By and  on August 6, 2014

E-commerce companies are having a Millennial moment.

They’ve moved out of their dorm rooms and set up shop, in many cases establishing substantial businesses with real sales traction — but they still can’t support themselves. With the exception of a few firms, such as Asos and Zulily, experts say fashion e-commerce companies are largely losing money and relying on funds from investors to rapidly accumulate customers and build their brands.

Nor are fashion e-tailers the only ones. Amazon.com continues to rack up megalosses as it aims for global domination, becoming the poster child for the business model for e-commerce and proving irrefutably that the road to black in the online world is a long one.

“Anyone who has taken money is absolutely not making money,” said Sucharita Mulpuru, vice president and principal analyst at Forrester Research, noting many e-commerce brands are spending capital on customer acquisition and brand building.

Bonobos, Warby Parker and BaubleBar are among those that Mulpuru said were engaged in the costly and time-consumer exercise of “buying growth.

“There are not a lot of examples of successful brands that have been blockbusters using that strategy,” Mulpuru said. “That’s where I’m baffled by investors continuing to pour money into this — [they] have naïve perspectives that they can be the ones to pour $50 million [into a company] and create a brand that’s going to kill its market.”

Scott Friend, a managing director at Bain Capital Ventures and an original investor in Rent the Runway, said it’s a fallacy that digital brands are cheaper to build than their brick-and-mortar equivalents.

“It turns out the nice thing about stores is that customers walk by, and the hard thing about the Web is that customers don’t just walk by,” Friend said. “You have to get them and getting them costs money.”

He said brands born online end up with a trajectory and economic model similar to those that were born as brick-and-mortar operations decades ago.

“To some extent, there was this unfair focus on these new brands and why their economics weren’t better faster — and the reality is it takes time,” Friend said. “The last-generation guys built one store and got it profitable, and then another and another, and as a result were profitable sooner, but smaller.”

On the other hand, online-first companies are building one, massive store on the Web with a national customer base behind it.

Creating a huge store out of the gate and building enough consumer momentum to fuel it profitably might be a very capital intensive path — but a decade from now, Friend projected that younger dot-com companies such as Warby Parker or Rent the Runway will be held in similar esteem to a J. Crew or Kate Spade.

Whether e-commerce players look to make a big splash with an all-out push for dominance or opt for slower, profitable growth, they’re venturing into a highly competitive landscape with some very established players and a range of business models that are still being tested.

There is a third way, though. Some of the Web’s most successful e-commerce companies have taken on the role of middleman, providing the platform for brands to court customers while driving huge profits from advertising. For instance, gross merchandise sales — including, increasingly, fashion brands — enabled by the main Chinese Web sites in Jack Ma’s Alibaba Group tallied $270 billion last year. Although the company’s own revenues amounted to a much smaller $8.44 billion, it managed to keep $3.71 billion of that as profit.

Ma said the company, which is planning for a blockbuster initial public offering on Wall Street this year, sees plenty of runway for its model and has his eye at the very top, on Wal-Mart Stores Inc., which is expected to post sales just shy of $500 billion this year.

“In the past, people did not expect Wal-Mart’s sales revenue could reach $500 billion,” Ma said recently. “It is scary. [Wal-Mart’s] $500 billion would require several million staff. It’s huge. Alibaba probably only needs 30,000 employees to create sales revenue as big as Wal-Mart’s. In order to have 10,000 more customers, they need to buy a big piece of land and buy a lot of equipment and stuff. We only need three more servers.”

Which gets to the heart of the matter.

Profits are what’s left from sales after the company covers its costs and pays taxes and so forth. Different business models have different cost structures. Online players have set up the technological infrastructure to run their sites, acquire customers and handle shipments to shoppers, while brick-and-mortar companies have inventory, lease expense and so on.

“On the e-commerce side, the fixed costs are reasonably high,” said Todd Huseby, partner in A.T. Kearney’s Digital Business Forum. “They’re generally funded by the venture capitalist” or other backers.

Huseby said shipping costs for e-commerce companies are significant.

“It’s about $2 for shipping a package through USPS and you can’t get away from that....It’s higher if you’re doing FedEx and some players, Amazon specifically, they’re hoping to build a distribution network on their own,” he said.

As a result, scale becomes very important. Early on, companies want to get bigger to cover to the cost of their initial investment. Once they’ve established themselves, they want to bulk up more to build capabilities and drive their costs lower. In a sense, it is the Wal-Mart model but online, rather than in physical stores.

“Amazon’s done such a good job on the operations of e-commerce that they’ve basically created what economists would call a winner-take-all market,” Huseby said. “It’s really, really hard for a new entrant to go into a category that Amazon is in without some completely different customer value proposition.”

The path Amazon has blazed — and continues to blaze — is part of the reason why so many companies emphasize exposure over profits early on. These Internet entrepreneurs figure that if Wall Street and investors give Amazon a pass on profits, why not their company?

Amazon’s founder and chief executive officer Jeff Bezos, who turned an early online bookstore into a commercial giant that sells almost everything and also plays in telecom and TV, is still investing heavily and at the expense of profits.

The company logged losses of $18 million for the first half, even as sales jumped 23 percent to $39 billion. Investors have largely accepted the lopsidedness of the company’s finances, seeing the growth and anticipating big returns down the line. But their patience has shown signs of waning. The company’s stock has fallen 12.9 percent to $312.32 since it detailed its second-quarter results July 24.

Aileen Lee, a 15-year veteran of venture capital firm Kleiner Perkins Caufield & Byers, said Amazon has been both building capabilities and doing right by its shareholders, even without posting profits.

“Amazon is worth $145 billion — and over the past 20 years there have been many times when pundits said Amazon should be more profitable, but they are in it for the long game,” Lee said. “They say they are going to reinvest in their structure at the expense at being profitable. They’ve become more capable...and in retrospect it’s been the smart choice for them. If they listened to pundits, I don’t think a lot of the cool things we have from Amazon today would exist.”

And while there have been grumblings from investors over profits, the stock has still been gaining ground, rising 32.9 percent over the past two years, versus the Dow Jones Industrial Average’s 25.5 percent gain.

NEXT: Asos, Nasty Gal and More >>


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