Following the money trail
Web retailers are doing well at growing the top and bottom line.
By Mark Brohan
Having survived a recession, the dot-com investment meltdown and, more recently, iffy consumer confidence brought on by high gasoline prices, web retailers are a confident bunch. They’re also pretty savvy entrepreneurs and business entities running growing—and profitable—online retailing operations, according to Internet Retailer’s latest survey.
The latest Internet Retailer survey—this one on current business operations and profitability—reveals that most retailers taking part in the survey are established, profitable for at least the last two years and expect robust sales growth, with 40% anticipating growth of 30% over 2005. But chain retailers, catalogers, virtual merchants and consumer brand manufacturers of all sizes are keeping a close eye on the bottom line, with 39.5% of all companies ready to reduce expenses, including their marketing, fulfillment and general overhead, to sustain profitability.
Private and profitable
The survey was e-mailed in early May to all subscribers of IRNewsLink, the magazine’s newsletter, and more than 200 responses were collected and analyzed using technology from WebSurveyor Corp., which has partnered with Internet Retailer in a series of surveys on the e-retailing industry. The results demonstrate that most participating companies, 87.5%, are privately held and have been in business for at least two years. 79% established their web retailing operations 4 to 9 years ago, compared with 7% in business for a decade or longer and only 4.5% just starting out.
The survey also reveals that web retailers across the board are bullish on their current and future business prospects. For starters, the great majority of participating companies, 79%, are profitable. Among all companies, 50.5% of virtual merchants have been profitable for 3 to 6 years, followed by 44.3% of chain retailers’ web operations, 28.1% of catalogers’ web operations and 20% of consumer brand manufacturers.
Not surprisingly, catalog companies, among the first wave of direct marketers to embrace business-to-consumer e-commerce in the 1990s, reported the longest period of profitability. 57.4% have been operating web sites in the black for more than 6 years, followed by consumer brand manufacturers at 25%, virtual merchants at 17.9% and chain retailers at 6.7%. Among companies that aren’t yet profitable, most aren’t anticipating a long wait—80% expect to be in the black in less than 2 years.
Great expectations
Running a profitable business for the long haul means that web merchants are connecting with customers by employing the right mix of merchandising, pricing and site experience while keeping their expenses in check. And because they are established operators with a good mix of new and repeat customers, the retailing organizations taking part in Internet Retailer’s latest survey expect to finish the year with solid gains in both sales and net income. A total of 40% expect annual sales to grow by more than 30% versus 47.5% at between 10% and 30% and just 12.5% that anticipate a yearly gain of below 10%. Consumer brand manufacturers, the group usually lagging the others, are the most bullish, with 45.5% expecting sales to grow in excess of 30% in 2006, followed by web-only merchants at 42.6%, chain retailers at 40% and catalogers at 17.6%.
Manufacturers also are confident that their direct-to-consumer web operations will deliver solid bottom line operating results. Overall 34% of all companies expect their net income to grow by more than 25%, while 39.9% anticipate gains in net income from 6% to 25%, and 26% believe they will end the year with net income up between 1% and 5%. But manufacturers are even more bullish on posting a big jump in net income, with 44% expecting an increase of more than 25%, compared with 36% of virtual merchants and 33.3% of chain retailers.
An even keel
In the run-up to the dot-com investment crash, many web retailers abandoned the bottom line in favor of spending lavish amounts on building their brands and acquiring customers. But today most established web retailers are operating on an even financial keel and keeping a watchful eye on growing their businesses while controlling expenses. For instance, web merchants taking part in the polling feel good about their gross margin, defined for the survey as revenue minus the cost of goods, and their operating margin, revenue minus cost of goods and all SG&A expenses. The survey found that 47% of participating companies believe their gross margin will increase by more than 35% this year, while 46% expect more moderate growth of 15% to 34%, and 6.1% below 15%.
A bigger gross margin is a key indicator of a healthy balance sheet because it shows how good a job a retailer is doing in controlling inventory and acquisition costs. Likewise higher operating income demonstrates how successfully a web retailing company is at operating its core business. 28% of all survey participants anticipate having operating income at least 15% higher this year over last. Consumer brand manufacturers are the most optimistic, with 47.6% anticipating a jump in their operating income of above 15%. That compares with 26.2% for web-only merchants, 25% for catalog companies and 22.9% for store merchants.
To ensure ongoing profitability, web retailers across the board are keeping a tighter lid on their key expenses, including marketing and fulfillment. When accounting for general and administrative expenses, 42.8% of all companies report that their general and office overhead costs represent 11% and 25% of total sales. Interestingly, almost 5% report very substantial general and administrative expenses, with those costs accounting for more than 25% of total sales.
Early on, many start-up retailers may spend an inordinate amount of their sales dollars on marketing and advertising as they look to catch on in their segment and build their brand over time. But the latest Internet Retailer survey shows that only 4.1% of all companies earmark more than 25% of all sales for spending on marketing and advertising. Most companies spent well under 25%, with 7.7% spending less than 1%, 18% between 2% and 3%, 19.9% between 4% and 5%, 28.1% from 6% to 10%, and 21.9% from 11% to 25%. A total of 46% of catalogers devoted 6% to 10% of sales to marketing and advertising, followed by manufacturers at 31.8%, virtual merchants at 27.8%, and chain retailers with 20%.
Skin game
Most web retailers taking part in the survey are primarily self-funded. Though there have been some very high profile initial public stock offerings in the past year, including Harry and David Holdings Inc. and BabyUniverse Inc., only 1% of survey respondents raised money with the proceeds of an IPO. Of all respondents, 54% are current owners who use their own money in addition to revenue generated by the business to support growth. Another 21.4% used additional capital from a short or longer-term bank loan to sustain operations in addition to incoming revenue and 1.5% relied on venture capital money.
With most of their own skin in the game, most retail companies in the survey say they won’t have to trim expenses going forward to hit profit and loss targets—60.5% have no intention of cutting costs to boost profits vs. 39.5% who will. But even in times of fast growth—the web remains the retail industry’s fastest growing channel—web merchants are keeping a close eye on both the top and bottom lines. And if they do cut expenses, their first reduction will come in general and administrative overhead. The Internet Retailer survey reveals 19.9% would first reduce their administrative overhead, followed by marketing and advertising, fulfillment and distribution and technology.
The biggest area all respondents say they would cut first is general and administrative overhead which typically includes spending on rent, office supplies, communications and other business operating expenses. Consumer brand manufacturers are the most likely to reduce general and administrative expenses first, according to the Internet Retailer survey. Next in line are catalogers, virtual merchants and chain retailers. 31.8% of manufacturers indicate that they would cut their administrative overhead to sustain profits, followed by catalogers at 29.4%, virtual merchants at 17.5% and chain retailers at 17.1%
Marketing and advertising is another area ripe for budget cutting. Most web retailers use a mix of affiliate, e-mail and search engine marketing to build their brand, attract new customers and retain existing ones. But with the high cost of search engine marketing brought about by increasing keyword bids, some web merchants are looking to cut back.
The survey found that catalogers were most likely to reduce their spending on marketing and advertising while consumer brand manufacturers were far less inclined to trim any marketing-related expenditure. 29.4% of catalog companies said marketing and advertising spending would be subject to cost-cutting, compared with 17.5% of virtual merchants, 8.6% of chain retailers and just 4.5% of consumer brand manufacturers.
Sacrosanct technology
Not surprisingly one of the budget areas that accounts for a typical web retailer’s highest fixed operating costs—technology—is also the least likely expense to be trimmed. E-commerce technology is expensive. Retailers’ e-commerce systems budgets range from $300,000 to $3 million per year, depending on the size of the company and the order processing volume, says Jupiter Research. It’s also not uncommon for a small web merchant to pay as much as $100,000 per year for a typical third-party e-commerce platform.
But having the right technology base is crucial to sustaining an online business and meeting customer expectations. The Internet Retailer survey finds that technology is the least likely area to be targeted for a budget cut. Only 5.9% of catalogers would cut back technology spending to preserve profits, compared with 8.6% of chain retailers, 9.1% of consumer brand manufacturers and 10.3% of virtual merchants.
mark@verticalwebmedia.com
