Bear! June 18, 2017 Snippets
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Four years ago, Andy Dunn — founder and CEO of Bonobos, the men’s apparel brand and e-commerce business — wrote a blog post about bears:
E-commerce is a bear | Andy Dunn, Bonobos (Spoiler: Amazon is the bear)
Andy walks us through a handful of strategies for anyone attempting to compete in e-commerce with the bear — proprietary pricing (flash sale businesses like Fab, One King’s Lane), proprietary selection (Modcloth, Nastygal), proprietary experience (Birchbox, Rent the Runway) and proprietary merchandise (Warby Parker, Bonobos). But then we get to the really frightening part of the post where he breaks down why e-commerce, so promising at the beginning, turns out to be an awful grind of a business:
“The entire e-commerce P&L is architected to make it almost impossible for you to generate EBITDA. Between gross revenue and net revenue, you typically have a meaningful returns line item. Then to get to your gross margin, you either are selling other brands which is a tough and thinner margin business or you are building your own vertical brand, where the margin can be terrific at scale but is offset in the early innings by increased team and marketing costs to generate that brand. Either way, after subtracting cost of goods sold, you’re now at gross margin dollars. Right? Wrong. At a traditional retailer, you’d be at gross margin. At a standalone e-commerce company, you’re only at what we call product margin, because you have to net out your (often meaningful) free shipping incentive to your customers to get to gross margin. Increasingly this is free shipping one or both ways.
Your gross margin isn’t really your contribution margin. You’ve got a host of variable to semi-variable SG&A expenses that are fundamental to doing e-commerce that are typically accounted for in SG&A. The cost of photography, merchant processing fees, customer service (being good at this is price of entry in e-commerce these days), and the non-freight cost of fulfillment, either through your own warehouse or a third-party logistics provider. Now it’s time to subtract your marketing spend to get to your true contribution margin.
Gross Revenue — Returns = Net Revenue — COGS = Product Margin — Free Shipping = Gross Margin — Customer Service — Merchant Processing Fees — Photography — Non-Shipping Costs of Fulfillment — E-commerce Operations = Sort of contribution margin — Marketing & Promotions = True Contribution Margin.
Okay, now you’re at true contribution margin. To make money this contribution margin has to more than cover the cost of your payroll. And your team is expensive, because you have three teams: a brand team, a service team, and a technology team. You’re building not just a merchandising engine, but a distribution channel as well. If you want to really make money doing this, the ticker you need is AMZN. Even at a huge scale, people will accuse you of not being that profitable.”
What’s happening here is yet another excellent illustration of The Red Queen Effect: “When everyone is special, no one is.” When you decide to pursue a differentiator — say high-quality photography, or free returns — then consumers may love you for it. They may give you your business because of it. But others will copy you and one-up you. They, too, will institute a free return policy. They, too, will hire professional photographers. Now you’re no longer differentiated, but you’re still stuck with the expense, and you can’t get rid of it because consumers expect it now. You can’t go back. You become saddled with ever more obligations that sit between your gross revenue and your contribution margin, which once upon a time weren’t a cost of doing business. And here you are thinking, “I thought the Internet was supposed to make things cheaper!” Well, it did. Just not for you.
This past Friday morning, four years since Andy’s post, the bear ate Whole Foods and everyone cheered. (Shortly thereafter, everyone went and listened to Scott Galloway’s interview with Recode that took place days before, in which he muses on that very acquisition.) In that four year time span, most of the e-commerce examples in Andy’s post — Gilt, Fab, One King’s Lane, Nastygal — are either gone or sold for spare parts. Warby Parker and Rent the Runway seem to be the only ones doing well on their own, along a few other successes in the meantime (Dollar Shave Club and Chewy in particular) with happy outcomes. The e-commerce industry is getting boiled down to a cruel calculus: When you do it, it’s a differentiator. When everyone does it, it’s a cost. And when Amazon does it, it’s a revenue stream.
But what about Bonobos, Andy’s own attempt to carve out a defensible business of his own? Within five minutes of the Whole Foods news drop, Walmart announced they were acquiring Bonobos for $310 million, or approximately 2x their 2017 projected revenue. On an ordinary day, it might have commanded a few more minutes of the news cycle. But not on Friday. Friday belonged to the bear.
Probably worth reading again right now:
Amazon’s antitrust paradox | Lisa M Kahn, Yale Law Journal
Why Amazon is eating the world | Zach Kanter, Techcrunch
Stevey’s Platforms Rant (the famous post by the former Amazon engineer) | Steve Yegge *Note: if you haven’t read this yet and want to understand what makes Amazon tick, this is the absolute best place to start.
Tokens or not?
Optimal token sales | Albert Wenger
Why OpenBazaar Token doesn’t exist | openbazaar.org
The token frenzy and its impact on venture capital thinking | beautyon
Leadership:
Yahoo’s legacy for me | Marissa Mayer
Decisions: what makes someone have “impact”, anyway? | Camille Fournier
The Warriors have broken basketball. Time for a new super team | The Economist
Mind-bending discoveries:
Fractal planting patterns yield optimal harvests | Lansing et al., Phys.org and PNAS
Black holes, cosmic collisions and the rippling of spacetime | Katie Mack, Scientific American
The persistence of prog rock | Kelefa Sanneh, The New Yorker
In memory:
Other reading from around the Internet:
WWDC 2017 — some thoughts | Steve Sinofsky
Screenshots, shots, shots shots shots shots | M.G. Siegler
What’s next in the Sales Enablement industry | Myk Pono, Openview
Netflix is now bigger than cable TV | Ian Morris, Forbes
This is why infrastructure is so expensive | Charles Morgan, Strong Towns
In this week’s news and notes from the Social Capital family, congratulations to Saildrone for being named among Inc.com’s top 25 disruptive companies, and it’s not hard to see why:
The most exciting drones aren’t in the air — they’re in the ocean | Will Yakowicz, Inc
Ever since we announcing our Series A investment in Saildrone last year, Saildrone has been a company that attracts a disproportionate share of questions — which we’re always delighted to field. There are many different ways to look at Saildrone — as an ocean bound robots company, as a climate change initiative, or perhaps even as a data services platform for products like weather, insurance, food, energy, or even drug policing. In Inc’s profile, we hear about one particular application of this data: monitoring Alaskan fish stocks and the ocean variables that affect them:
“The company’s data-as-a-service program charges $2500 a day, and customers currently include commercial fisheries, the National Oceanic and Atmospheric Administration, the US Coast Guard, and the Department of Homeland Security. (Saildrone’s boats can also report to the DHS and the Coast Guard when they find narco-subs or boats smuggling drugs.) Eventually, Jenkins says, Saildrone could have enough drone boats to be able to predict the world’s weather with more precision than traditional satellites — something that private companies in shipping, oil, and plenty of other industries would surely want.
Jessica Cross, an oceanographer at the NOAA, is one of the three principal investigators using the Saildrone (and other technologies) to study how the Arctic Ocean is absorbing carbon dioxide and how that affects fish populations, the food chain, and subsistence and commercial fisheries. She says about 60 percent of the world’s commercial fishing is done in Alaska, which means the fish in these waters contribute to food security everywhere.
“We are collecting the best data we can to help us answer the critical questions,” says Cross. Among these questions, she includes, “What impacts do changes in the Arctic have on the large-scale climate and weather systems?” and “Will physical changes in the Arctic affect ecosystems that commercial and subsistence fisheries depend on?”
What’s so interesting about this platform approach is that boats can be deployed to collect data for many different projects at once: at first they might be used for single-purpose applications, but as production ramps up we’ll soon see a blanket of autonomous boats cover first specific areas, and then entire oceans. They’re well on their way making progress towards the Saildrone mission: to create the highest resolution ocean data set in the world and use it to make global processes such as weather forecasting, carbon cycling, global fishing and climate changes more predictable, visible and actionable. They’re truly a team that would rather let the results speak for themselves, so if you want to find out more about what they’re doing the best way to do so is to reach out directly. Even better, you might even consider joining the team — they’re currently hiring for a business development manager, infrastructure engineer, lead mobile engineer, ocean sensor technician, and office manager — all in Alameda. Otherwise, you can always just hang out near San Francisco Bay — or the Alaskan sea — and keep an eye out for something red out on the water.
Have a great week,
Alex & the team from Social Capital
