e-Commerce startups fail at an alarming rate. I think in the last decade I know about 15 e-commerce startups that have gone burst. Most didn’t survive two years, and the rest quit after four gruelling years. Even our two darlings Jumia and Konga are not doing too well. Konga was sold at a loss, and Jumia group is using revenue from other subsidiaries to cover up what everyone knows – e-commerce startups in Nigeria are struggling.
If you go online, search “why e-commerce startups fail”, here are the top 10 reasons you will find. But do they really explain the problem with e-commerce in Nigeria?
- Poor online marketing
- Lack of online search visibility
- Little to no market for their products or services
- Running out of cash
- Price and costing issues
- Got outcompeted
- Retail giants dominating a large share of the market
- Lack customer service
- Poor team around them
- Product mistiming
Source – https://ecommercenews.eu/10-reasons-why-ecommerce-startups-fail/
To be clear, these are valid reasons for failure, and if you think about it, those reasons apply to every startup, not just e-commerce. But there is something unique about e-commerce that most people don’t see.
And you won’t see it unless you have actually run a brick and mortar retail store. If you have ever owned a shop, then you know where I am going.
It is not a big secret. It is simple. Here it is.
Your margin on every product sold is so small, you need to sell a lot of it for the business to make sense.
AND YOU MUST MAINTAIN SALES VOLUME WHILE keep your costs down.
It is why the supermarket in your area cannot afford to pay the checkout lady a proper salary even if it appears business is doing great and there is always a crowd when you go in. It is not because the owner is stingy, it is just the economics of the retail business. I know this, because growing up, my mom had three retail stores, and I was in charge of 1.
At that time, I didn’t know fancy financials, but I knew profit. I knew we made more profit from pure water than from the big boy that spends 6,000 on provisions (This was in the mid 1990s, 6,000 Naira on provisions was a big boy. For context, Coke was 20 Naira).
Sometimes we had a really good day, the cash drawer was full, but when we sat down to calculate our profit, by removing the cost of replacing each sold item, what we were left with was not exciting. Believe me when I say, it takes an immense amount of discipline to run a retail store.
So let’s go back to e-commerce, and why this insight matters. An e-commerce startup is not all online. The “e” in “e-commerce” is just 10%. The remaining 90% is gruelling operational offline work. Which makes it subject to the same economics as a retail store. But before I go on, there are two kinds of e-commerce.
There is the kind where you offer a platform for merchants to sell to consumers. You do not actually own any of the items. This is your 2-sided marketplace. Jumia and Konga are here.
And there is the kind where you sell your own items, there are no other merchants. It is simply you selling to your customers. This is not a market place, it is the online version of your retail store. The few supermarkets with online stores are here.
The two are very different in business models with different cost structures and revenue model, and I would revisit this later. However, irrespective of which one, you all make money off the difference between the actual cost of the product and the price you sell at. And this brings me to a more fancy term called Operating Income.
Operating Income = Total Sales – Cost of Goods, Logistics and Salaries
It is not a scary equation. Terms like total sales, cost of goods, logistics, salaries; are familiar to us.
When operating income is positive, we say the business is able to generate profit from its normal business operations of buying goods, selling it, and paying employee salaries. A positive operating income means the business works. The business generates enough income to cover day to day operations and still have extra to cover taxes and other expenses like buying a new generator or freezer.
When operating income is zero, we say the business is at break-even. The business is certainly not profitable overall (since this business will still need to pay taxes), but at least it can now cover its day to day operations.
When operating income is negative, we say the business cannot cover its running cost and will need to borrow funds to keep the lights on. Usually the founder draws from their personal savings or investments to cover the business costs.
Every business starts with a negative operating income. After a while the business breaks even, and then eventually things become positive and the entrepreneur can begin to earn an income from that business.
Operating Income = Total Sales – Cost of Goods, Logistics and Salaries
If you take a deep look at that equation, you will see why retails stores survive while e-commerce startups struggle.
Let’s say an e-commerce store and a retail store generated 1million Naira in sales yesterday. Who do you think made the most profit?
|Retail Store||E-commerce startup like Konga|
|Cost of Goods||Cost of the item||Cost of the item plus small profit for the merchant.|
|Logistics||Low. Customers come into store to get items. Logistic cost of getting items into store is spread over a lot of items fitting into the bus used to buy the items from distributor (or container from China)||High. Every transaction has a high logistics cost, since they need to be delivered to customer. Logistic cost can only be spread over items fitting into motorcycle, which makes it a significant component of every product sold.|
|Salaries||Low. None of your staff need special skills.||High. Special skills required. Managing online content, professional customer service, accountant and operations administrator.|
As you can see, the cost of running an e-commerce store day to day, is a lot higher than the physical retail store. It may cost more to setup a retail outlet. But after the initial setup or investment, the daily operating expense for a retail store is low. There is little logistics and administrative cost to selling in a retail store.
Apart from low operating cost giving the retail store bigger profit. There is one other advantage to having low operating cost. It is the ability to last. Low operating cost means you can survive periods of poor sales, especially if you sell products that don’t expire. The e-commerce startup does not have this advantage. Monthly salaries erode investments very quickly. This inability to last through drought, combined with the per transaction cost of selling, is what makes e-commerce a really difficult startup to build.
There is nothing complicated about business. You will be surprised at how simple things can be responsible for a business demise.
Here is what Nick Imudia, the new CEO of Konga said, after the acquisition.
Yes, you read that right. Konga plans to fix itself by establishing physical stores across Nigeria. Just an Harvard way of saying “this e-commerce platform shit is not working, let’s go back to the basics, igbo-boy style.”
Remember when I said there were two types of e-commerce? The one that is a marketplace, connecting merchants to customers. And the one that is an online channel for a retail store? Well, Konga is moving to the second model. And I think that is brilliant!
This is the lesson I hope new entrepreneurs will learn. I say “new entrepreneurs” because the CoVid-19 pandemic is minting new entrepreneurs. People are home, some have a lot more time to think and be visionary. A few will take the next step and actually start something.
An e-commerce business is just like any traditional business, in the sense that there are lots of offline activities you need to engage in. Thinking otherwise, that is, thinking you can run your e-commerce startup from your laptop is what has misled a lot of smart entrepreneurs.
In my day job, I lead a company that builds products for startups. And we have gotten a spike in enquiries during this period. It appears everyone wants to start something, which is fantastic. As it stands e-commerce is currently the #1 request since the start of the pandemic, before then, it was fin-tech.
E-commerce startups have certainly seen their fortunes change for the better during this pandemic. Most people now have to buy online rather than go to the store. So yes, this pandemic presents an opportunity. But it is an opportunity you needed to have prepared for.
Does that mean you shouldn’t start your e-commerce business now? No, you certainly can. But it is unlikely you are able to take advantage of this particular pandemic. What the pandemic does for you, is give you a better market, post-pandemic. What do I mean by a better market?
Well, there is one part of that equation I haven’t spoken about. And it is the “Total Sales” part.
There are two opportunities the CoVid-19 pandemic has created for e-commerce and they have to do with sales.
- The first is the market size, which has increased. More people are online. The people who weren’t online shoppers before now, have now done online shopping, and they are finding out, it ain’t so bad. A percentage of them will stick post-pandemic.
- The second and less obvious opportunity is the type of sales. I didn’t speak about the “Total Sales” part, while analysing the challenges e-commerce startups face. But they also face a big challenge on sales.
You see, when a retail store sells something, cash is exchanged, and the transaction is complete. 99.9% of the time, that is where it ends. Not so for e-commerce. For e-commerce, when the online transaction is complete, there is a payment option called “Pay after delivery”. All e-commerce founders hate that stuff, but they have had to put up with it so far.
“Pay on delivery” means even if the transaction is completed online, you cannot rejoice yet. The customer has not really committed and could easily cancel the transaction tomorrow. Which means, the 1million Naira you recorded in sales yesterday, is not really 1 million in cash sitting in your account. So while your retail counterpart is recording cash sales, you are recording an alien form of credit sales that may not materialise. At least half of the e-commerce startup founders I know, will point to this issue as the reason they closed down.
Well, there is now an opportunity to completely eradicate that option. With most people having no choice but to shop online, you can build a reputation for guaranteed on-time delivery, and remove pay on delivery, which most customers use as a safety option anyways.
I believe the post-CoVid19 world will be a very different one. The way we work will change, the way we do business will change. Business models will need to be reviewed, and strategic frameworks will need to be revisited. But don’t be alarmed, fundamentals will never change.
I have thoroughly underestimated how much I have to say on this topic, I have chosen to skip some notes, so as not to make the writing complicated. In a future post, I will write on why the second model of e-commerce is much better for the Nigerian ecosystem. Some of you may have figured it is actually an hybrid model, and that is part of what makes it brilliant.
This is good stuff. Brings clarity to a discussion I had with my partner about our proposed start-up.
Thank you Olufolahan. I happy this helps bring some clarity to your startup idea.
Thanks for the informative write up. I am also an emerging ecommerce entrepreneur. Based on your write up I find it difficult to understand that a marketplace model incurs cost of sales in which you term ‘Cost of the item plus small profit for the merchant.’
I expect that the platform only serves as a bridge between the vendor and the final consumer.
Can you please explain further.
As a marketplace, you help your merchants sell.
Say you have a merchant that sells phones. And one particular Samsung phone from that merchant is listed as 85,000 Naira. That 85,000 Naira listed, includes your profit and the merchant’s profit.
Let’s say the cost of importing the phone and getting it to the merchant’s store arrives at an estimated 74,000 per phone. That’s the cost of the item, to the merchant. The merchant then adds a profit of 8,000 Naira, and says he can only sell the phone at a minimum of 82,000 Naira.
It means if a customer where to purchase that Samsung phone at 85,000 Naira, your cost of sale is 82,000. This is the cost of the item to you the marketplace owner. And this cost includes the cost of the item to the merchant plus the merchant’s profit.
Now, some marketplace simply take a percentage of sale. But the idea is still the same. The merchant who owns the product must make a profit, and that profit is part of your own cost.
PS: Cost of Sales is also more technically known as “Cost of Goods Sold”