online retail. Amazon, by far the biggest player, captured 44% of e-commerce spend in the US in 2017, up from 38% the year before (link). It also captures more than half of all online spend growth in the US (link). Meanwhile, e-commerce exits (IPO or sale) of VC backed private companies are declining (link), suggesting many e-commerce business models are hard to sustain in the long run. A likely reason is that too many companies are relying on online marketing spend to drive sales. However, the cost of advertising has risen significantly in the past few years, which puts pressure on margins and unit economics. This is in contrast with e-commerce winners, who have built their business around customer retention.
Customer retention is a neglected growth engine
About every marketer I have spoken to over the past few years has complained about the rise in marketing costs. This is a general trend across both business-to-consumer (B2C) and business-to-business (B2B) companies. A survey ran on 743 business shows that they saw an average increase of around 65% in customer acquisition costs over the last 5 years.
Source: Tomasz Tunguz
However, looking at the average cost of acquisition hides the differences between the winners and the rest. In B2B it’s been long established that retaining customers and growing them is a lot cheaper than acquiring them. forEntreprenerus’ 2017 SaaS survey showed that the median cost of acquiring a dollar revenue was $1.15 for new customers. This means SaaS businesses lose money on customers in the first year, and only turn a profit if the customer renews. Growing and retaining customers, on the other hand, is a lot more cost-efficient. Getting an additional dollar of revenue cost half of that, or $0.57 when upselling an existing customer, that is, selling additional or more expensive products to them. Growing existing accounts through more usage was even less expensive, at $0.30 and retaining customers was the cheapest way to grow revenue, at just $0.15 for every dollar of revenue. Acquiring customers is crucial to expanding the customer base, but this data shows it is the most expensive way to grow revenue.
There is no comparable survey for B2C businesses that I am aware of, but there is little reason why it would be any different in e-commerce. Getting someone new to buy your products is a lot harder than getting a satisfied customer to buy yet another one. Easier directly translates into cheaper. Applying the data from B2B to e-commerce, we would expect the marketing cost to go down with subsequent purchases.
A lot of e-commerce businesses focus on acquisition and underinvest in customer retention and growth. This eventually holds back their growth and really the long-term sustainability of their business models. The three most common KPIs for e-commerce marketers tend to be traffic, conversion rate, and sales. There is nothing related to customer retention or growth. This is where the winners in the market take a different approach. A great example is Jeff Bezos’ letter to Amazon shareholders from very early days in 1997. In his note, he did not discuss total sales or traffic, but instead, he focused on customer retention: “the percentage of orders from repeat customers grew from over 46% in the fourth quarter of 1996 to over 58% in the same period in 1997.”
Marketing spend as a competitive disadvantage
A simple measure of how good a company is at retaining and growing its customers is their marketing spend as a share of revenue. Companies that focus on acquisition will have higher marketing spend, as the cost of acquisition is higher than the cost of retention and customer growth. We can look at select public companies to understand how much this metric varies across businesses.
Source: 2016 company annual reports
The data strongly suggests that Amazon, ASOS, Wayfair and JD.com are the best at retaining and growing their customers. It might be easy to dismiss their low marketing spend with the argument that these are well-known brands with large customer bases. Many e-commerce businesses believe that high marketing spend can be justified by high growth. However, the story of Amazon proves that marketing spend is not a prerequisite for growth. Amazon has been growing steadily over the past 15–20 years while maintaining just a 2–5% marketing spend as a share of revenue. Even in the early years of hypergrowth, Amazon was spending just 10–17% of their revenue on marketing.
Source: Amazon annual reports. Figures are totals, incl. AWS, Amazon Prime and other services.
A vast majority of e-commerce businesses are still private, so it is hard to examine broader industry data. However, my experience suggests it is not unusual for e-commerce businesses to spend 20–25% of revenue on marketing, in line with the likes of Blue Apron, Etsy, or Hello Fresh. This puts them at a huge disadvantage compared to businesses that spend less on marketing. If a business is spending 20% of its revenue on marketing, it means Amazon can offer the same product for 15% less while making the same margin. This puts the business at a huge competitive disadvantage and threatens the long-term sustainability of its model.
How to build a sustainable e-commerce business
A lot of e-commerce businesses have been investing heavily in marketing technology, which has led to an explosion in the offering. The Martech Lumascape now counts over 6,000 companies offering software solutions to marketers. However, technology providers are unlikely to solve this problem. Building a business centred around customer retention and growth requires a thorough examination of the product proposition and an organizational alignment. There are three key areas an e-commerce business needs to address:
Product offering: Your product offering needs to be such that your customers can shop regularly. People don’t buy curtains, luxury watches, or mattresses often enough to be repeat customers. If people can’t shop regularly, they will not be loyal. You don’t necessarily need a wide inventory, but one that is purchased often enough. People don’t buy furniture frequently enough, so IKEA sells other household items through its marketplace. Dollar Shave Club has limited inventory, but men buy razors about monthly.
Customer proposition: The right inventory is a prerequisite for customer retention, but e-commerce is extremely competitive. Customers need more reasons to keep coming back. Amazon has a Prime membership, ASOS offers the widest inventory of fashion at the lowest prices, and Dollar Shave Club offers subscriptions that take a big hassle out of life. You need to ask, “Why should a customer come back?”
Organizational goals: Goals and KPIs drive the priorities of an organization. You need to track, measure, and set goals around customer retention and growth. Traditional metrics such as traffic, conversion rate, and total sales are inadequate. Some better alternatives to explore would be i) the share of purchases that come from repeat customers ii) three or six-month customer value iii) the share of first-time customers that make a second or even third order iv) the total number of customers who made a repeat purchase in the last month.
Disclaimer: The opinions expressed in this article are my own and do not necessarily reflect those of my employer. This article is not based on any confidential data.
