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VALUINGAMERICA’S TOP E-RETAILERS

How to build value in an internet retail business

A GUIDE FOR E-RETAILERS AND

INVESTORS

IR RESEARCH the global leader in e-commerce data

I N T E R N E TR E T A I L E R

©Copyright 2017 Internet Retailer® & Vertical Web Media LLC. All rights reserved.

INTERNET RETAILER VALUING AMERICA’S TOP E-RETAILERS 2

Most entrepreneurs who start online retail businesses dream of one day getting rich, either by selling their business to an investor or going public. Investors,

whether they’re buying a company outright or shares of stock, want the value of their investment to increase. Both have a stake in understanding what an online retail business is worth today.

This report is designed to help them understand the current value of online retail businesses and the strategies that can make those businesses more valuable.

The conclusions of this report can be summed up in the following three points:

Shopping is moving to the web and there is considerable investor interest in fast-growing online retailers that do something unique. Wal-Mart’s acquisition of Jet.com and Unilever’s purchase of Dollar Shave Club—both at multiples of more than four times prior-year sales—are recent examples of that interest.

Amazon’s growing dominance of e-commerce has made investors increasingly wary, however. An analysis of two dozen acquisitions of Internet Retailer Top 1000 retailers shows that from 2009-13 the median purchase multiple was 1.56 times the retailer’s online sales the year before the sale; since 2014 the median multiple has been less than 0.77 times sales. A big part of that is the shadow Amazon casts over online competitors—especially those that sell commodity goods available on Amazon.

Executive Summary

1

2

MULTIPLE OF PURCHASE PRICE OF TOP 1000 RETAILERS

VERSUS PRIOR-YEAR ONLINE SALES

Source: Internet Retailer

PRE-2014

1.562014 ON

0.77

BYDON

DAVISEditor in chief,

Internet Retailer



EXECUTIVE SUMMARY

Investors are quite clear on what they want: a unique value proposition, including a credible defensive position against Amazon; strong revenue growth, generally above 20% a year; profits or a solid case that profits are coming; and a management team that can keep on growing the business or bring e-commerce expertise, and that can deliver value even if the founder departs.

3

VALUE OF TOP 1000 E-RETAILERS SOLD SINCE 2009 (Dollar amounts in millions)

Company sold Buyer Date PricePrior-year

salesPrice/Sales

Shoebuy Jet/Wal-Mart December 2016 $70.0 $374.2 0.19

Blue Nile Bain Capital/Bow Street LLC November 2016 $478.0 $480.1 1.0

PersonalizationMall.com Bed Bath & Beyond November 2016 $190.0 $160.1 1.19

Monoprice YFC-BonEagle Electronic Co. November 2016 $40.0 $156.7 0.26

Etailz Trans World Entertainment October 2016 $75.0 $93.0 0.80

Jet.com Wal-Mart August 2016 $3,300.0 $800.0 4.10

Dollar Shave Club Unilever July 2016 $1,000.0 $152.0 6.60

One Kings Lane Bed Bath & Beyond June 2016 $11.8 $355.0 0.03

Gilt Groupe Hudson's Bay Co. January 2016 $250.0 $600.0 0.42

Living Direct Build.com/Ferguson October 2015 $22.0 $65.0 0.34

Orchard Brands Capmark Finance May 2015 $410.0 $318.5 1.29

Net-A-Porter Yoox March 2015 $1,400.0 $829.0 1.70

SkyMall C&A Marketing January 2015 $1.9 $80.0 0.02

Trunk Club Nordstrom July 2014 $350.0 $21.0 16.70

Vitacost.com Kroger June 2014 $280.0 $382.7 0.73

Coastal Contacts Essilor February 2014 $385.7 $195.2 2.00

ideeli Groupon January 2014 $43.0 $180.0 0.24

Monoprice Blucora October 2013 $180.0 $118.8 1.52

Dreams Fanatics June 2012 $183.0 $113.0 1.60

Drugstore.com Walgreens June 2011 $429.0 $456.5 0.94

Tiny Prints Shutterly March 2011 $333.0 $99.5 3.30

Quidsi Amazon November 2010 $545.0 $182.0 2.70

Whitney Automotive U.S. Auto Parts August 2010 $41.0 $128.0 0.32

Retail Convergence GSI October 2009 $350.0 $157.0 2.20

Zappos Amazon July 2009 $847.0 $1,010.0 0.84Source: Internet Retailer



ContentsPART I

Value multiples & methodology

PART III

Conclusion

PART II

Four primary ways to add value to an

online retail business

GUEST COLUMN

How online retailers can increase

their value in an Amazon world

By Eric Roth and Ryan Hays, Lazard Middle Market

VALUINGAMERICA’S

TOP E-RETAILERS

5

22

24

11



The typical Internet Retailer Top 1000 merchant that does most of its business online is worth a little over $17 million. That’s based on an analysis of 553 privately held companies— 453 retailers that sell primarily online and

another 100 that mail out printed catalogs but book most of their revenue on the web. (Not included in this study are 447 companies in the Top 1000 that either operate bricks-and-mortar stores or are manufacturers, and thus derive much of their revenue from sources other than e-commerce.)

The $17 million median for the 553 web-only and catalog retailers, however, doesn’t tell you much, because there is such a big variance in the value of these companies. We believe bidding likely would start at $3 billion for L.L. Bean, the outdoor apparel retailer that’s attracted a large and loyal following in more than a century of operation and that offers its own branded merchandise not available elsewhere. But many of the smaller e-retailers on this list would have trouble finding any buyer, unless it was a similar company that wanted to add a related category and customer base.

Our analysis suggests that value is closely linked to size, as investors are more interested in companies that have reached a certain scale. The 14 retailers that rank among the 100 largest web merchants in the Top 1000 have a median value of $693 million, while the 66 in the bottom 100, by our estimate, have a median value of only $4.26 million. The

VALUINGAMERICA’S TOP

E-RETAILERS

PART I

Valuemultiples &

methodology

MEDIAN VALUE OF PRIVATELY HELDCATALOGERS VERSUS WEB-ONLY

RETAILERS IN TOP 1000


WEB-ONLY

$56MILLION

CATALOGERS

$131MILLION



PART I VALUE MULTIPLES & METHODOLOGY

median value of the 100 catalogers was $131 million, more than double the $56 million for the 453 web-only retailers. But that was largely a function of size: The average cataloger on this list was No. 485 in the Top 1000, while the average web-only retailer was No. 601.

For each retailer we calculated its value as a multiple of online sales. For all the retailers in the study, the median value was equal to .81 sales. Interestingly, the median ratio for catalog and web-only retailers was the same: .81. But the larger retailers in the Top 500 had a median multiple of .945 times sales, versus .77 for those in the Second 500.

DECLINING MULTIPLESThe average value of .81 times prior-year sales is roughly in line with our analysis of 25 acquisitions since 2009 involving Top 1000 retailers for which there is reliable information about the purchase price. For all the deals on the list the median prior-year sales multiple was .96, but it has ticked down noticeably in recent years: E-retailers purchased before 2014 commanded a multiple of 1.6 prior-year online sales, while for those sold since then the multiple was under 0.8.

Those deals, however, may understate the value of many successful online retailers. That’s because a number of the deals involved compa-nies that were struggling. Gilt Groupe and One Kings Lane are flash-sale retailers—a category that was hot in the period shortly after the 2008-9 recession when retailers and manufacturers had lots of unsold inventory that they were looking to unload, but that’s declined in appeal since then. Gilt, which reportedly was valued at one time at $1 billion, sold to retailer Hudson’s Bay Co. for $250 million early in 2016.

VALUE BY TOP 1000 RANK

1-100 101-200 201-300 301-400 401-500 501-600 601-700 701-800 801-900 901-1000


(Median value, in millions of dollars)

$244.72

$692.96

$25.97$60.37

$11.41

$115.91

$11.85$25.20$7.68 $4.26

GILTGROUPEMay 2011

value

Jan. 2016purchase

price

Wall Street values most publicly traded online

retailers at less than one times sales.

The exception, of course, is Amazon.com Inc., which as of

early February had a market capital-ization (share price times number of

shares outstanding) of 4.2 times 2015 revenue as reported in Top500Guide.com.

But an analysis of 15 other retailers that derive their revenue primarily from the web—all in the Internet Retailer Top 500—shows their median stock market value is only .937 times 2015 online sales. That is eerily close to the multiple we came up with for privately held online retailers in the Top 500: .945 times 2015 online sales.

That roughly 1x revenue multiple also held in the recent acquisition of online jewelry retailer Blue Nile Inc., a publicly traded e-retailer that agreed to be taken private in November 2016. Private equity firms Bain Capital and Bow Street LLC led the $478 million deal. The online jewelry retailer generated sales of $480.1 million in 2015, making the multiple of value to sales almost exactly 1.0. While a pioneer in selling jewelry, and especially engage-ment rings, online, Blue Nile had been growing slowly. Its 2015 revenue growth was only 1.38% over 2014 and its five-year compound annual growth averaged only 8.38%, well below the roughly 15% annual increase in U.S. online retail sales in recent years.




Other companies on the list simply were struggling to make a profit. One example is SkyMall, which in the pre-internet era was a successful catalog that travelers found in the seat pockets of airliners, but no longer offers much of a value proposition when travelers can easily shop online via their phones. Another example is Shoebuy, which Wal-Mart purchased in late 2016 at a multiple of around 0.2 times 2015 online sales. Investment bankers not involved in that deal surmised that Shoebuy was neither profitable nor growing quickly.

More successful companies may well be able to sell at higher multiples of revenue. Some experts say successful, fast-growing online retailers can expect a valuation of at least two to three times revenue. In our analysis,

Successful, fast-growing online

retailers can expect a valuation of at least

two to three times revenue.

Value/sales, with web sales and market capitalization in millionsCompany Market cap 2015 sales Value/sales

Amazon $388,500.0 $92,448.0 4.202

1800Flowers.com $633.6 $849.9 0.745

CafePress $57.5 $104.5 0.550

Etsy $1,490.0 $2,388.4 0.624

FTD Companies $621.2 $314.4 1.976

GeekNet $134.5 $143.5 0.937

Groupon $2,040.0 $1,849.9 1.103

HSN $1,790.0 $1,920.0 0.932

Liberty Interactive (QVC) $12,920.0 $4,276.0 3.022

Overstock $411.8 $1,658.0 0.248

PC Connection $744.2 $926.6 0.803

PetMed Express $428.5 $183.5 2.335

Shutterfly $1,260.0 $1,059.8 1.189

U.S. Auto Parts Network $117.9 $264.6 0.445

Vistaprint (Cimpress) $2,620.0 $1,494.2 1.753

Wayfair $3,630.0 $2,040.2 1.779

MEDIAN 1.020

MEDIAN WITHOUT AMAZON 0.937

Source: Internet Retailer, based on February 2017 stock prices

THE VALUE OF PUBLICLY TRADED

ONLINE RETAILERS




we identified 10 retailers that we believe could attract a value of more than two times sales. One was the venerable L.L. Bean. Others were newcomers with unique business models, such as Everlane, which shows shoppers the cost of every garment and the retailer’s profit margin, and Blue Apron, which is a leader in the hot category of retailers that deliver the ingredients for dinners that customers prepare themselves.

But it’s also likely that Amazon’s outsized growth in the last several years has changed investors’ views of the value of the typical online retailer. Investment bankers active in this space agree that the Amazon impact is real and that investors are more wary now than they were a few years ago about the prospects of retailers that primarily sell online. That wariness also stems from the relatively modest profits turned in by publicly traded online retailers.

PROFIT AND GROWTHIn the current climate, a company that can show it is making money will attract much more attention from investors from one that’s not. And the combination of profit and growth makes for an even better story.

When investment bankers assess the value of an online retailer today they typically start with the company’s EBITDA—earnings before interest, taxes, depreciation and amortization. That is a proxy for cash flow that is widely used on Wall Street to evaluate growing companies whose net income—profits when including interest, taxes, depreci-ation and amortization—are likely depressed by big investments in technology and growth.

Many growing online retailers are investing heavily in software, which in some cases they treat as a capital expense, says Eric Roth,

Everlane Inc.

Creekstone Farms Premium

Beef

Poppin.com

Plated.com

Blue Apron Inc.

Betabrand Inc.

Naked Wines.com

Inc.

L.L. Bean Inc.

Sundance Catalog Co.

Rent the Runway Inc.


THE TOP 10 IN VALUE TO SALES

(10 retailers that Internet Retailer estimates would command a value of more

than two times sales)




managing director and head of the consumer retail group at Lazard Middle Market, a subsidiary of investment bank Lazard Ltd. that focuses on midsized companies. Since a capital expense is reflected in depreciation and amortization, those investments do not factor into EBITDA, providing a clearer view of the e-retailer’s cash flow from operations. Investment bankers often also used a variant, adjusted EBITDA, to factor out one-time expenses and get a clearer view of a company’s cash flow.

Unlike Internet Retailer, which does not have access to the accounts of the online retailers studied for this report, investment bankers do get to see the books of companies when they’re working on a deal. That enables them to use EBITDA as a gauge of a company’s value.

A typical online retailer might command a value of five to seven times EBITDA, says Stuart Rose, managing director of Tully & Holland, an investment bank that specializes in consumer product companies. A strong company—for example, one whose EBITDA exceeds 20% of sales and can show steady growth—might command a multiple of 15 times EBITDA, Rose says.

What constitutes strong growth? Above 20% yearly growth is good, Rose says. “Below 8% we’re not so happy.”

Online sales growth was one of the factors in Internet Retailer’s formula for calculating company value. The 175 online retailers with 5-year growth that averages over 20% commanded a median value of 1.26 times sales, nearly double the .68 times sales multiple of the other 378 e-retailers in this study.

TWO HAPPY EXITSWhile profit and growth are important, every deal is different, and there is a lot more that goes into the value of an e-commerce business. One example is last year’s acquisition of Jet.com by Wal-Mart Stores Inc. Wal-Mart paid $3.3 billion for a company that, according to CEO Marc Lore, was years away from being profitable. In another noteworthy deal in 2016, consumer goods manufacturer Unilever bought Dollar Shave Club, the fast-growing online seller of its own brand of shaving equipment. Unilever paid 6.6 times prior-year sales for Dollar Shave Club and Wal-Mart paid more than four times Jet’s 2016 revenue run rate.

In both cases, the acquirers were huge companies whose businesses were under threat from the growth of e-commerce. They were willing, and able, to pay handsomely for proven e-retail executive talent and

A typical online retailer might command a

value of five to seven times EBITDA. A strong company might command a

multiple of 15 times EBITDA.— Stuart Rose,

managing director, Tully & Holland

MEDIAN MULTIPLE OF SALES OF E-RETAILERS GROWING AT MORE THAN 20% A YEAR

WAL-MART PAID MORE THAN FOUR TIMES JET.COM’S 2016 REVENUE RUN RATE.

UNILEVER PAID 6.6 TIMES

PRIOR-YEAR SALES FOR DOLLAR SHAVE CLUB.

VERSUSMULTIPLE OF OTHER ONLINE RETAILERS.

1.260.68




to acquire brands that had reached significant scale and provided value in unique ways to online shoppers.

Those deals were good news for internet retailers looking to raise money because they showed that there can be successful exits for investors who put money into online retail busi-nesses, says Randy Nicolau, CEO of Poppin.com, No. 519 in the Internet Retailer 2016 Top 1000.

Before those deals, most of the recent acquisitions of online retailers had been “fire sales” of struggling e-retailers like Gilt Groupe, or sales to Amazon of successful businesses like Zappos or Quidsi, the parent company of Diapers.com. But the sales of Jet.com and Dollar Shave Club demonstrate that there are buyers other than Amazon willing to pay hefty multiples for successful e-retail businesses, Nicolau says. “Those two big exits have really changed investor perception in this space,” says Nicolau, whose company has raised $34.1 million in five funding rounds, according to Crunchbase. “We’ve seen a lot of inbound interest as a result of those transactions.”

MethodologyInternet Retailer has been collecting the online sales data of North American retailers since 2003 and used that more than a decade of sales data as a starting point for estimating the value of 553 privately help web-only and catalog retailers in the Top 1000.

That sales data provided not only the current size of each of those companies, but also their one-year and five-year growth and allowed us to compare each company’s growth to that of e-retailers in its category.

In addition, our researchers looked at each of the retailer’s e-commerce sites to determine whether they offer private-label merchandise: Investors favor retailers that derive a lot of their sales from their own branded goods that are not available elsewhere. They also took note of whether each retailer sold on the Amazon and eBay marketplaces, as investors favor retailers that do most of their business on their own websites where they can more readily build ongoing relationships with customers.

The formula for calculating each retailer’s value also took into account a variety of other data Internet Retailer has accumulated over time. That includes the mobile and social media activity of each retailer and how fast its website loads.

Finally, the estimates draw on Internet Retailer’s own reporting about the Top 1000, adjusting estimates based on what we know of each company.

The estimated value of each of the 553 online retailers will be available as a premium subscription to Top500Guide.com,

Internet Retailer’s online e-commerce database.

The information on estimated net sales value is proprietary to Internet Retailer and protected by worldwide copyright laws and treaty provisions and may not be copied, reproduced, modified, published, uploaded, posted, transmitted, or distributed in any way without Internet Retailer’s prior written permission

The information on estimated net sales value may be used for information purposes only and is not intended as investment advice or an offer or solicitation for the purchase or sale of any financial instrument. The estimates were made without access to the financial records of the retailers, and without knowledge of the profitability of each company. We make no warranties or representations as to these estimates, which are provided on an “as is” basis and may be used only at recipient’s risk. TO THE FULLEST EXTENT PERMITTED BY LAW, VERTICAL WEB MEDIA, ITS AGENTS, ITS AFFILIATES, ASSIGNS, LICENSORS AND ITS VENDORS, DISCLAIM ALL REPRESENTATIONS AND WARRANTIES REGARDING SUCH ESTIMATES, EITHER EXPRESS OR IMPLIED, STATUTORY OR OTHERWISE, INCLUDING BUT NOT LIMITED TO THE IMPLIED WARRANTIES OF MERCHANTABILITY, NON-INFRINGEMENT OF THIRD PARTIES’ RIGHTS, AND FITNESS FOR PARTICULAR PURPOSE.

‘Those two big exits have really

changed investor perception in this space. We’ve seen a lot of

inbound interest as a result of those transactions.’

— Randy Nicolau, CEO, Poppin.com, referring to

the Jet.com and Dollar Shave Club

deals.

CUSTOM RESEARCH ON THE VALUE OF AMERICA’S E-RETAILERS

Who are America’s most valuable e-retailers?

What’s the value of your e-commerce business compared to that of your competition?

What e-retailing categories boast the highest valuations?

?Internet Retailer’s Research Division can produce custom valuation reports that provide the answers by tapping into our valuation database on America’s top 553 privately-held e-retail companies.*

For custom valuation report content and pricing details contact

Steve RogersCustom Research Sales Director

[email protected]: 312.572.6263

Data does not include valuations of publicly-held web merchants or catalog retailers. The report also does not include any data on consumer brand manufacturers. Data does not contain any estimate of the companies’ operational expenses or company financials. This report is based exclusively on Internet Retailers data and historical data and does not include financials provided by the company.

*

IRRESEARCH the global leader in e-commerce data

mailto:steve%40verticalwebmedia.com?subject=



Profit is the surest proof of a company’s success. But investors are forward-looking and may see great value in companies that have not yet made money. Amazon, for example, raised $54 million in a 1997 IPO even

though it was losing money. Google and Facebook are two other prominent examples of companies that attracted investor interest before they made money, and paid off handsomely for those who bet on their potential.

While those are exceptional cases, there are many online retailers today that are growing quickly and that have a good story to tell. They frequently need to invest to serve their growing customer base and to attract more customers. While that often keeps them from making money now, potential buyers and investors may see the potential and the value. The $3.3 billion Wal-Mart paid for Jet is one recent example.

What, besides profits, makes an online retailer attractive to investors? This section of the report will take up four key things investors look for: unique product, scale and potential for growth, an attractive customer acquisition and retention strategy, and a strong management team. And it will provide advice from retailers and investment bankers about how a business owner can increase its value in these four areas. Let’s look at each of these in turn.


E-RETAILERSPART II

Four primary

ways to add value to an online

retail business



PART II ADDING VALUE

1. PROPRIETARY PRODUCTThe best way to compete with Amazon and all the other online and offline retailers is to sell merchandise they can’t offer. That gives an e-retailer something unique to offer consumers and means it isn’t as vulnerable to online price comparison because—if the consumer wants the product—there’s only one place to go to get it.

That provides the kind of defensive moat that gives investors confidence a business will be able to grow and prosper.

“We find that what investors want is companies that have a defense against Amazon,” says Stuart Rose of Tully & Holland. “And the only effective defense we’ve found is proprietary product or customization or personalization, things Amazon doesn’t play well with.”

That shows up in our survey of privately held web-only and catalog retailers: Those with a significant portion of sales coming from their own branded product, or merchandise not readily available elsewhere, command an estimated valuation roughly double that of e-retailers that only sell goods from suppliers that are available from many other retailers.

It also shows up in the buzz among investors and retailers about what CEO Randy Nicolau of Poppin calls “vertically integrated, digitally native” companies: retailers that from the start sold their own branded products via the web. Prominent examples include eyeglass retailer Warby Parker, men’s clothing brand Bonobos, apparel e-retailer Everlane and preppy apparel seller Ivory Ella that donates 10% of its net profits to charitable causes. Another fast-growing retailer that’s attracted avid investor interest, pet supplies merchant Chewy.com, is exploring devel-oping its own private-label pet food products, says CEO Ryan Cohen.

There’s good reason for online retailers to move into private-label goods: Not only does it avoid competing with the likes of Amazon but it can earn a significantly higher profit margin on its own branded goods that it sells on its own website. Tiny Prints, which designed its own products such as invitations and announcements, posted gross profit margins above 50%, according to co-founder Ed Han. That helped the company sell to Shutterfly Inc. for more than three times prior-year sales, by Internet Retailer’s estimate.

In general, online retailers that sell their own product typically make profit margins of at least 40%, and sometimes as high as 60%, says Eric Roth of Lazard. By contrast, he says, an e-retailer selling goods sourced from other suppliers, or third-party goods, rarely commands a profit margin of 30%. The typical difference in margin between selling

‘We find that what investors want is

companies that have a defense against Amazon. And the only effective

defense we’ve found is proprietary product or customization or personalization,

things Amazon doesn’t play well with.’

— Stuart Rose, managing director,

Tully & Holland

MULTIPLE OF VALUE TO SALES OF RETAILERS THAT MAINLY SELL PROPRIETARY PRODUCT

VERSUS THOSE THAT DON’T.

1.350.54


POPPIN.COM ADDED ITS OWN LINE OF

OFFICE FURNITURE AND GREW SALES BY

73%IN 2016.




private-label and third-party goods could be 50% versus 25%. “That’s real money,” Roth says.

Nicolau says the strategy behind Poppin.com was based on the concept of offering proprietary products that injected a design sensibility into a category heavily shopped online: office products. He noticed as he was considering investing in Poppin in 2011 that office supplies were offered by five of the top 10 retailers in the Internet Retailer 500: Amazon, Wal-Mart, Staples, Office Depot and OfficeMax.

“They were all selling the same Swingline stapler and Post-It notes, and hammering each other in terms of margin, but driving tons of volume,” he says. “We knew we were never going to out-Amazon Amazon.” But he also concluded that a line of well-designed office products in matching and lively colors could catch on. More recently, Poppin has introduced its own brand of office furniture and increased sales 73% to $40 million in 2016. Nicolau projects another 50-60% growth in 2017.

The fact that Cuddledown mainly sold pillows, comforters and bedding that it designed and in some cases manufactured had a lot to do with it getting an attractive price when it was sold to Potpourri Group in 2012, says former president Chris Bradley, who would not divulge the purchase price or multiple. He says 75% of Cuddledown’s merchandise was proprietary. Rose, who worked on the Cuddledown deal, says an e-retailer should get at least 40% of its revenue from private-label goods to make that an effective defensive position against competitors.

UNIQUE SOURCES OF SUPPLYWhile online brands like Cuddledown and Poppin design their own products, there are other ways to obtain and sell merchandise that won’t be available on Amazon.

For example, PropertyRoom.com, No. 327 in the Top 1000, auctions off property seized by more than 3,000 law enforcement agencies across the U.S. It generated more than $68 million in online sales in 2015, Internet Retailer estimates.

The Real Real Inc. (No. 206) is based on the concept that many women have fancy dresses in their closet they no longer wear and would be happy to sell, if it were easy to do. The Real Real devel-oped a process for authenticating that the items consumers send in are from genuine designer labels and sells them on consignment. Gemvara (No. 474) does the same with jewelry, and has added a business of resetting rings and other items for online shoppers.

Online retailers that sell their own product typically make profit margins of at least

40%, and sometimes as high as 60%. Those that sell

goods from other suppliers rarely

command a profit margin

of 30%.




Nearly $2.4 billion in total sales were transacted on Etsy.com (No. 23) in 2015, most of that from handmade items sold by artisans around the world. Zazzle (No. 148) sells items designed by artists and artisans, taking a commission. It’s raised $48 million in funding. As Eric Roth of Lazard points out in his article on page 24 of this report, YDesign differentiates itself by selling home furnishings from small companies that prefer not to sell on Amazon.

THE PERSONAL TOUCHAnd while Amazon is extremely efficient at selling big volumes of standard product, it’s not known for offering great personalization options. That offers openings for retailers that develop the capability to offer customized merchandise.

For example, CafePress (No. 249), Threadless (No. 387) and Spreadshirt (No. 442) all solicit designs from artists around the world and then create T-shirts and other items on demand.

Other e-retailers recognize the opportunity to offer customized product that can turn a commodity item into something unique. For example, construction companies often have trouble getting workers to keep their hard hats on, leaving them open to possible safety fines, says CEO Kevin Hickey of Online Stores. The company, which operates several e-commerce sites selling work apparel and boots, offers to add designs to hard hats—such as flags, camouflage or a trendy carbon fiber finish—to make them more appealing to workers. “These are all unique products that nobody else has got, and we make a pretty good margin on them,” Hickey says.

That kind of unique product is one of the secrets of success—and of attracting investor interest—in the age of Amazon. Another is selling products that are complex, high-priced and bought very occasionally—the kind of items a consumers wants lots of information about before making a purchase.

That’s one reason why private equity firm Rotunda Capital Partners in 2014 purchased a majority interest in Discount Ramps LLC, an online retailer of ramps for motorcycles, wheelchairs, cars and loading docks. Many product pages on DiscountRamps.com feature videos that show in detail how the ramp operates, along with technical specifications.

“It’s the kind of product that requires customer education,” says Rotunda Capital partner Corey Whisner. “It’s not something people buy




every day. Maybe you could buy it from Amazon, but you’re probably better off going to a specialist.”

DiscountRamps.com, No. 445 in the Internet Retailer Top 1000, grew its online sales more than 28% to $36.9 million in 2015 and has posted a five-year growth rate of more than 15.5%, just ahead of the U.S. e-commerce market as a whole.

2. BIG IS BEAUTIFUL (TO INVESTORS)Investors are more interested in online retailers that are already selling a lot—especially if they have a case that they can sell a lot more in the future.

The reason is simple: A web merchant selling $100 million that doubles in size is now a $200 million company and may well be worth $200 million or more to another buyer, whereas 100% growth only makes a $10 million company into a $20 million company. That’s why smaller companies attract scant investor interest.

Private equity investors only begin to pay attention when a company has at least $10 million in annual revenue and $1 million in EBITDA, says Rose of Tully & Holland. There are business brokers that handle sales of smaller companies, and another retailer might buy a smaller e-retailer as an add-on. But private equity won’t get involved in deals for very small companies, he says.

Among the 25 publicly announced deals Internet Retailer studied for this report, the smallest revenue number for a Top 1000 e-retailer acquired was the $21 million Trunk Club booked in 2013, the year before it was acquired by Nordstrom for $350 million. That was during a time when Nordstrom was making investments to build up its e-commerce expertise, including acquiring flash-sale site Hautelook and investing in Bonobos. The tony department store chain might have gotten value from the Trunk Club talent it acquired, but it recognized late in 2016 that it didn’t justify the purchase price and wrote down $197 million of that investment.

In general, strategic investors—one retailer buying another, for example—are looking for businesses that already have reached a significant size, says Akshat Dubey, deal strategy principal at the strategy & advisory unit of consulting firm PwC. “Strategics tend to get interested in companies once they have some scale,” he says. “They don’t want to take on the job of fixing the operation. If someone else has done that, they’re willing to pay a premium for that.”

Private equity investors only begin to

pay attention when a company has at least $10 million in

annual revenue and $1 billion in EBITDA




A private equity firm, Dubey says, might be interested in a firm that’s not yet very big, especially if it appears there are ways to improve results by professionalizing the operation.

Like investors, Internet Retailer’s valuation formula puts a premium on size: The retailers in the Top 100 are valued at 13 times more than those in the 401-600 range, by our estimate, and more than 150 times more than those ranked 901-1000.

One other reason why it’s hard to sell small companies are the fees investment banks charge for managing such deals. Those fees can easily run north of $1 million, and acquiring companies rarely want to pay more than 2-3% of the value of the deal in advisory fees. That means that the investment banks that broker deals like these are usually only going to get involved when an online retailer has at least $30 million in sales, and more often $50 million or more.

ROOM FOR GROWTHBeyond current size, investors look for potential for growth. Investment bankers often talk about looking for the “white space” ahead of an online retailer. If they’re selling a very niche product, how much more of it can they sell?

While the category has to be large enough that there is room for significant growth, the online retailer has to be able to make a credible case that it can capture a significant share of that larger category. One example of an e-retailer making that case is Poppin.com, which is growing rapidly by selling its own brand of color-coordinated office products and modular office furniture.

Another example is Chewy, which expected its final sales total for 2016 would come in at $880 million, more than double the $423 million of 2015. Chewy has taken on far larger competitors in part with personal service—something that’s not easy for a website to provide. The e-retailer operates a round-the-clock contact center and its 450 customer service agents are encouraged to chat with customers about their pets to build loyalty. The e-retailer also sent 2 million handwritten holiday notes to customers that, CEO Ryan Cohen says, merely wished them and their pets a happy holiday, and included no coupon or pitch to buy.

Another web-only retailer attracting investor attention is Stitch Fix, which sells apparel—a nearly $300 billion market in the U.S. alone but one in which there are many competitors. Stitch Fix differentiates itself by creating a style profile for each customer and offering to send five

Strategic investors are willing to pay a premium for e-retailers that have

grown to a significant

size.




items to the shopper’s home for her to try on. She’s encouraged to send back what she doesn’t want, and shipping both ways is free.

While size is important, retailers should keep in mind that sometimes they will get more credit for growth than scale, says Ed Han of Tiny Prints, which Shutterfly Inc. purchased in 2011 for $333 million. During an extremely fast growth phase, an e-retailer might command a high multiple, but that multiple could be lower a year later when the company’s sales are greater but growth is lower.

“It’s ironic that you could be a $50 million company that attracts investment or sells at $150 million, or you could grow to $150 million and still sell for $150 million,” Han says. “There are people willing to pay three times sales when you’re the next Amazon or other high-growth retailer. But a lot of retail companies’ sales top out at around $100 million, and what they can get at that point may be not much more, or even less, than what they could get when they were at $50 million.”

In other words, as in many things, timing is crucial. Each retailer must evaluate when it can get the most value for its business. And investors must look critically at high-flying retailers to determine how much growth lies ahead.

3. SALES STRATEGY AND ECONOMICSHow you sell can be as important as what you sell. The most valuable online retailers sell their own product exclusively on their own website: That way a consumer must go to them to get their merchandise, they don’t have to compete on price and they build a file of loyal customers they can market to.

With the dramatic growth of Amazon—and especially its marketplace that sells goods from other retailers—the question of whether a retailer sells on Amazon comes up in many conversations with investors. Those Amazon sales are viewed as less valuable because a marketplace seller who makes a sale on Amazon is not allowed by Amazon rules to follow up with that customer. That sale doesn’t add to the retailer’s email list. And the next time the shopper goes back to Amazon to shop for that product she may buy from the same seller because she was satisfied with the previous purchase, but she’ll also likely see lots of merchandise from competing retailers.

“Someone totally reliant on Amazon is a lot less attractive than someone who is relying on their own customer relationships,” says Corey Whisner, partner at Rotunda Capital Partners, a private equity

‘There are people willing to pay three times

sales when you’re the next Amazon.’— Ed Han, Co-founder,

Tiny Prints




firm specializing in lower mid-market firms. “Not that there shouldn’t be sales through Amazon, but it should be one channel among many.”

Eric Roth of Lazard goes further: He thinks the lure of Amazon’s massive customer base represents a danger for many smaller online retailers. “The Amazon Marketplace is a highly addictive drug for most e-commerce guys who lack scale,” he says. “The most valuable revenue you have is revenue from your own website. If you’re doing less than 70% or 80% of your business from your own website, that’s dangerous.”

To a lesser extent, sales on eBay and other online marketplaces are also less valued by investors. While the restrictions on follow-on marketing are usually less onerous, the customer is likely to return to that market-place where she’ll see many competing products.

In the Internet Retailer study of 553 privately held e-retailers, those that don’t sell on Amazon and eBay on average earned a valuation more than double that of those who sold on at least one of those marketplaces.

THE CATALOG QUESTIONThere are many ways besides online marketplaces to reach consumers directly. Investors look at each method from the perspective of whether they bring a retailer loyal customers and at what cost.

Retailers send fewer printed catalogs than they did in the pre-internet days, but there are still 100 privately held retailers in the Internet Retailer Top 1000 that generate a lot of business from catalogs, even if many times the consumer purchases online. Do catalogs add or reduce the value of such companies? Opinions vary.

Stuart Rose of Tully and Holland, who has a long history of working with catalogers, believes catalog customers typically have a higher lifetime value to a retailer than a shopper who only buys online. “Internet customers tend to buy a single item, there’s a smaller average order value and less loyalty,” Rose says. “To the extent you can build loyalty you increase the value of a retailer.”

But others say the cost of printing and mailing catalogs increases the expense of generating sales. Tom West, CEO of digital marketing agency Springbox who works with private equity firms to assess potential acquisitions, says the marketing spend on catalog-generated revenue averages around 30%, versus 10% for driving sales online. However, that can be an opportunity: If the catalog retailer can drive more of its loyal shoppers via online marketing, such as email, that can cut their costs and improve margins.

‘If you’re doing less than 70% or 80% of your

business from your own website, that’s dangerous.’

—Eric Roth, Managing Director,

Lazard

E-RETAILERS THAT DON’T SELL ON AMAZON AND EBAY ARE VALUED

BOTH CATALOGERS AND WEB-ONLY RETAILERS HAVE A MEDIAN VALUE OF

0.81 TIMES SALES

HIGHER THAN THOSE THAT DO.

150%






THE VALUE OF SEARCH ENGINE SHOPPERSJust as there is more than one way to look at catalogs, there are varying perspectives on search marketing.

West says he recently analyzed six highly successful e-retail companies in a variety of categories and found they all were winning at SEO, showing up high in the natural search results on Google and Bing. That’s a big win, because a retailer doesn’t pay for clicks from those links, unlike with paid search ads.

“These guys have 20-50% of their traffic coming in for free, which means they’re able to make their marketing dollars work dramatically harder” to drive other shoppers to their sites. Strong SEO results means “you’ll have lower marketing spend per dollar of revenue than the next guy.”

But it can be dangerous to rely too much on showing up high in organic search results at a time when Google in particular has been devoting more of the search results page to paid ads. One banker recalls a retailer client that got 80% of his traffic from organic search and found that investors didn’t think that would be sustainable. Plus, while a retailer can grow quickly by spending more on paid search ads, there is no sure way to improve SEO and drive a lot more sales. “You need to have a balance between free and paid search,” West says.

As an example of running into the limits of SEO, Roth points to Wayfair. The web-only retailer built its business by rolling out some 270 niche e-commerce sites like BedroomFurniture.com and Cookware.com. Those distinctive URLs helped those sites show up high in natural search results, but consumers didn’t know they were all owned by one company, and thus cross-sell opportunities were lost. By uniting under one brand and investing heavily in pay-per-click search ads, Roth says, Wayfair was able to grow quickly and carry out a successful $319 million IPO in 2014.

Rose agrees that investors are not always enamored of traffic from natural search results, because it’s not easy to grow. “I know how to increase pay-per-click traffic,” he says, “but I don’t know how to increase SEO traffic.” In general, Rose says, investors prefer sources of traffic that are in a retailer’s control, whether that’s paid search, email, catalogs or TV advertising.

CUSTOMER ACQUISITION ECONOMICSInvestors are well aware, however, that an online retailer can dramati-cally increase sales by pouring money into paid search without neces-sarily building a sustainable business. Online retailers like Fab.com

Investors prefer sources of traffic that are in a retailer's control like

paid search, email, catalogs or

TV ads.




and Choxi (former NoMoreRack) that grew rapidly and then collapsed quickly are cautionary examples.

That’s why investors look at both sides of the marketing equation: what it takes to acquire a customer and how much the typical customer spends with that retailer over time.

That ratio of customer lifetime value to acquisition cost is one data point online retailer Mobovida tracks closely, says Edwin Choi, vice president of marketing for the company, which raised $1.9 million in early-stage funding in 2014 but has yet to generate enough web sales to crack the Top 1000. He says for Mobovida, which sells cell phone cases, the ratio of customer lifetime value to acquisition cost is at least 6:1.

He says Mobovida achieves that healthy ratio by constantly testing all its marketing, whether that’s paid search, SEO or ads on social networks like Facebook and Instagram. “We’re fanatical about every penny,” he says.

Those marketing channels are also used to quickly test new products. Choi says Mobovida will produce a few hundred pieces of a new product and see how online shoppers respond to it. If response is good, the e-retailer can get 5,000 to 10,000 items shipped from factories in China within four weeks.

In one case, consumers on Facebook let Mobovida know they wanted more slots for credit cards and a case made out of suede. That feedback enabled the online merchant to produce two successful new SKUs.

A strong following on social media can produce lots of free traffic to an e-commerce site as well as feedback and word-of-mouth promotion from one friend to another. That’s why there is strong interest from investors in apparel brands like Ivory Ella LLC and Lauren James that market themselves primarily via online social networks.

4. MANAGEMENT MATTERSThe quality of an online retailer’s management team has a big impact on the company’s value, investment bankers say.

That was shown in a big way in Wal-Mart’s $3.3 billion acquisition of Jet.com in 2016. Jet’s founder and CEO, Marc Lore, quickly became Wal-Mart’s e-commerce chief, and several others who came over from Jet replaced senior Walmart.com executives.

Of course, Jet had raised $565 million in less than two years of existence before it was bought by Wal-Mart, and it had the cash to bring in top




e-commerce executives, many of whom previously had worked with Lore at Quidsi, the parent of Diapers.com that Amazon acquired in 2010. Many of the entrepreneurs driving fast-growing start-ups may not feel they can afford to invest in bringing in professionals to manage the company’s finances and operations.

It’s a common mistake, says Eric Roth of Lazard. “When you’re closing in on $100 million in revenue, maybe even $50 million, not having a CFO [chief financial officer] or controller is a mistake,” Roth says. “The professionalism of a team, or lack thereof, it’s hard to quantify what it means, but it does matter.”

When a business that is primarily managed by the CEO gets bought, often 30-40% of the purchase price will be in the form of an earn-out over time to guarantee that the brains behind the operation sticks around to run the business, Roth says.

Professionalizing management can take many forms. For Chewy, which must deliver heavy bags and cans of pet food, efficient fulfillment is a priority. The fast-growing retailer has hired more than 50 Amazon fulfillment executives at the manager level or above to ensure its fulfillment operation is as efficient as possible, says CEO Ryan Cohen.

For Online Stores, which operates eight e-commerce sites, it’s meant investing heavily in information technology talent and systems to cut costs, says CEO Kevin Hickey. It’s automated as much of its operation as possible, and made sure its accounting and planning software is plugged into the inventory systems of suppliers so it knows what’s in stock and when out-of-stock items will be available again. That’s enabled Online Stores to cut its headcount from 130 to 80 in the past five years, even as its sales have increased 30%.

Another aspect of professionalism is preparing for a sale. After going through the process of selling Cuddledown, the catalog and online retailer of bedding products, former president Chris Bradley says he wished he had started years earlier getting the business ready for sale. “Make sure you have audited financial state-ments, preferably from one of the larger accounting firms,” Bradley says. “Have a signed, final copy of every single contract that you have and probably ever had. And have all that in a binder.”

When Bradley was told selling the company would become a full-time job, he didn’t believe it. But for nine months it was. His advice to e-retailers contemplating a sale: Start preparing early and get an experienced investment banker and mergers and acquisition lawyer to help you through the process.

‘When you’re closing in on $100 million

in revenue, maybe even $50 million, not having a CFO or

controller is a mistake.’—Eric Roth,

Managing Director, Lazard

50Number of

Amazon fulfillment managers Chewy.com

hired to professionalize its operation.

CUSTOM RESEARCH ON THE VALUE OF AMERICA’S E-RETAILERS

Who are America’s most valuable e-retailers?

What’s the value of your e-commerce business compared to that of your competition?

What e-retailing categories boast the highest valuations?

?Internet Retailer’s Research Division can produce custom valuation reports that provide the answers by tapping into our valuation database on America’s top 553 privately-held e-retail companies.*

For custom valuation report content and pricing details contact

Steve RogersCustom Research Sales Director

[email protected]: 312.572.6263

Data does not include valuations of publicly-held web merchants or catalog retailers. The report also does not include any data on consumer brand manufacturers. Data does not contain any estimate of the companies’ operational expenses or company financials. This report is based exclusively on Internet Retailers data and historical data and does not include financials provided by the company.

*

IRRESEARCH the global leader in e-commerce data




Shopping keeps moving online, which will continue to make online retailer valuable acqui-sition targets, particularly for store-based retailers seeking to catch up with Amazon in e-commerce. While sales at physical stores increased only 2.4% in November and December 2016, according to an Internet Retailer analysis of U.S. Commerce Department data, online sales grew between 11% and 19% over the holiday period, based on various estimates. The successful recent exits of online marketplace Jet.com and shaving supplies e-retailer Dollar Shave Club should give investors more confidence about putting money into the online retail category.

The internet keeps bringing in new kinds of retail companies, and that’s not likely to change. Think of the companies like Blue Apron and Plated delivering to consumers the ingredients for dinners they cook, online consignment retailers like The Real Real or customized jewelers like Gemvara. Some of these will change retailing forever, just as Netflix transformed entertainment. But some will fade and cost investors money, as comparison shopping engines and flash-sale sites did. Into which category will subscription retailers fall? Web merchants who market themselves as socially conscious? A hard look at how often customers return and how much they buy over time versus an e-retailer’s marketing costs will help investors separate the company’s building lasting value from those destined to fizzle out.

Every e-retailer must be evaluated from the perspective of: Is this company doing something Amazon can’t do well or is not likely to try? Even unique brands like L.L. Bean and Burberry aren’t immune from competition from Amazon, given the No. 1 e-retailer’s growing investment in private-label goods. But what Amazon does best is move large quantities of commodity prod-ucts efficiently. It hasn’t shown it can provide the kind of expertise consumers want when buying complex products or that it can customize merchandise at scale. Those are areas where successful online retailers may retain a competitive advantage.


E-RETAILERS

PART III

Conclusion FOR INVESTORS

As this report was written with both buyers (strategic and financial investors) and sellers (online retailers) in mind, we’ll conclude with key takeaways for each audience.



PART III CONCLUSION

You have to be unique in some way to succeed in e-commerce today. Selling the same products shoppers can find at Amazon or Wal-Mart won’t pique investors’ interest, or likely lead to sustained profits. Proprietary product, a unique service or the ability to customize product are among the ways an online retailer can set itself apart.

Build a large file of loyal customers that will buy from you again and again. That will enable you to market to them at low cost, whether that’s through email or social media. Excellent customer service is a key component of that strategy: A happy customer is likely to spread the word through social networks like Facebook, Twitter, Pinterest and Instagram, multiplying the impact of each positive interaction, and attracting new customers at low cost.

Recognize when it’s time to bring in professional managers. A tough CFO or controller will not only keep your costs in check and help you avoid expensive mistakes, he or she will bolster investors’ confidence in your company. Obtain audited finan-cial statements and make sure to keep a copy of every contract in one secure place. That will save time and frustration when it comes time to make a deal.

Conclusion

FOR ONLINE

RETAILERS



Wal-Mart Stores Inc.’s scale and breadth of offering means it competes head to head with Amazon across hundreds of product categories and millions of third-party SKUs with nearly total price transparency. The recent

acquisition of Jet.com, a company that is far from profitable with approximately $1 billion in gross merchandise value (which translates to a fraction of that in Jet.com revenue), for $3.3 billion is, on some level, an acknowledgement of this dynamic.

E-commerce comprises less than 3% of Wal-Mart’s total sales and Wal-Mart is committed to increasing this percentage. Jet.com’s senior management team and ability to complete online, albeit in a low-margin manner, across a broad array of products made them a logical acquisition target. Time will tell whether Jet.com will pay dividends for Wal-Mart’s online strategy. The rest of the e-commerce landscape, however, is comprised of retailers who are more specialized and lack the global scale of Wal-Mart. As a result, they can be more selective in how they compete; they don’t have to “out-Amazon Amazon.” This article highlights several strategies that online retailers are using to compete in an Amazon world and increase the value of their businesses.

DIFFERENTIATE THROUGH PRODUCT EXPERTISEAccording to retail price and intelligence data provider 360pi, Amazon currently offers nearly 16 million products (excluding books, wine,


E-RETAILERS

SMALLER ONLINE RETAILERS CAN BE

SUCCESSFUL BY FOCUSING ON A FEW AREAS THAT DIFFERENTIATE THEM

FROM AMAZON AND EXECUTING

FLAWLESSLY.

How online

retailers can increase their value in an Amazon world

BY ERIC ROTH, MANAGING DIRECTOR AND HEAD OF THE CONSUMER RETAIL

GROUP, LAZARD MIDDLE MARKET

AND RYAN HAYS, A DIRECTOR IN THE SAME GROUP



EXPERT ADVICE HOW TO INCREASE VALUE

media and services). The total rises to nearly 420 million, however, when items offered by Amazon Marketplace sellers are included. Such breadth of product assortment comes at a cost—it is difficult, if not impossible, to staff customer service representatives that possess product knowledge, let alone in-depth product knowledge, across such a wide range of product categories. This represents an important opportunity for more focused online retailers to differentiate them-selves by providing substantive advice to consumers. This strategy is especially effective where products are application-specific, have high average order value (AOV), or other complications which make them more likely to generate consumer questions.

Online retailer Power Equipment Direct Inc. is an example of a retailer that’s differentiated itself with product expertise. PED has built a successful online business selling outdoor power equipment, such as electric generators, snow blowers and lawn mowers. Most of PED’s product categories have high average order values or are application-specific, creating an opportunity to provide meaningful product expertise online and through its call center. Each product category has an assigned product expert who possesses in-depth knowledge about the products in his or her category.

Encouraging customers to submit online inquiries or call with questions is an effective differentiator. Not only do phone calls have a significantly higher conversion rate and AOV than web orders, customers who place an order on the phone have a higher reorder rate than those who place orders exclusively through the website.

ECS Tuning provides another example. It is an online retailer of aftermarket performance parts for a select group of automotive manufacturers (Audi, BMW, Mercedes, Mini, Porsche, and Volkswagen) that have an enthusiast customer base. Competing in the automotive aftermarket category requires not only that online retailers maintain accurate databases, indexing which parts are compatible with which makes, models, and years, but also it requires an in-depth understanding of what the consumers themselves want to achieve with the purchase. The ability to solve a customer’s problem (or prevent one by ensuring the right part for the job) is an invaluable differentiator, which is why the ECS Tuning focuses on hiring customer service representatives who are auto enthusiasts with deep knowledge and passion.




DELIVER THE UNEXPECTEDDifferentiation through customer service requires more than just timely responses to inquiries about order status or a hassle-free experience when dealing with the unpleasant matter of cancellations or returns. Those are now table stakes for minimally acceptable service levels. Delivering unexpectedly positive customer service experiences create meaningful differentiation and enhanced brand loyalty.

Online pet food retailer Chewy.com delivers exceptionally high customer satisfaction through a relentless focus on delivering the unexpected. Chewy’s tactics for establishing and maintaining a loyal customer following are varied and sometimes unconventional: lottery drawings for pet parents to win free oil paintings of their pets have perhaps created more buzz than anything, but handwritten thank-you cards sent to each customer and the profiles and notes kept by Chewy on each pet have enabled the company to create a genuine, personalized connection with their customers. While these tactics may seem incremental, doing the small things right can produce big results. Chewy.com expected to generate $880 million in sales in 2016 and around $1.5 billion in sales for 2017.

NAVIGATE SUPPLY CHAIN COMPLEXITIESOne of the challenges for Amazon in managing over 15 million SKUs is that it is difficult to navigate complex supply chains, particularly when dealing with manufacturers or distributors in sectors that requires a hands-on approach or in-depth buying expertise.

That difficulty provides an opportunity for a retailer like YDesign Group, which offers design-driven modern home furnishings in the lighting, bath and furniture categories. Many of the manufacturers represented by YDesign are small brands that have chosen not to distribute through Amazon. The complexities of facilitating timely drop-ship deliveries (as well as returns) by small, artisan manufac-turers in relatively low order volumes is a pocket of e-commerce that creates challenges for larger e-commerce players whose models are based around scalability of infrastructure and processes.

PET SUPPLIES E-RETAILER CHEWY.COM

SENT 2 MILLION CUSTOMERS PERSONALIZED HOLIDAY CARDS

IN LATE 2016.




Off-price retail represents another pocket of supply chain complexity for Amazon. It is difficult for Amazon to offer first-quality goods at significant discounts to MAP pricing without jeopardizing relation-ships with the manufacturers. (Manufacturers often create minimum advertised price, or MAP, policies that effectively limit discounting by resellers.) And while many Amazon Marketplace sellers offer purport-edly first-quality merchandise at low prices, these retailers often do so in limited quantities and lack brand recognition, which can cause skepticism about the product being offered.

Overstock.com, with nearly $1.7 billion in annual web sales, has been the leader in this category online. But it is not alone. FragranceNet.com has successfully established itself as the off-price leader in the fragrance and hair care categories by leveraging nearly two decades of experience and developing proprietary technology and tools that enable its merchants to secure inventory at a relatively low cost from a complex, global supply chain.

DEVELOP UNIQUE PRODUCTSWhile the convergence of brands and channel—i.e., retailers are increasingly developing and selling their own products, while brands are increasingly operating their own retail stores and e-commerce sites—is a macro trend that has been accelerating, Amazon has certainly helped to hasten its arrival. By increasing access to third-party brands at low prices, Amazon has squeezed the margins of retailers in almost every category, brick and mortar or online. In response, retailers have placed a greater emphasis on private-label products.

Such products generate higher margins by cutting out a step in the supply chain and are not shoppable—that is, a consumer can’t compare price because the retailer that creates its own branded goods is the only source of that merchandise. Private-label goods also can reduce dependence on increasingly expensive brand-oriented keywords. A retailer selling Calvin Klein dresses will be competing on Google with the likes of Macy’s, Lord & Taylor, Amazon and Calvin Klein itself. But an e-retailer like Lulus.com that designs its own clothing dominates search results for its Catalina Classic Bodycon Midi dress.




Another example is eBags Inc., which has successfully leveraged private-label products for over 10 years to supplement its third-party brand product offering in the otherwise highly competitive luggage and travel accessories market. And while such opportunities for established retailers can prove highly effective, digitally native vertical brands have sought to harness the power of the e-commerce channel as the primary point of distribution for their own branded products.

The market is well acquainted with the early successes of Bonobos, Warby Parker and Dollar Shave Club. But the trend toward digitally native vertical brands has produced a class of exciting companies across a broad spectrum of product categories—Away (luggage), Casper (mattresses), Honest Company (household products), Mac Wheldon (underwear), and Paula’s Choice (skin care) are several examples. By focusing on developing successful consumer products and controlling their distribution, these brands have harnessed the scalability of the e-commerce channel, while avoiding the pitfalls of direct competition with much larger, better-capitalized players like Amazon.

PURSUE ALTERNATIVE GO-TO-MARKET STRATEGIESAccording to BloomReach’s State of Amazon 2016 report, approximately 55% of consumers turn to Amazon first when searching for products, up from 44% in 2015. And when consumers do start their searches elsewhere, it doesn’t necessarily get easier for online retailers, as they still compete with Amazon, as well as other large retailers in a highly efficient market for the top search terms.

While some retailers, such as Wayfair Inc. and Build.com Inc. have invested heavily to brand their own sites in furniture/home décor and home improvement products, respectively, to become destinations themselves, such investments are implausibly expensive for most smaller online retailers. The competitive pressure in online search and the expense associated with brand building has accelerated the trend of online retailers looking to other, frequently traditional retail channels.

As competition in (and cost of) digital advertising continues to increase, many online retailers are increasing their offline advertising budgets, especially in print media. Direct mail offers a variety of




benefits and flexible formats (for example, from postcards to free-standing inserts to full catalogs) that cannot be as easily conveyed in digital formats. Catalogs in particular offer an opportunity not only to artfully communicate a strong brand message to the consumer, it also encourages consumers to actually shop—by browsing a curated selection of products—rather than to simply search and transact.

Additionally, many formerly pure-play online retailers (e.g., Warby Parker, Bonobos, BaubleBar, and Rent the Runway) have ventured into bricks-and-mortar formats to drive brand awareness and enable consumers to touch and try their products. Other online retailers use pop-up shops to reap the benefits of a bricks-and-mortar presence around high-volume seasons without making large bets on long-term leases (e.g., The Tie Bar).

Interestingly, several online retailers have sought to gain exclusive access to customers at the source of their discretionary income—their employers. For example, online retailer Purchasing Power offers a wide range of general merchandise products through an employee portal tailored to the specifications of a particular employer. The company also offers installment payment programs directly through payroll deduction to facilitate big-ticket purchases.

Similarly, GovX, is an e-commerce site that serves active-duty, reserve, and retired members of the U.S. armed forces, law enforcement, first responders, and other government agencies. Membership, which is established through a verification process, grants access to discounted merchandise and special offers.

CONCLUSION: SMALLER RETAILERS CAN COMPETE WITH AMAZONAmazon’s scale creates opportunities for smaller, nimbler online retailers to differentiate themselves by finding highly defensible niches or employing tactics that are difficult to execute within an organization that’s generating annual sales in excess of $125 billion. Unlike Wal-Mart, which must directly compete with Amazon across the board to protect its core business, smaller online retailers can be successful by focusing on a few areas that differentiate them from Amazon and executing flawlessly. And those that are successful will draw interest from investors.

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