Why read this? : We share the challenges you face with the direct to consumer business model. Learn the challenging financial drivers behind D2C which often freak out accountants. We share lessons and examples from our first direct to consumer business model. Read this to learn how to navigate the financial challenges of D2C.
Direct to consumer business model
As business owners who also run our own Direct to consumer (D2C) online store, we know one of the most important concerns is your finances.
Keeping a close eye on your profit and loss matters a great deal.
If you’re a small business, then you’re probably also the ‘finance team’ for your business, so it’s easier.
But in a larger business, chances are you have a finance team or an accountant who controls the finances for the D2C channel.
And who’ll want to validate your direct to consumer business model.
From the D2C channels we’ve set up in the past, we know D2C requires a different way of thinking about the business model.
And ‘different way of thinking’ isn’t a phrase you normally think of when it comes to accountants.
Let’s face it, accountants LOVE stability. They LOVE predictability. How many meetings have you sat in where someone from finance asks you why you didn’t hit THAT number? Or why your forecast isn’t higher, given the money you’re spending. They do like to get into the numbers, don’t they?
Direct to consumer - always start with the consumer
As the old saying says, money makes the world go round. Accountants are important in any business. But you need to remember where the money comes from. It comes from customers. You put them first, and only when you satisfy them should you start counting your money.
If the D2C experience is good for customers, then it follows, D2C will benefit your business by bringing in more customers.
And customers aren’t stable.
Customers aren’t predictable.
Just ask the toilet paper manufacturers how their forecast accuracy is going just now. (Sorry, trying to socially distance ourselves from all the Coronavirus bandwagon jumping going on right now. But it’s so pervasive, it’s hard to not refer to it at all.)
Heck, even, sales and marketing people who are normally more pre-disposed to disruption and change can really struggle with the D2C profit and loss (P&L). That’s why this week we share lessons from our very first D2C business case. We learned a lot about D2C when we did this, and we think those lessons are worth sharing.
Our first direct to consumer business model - some context
We’d put together an overall e-Commerce strategy and plan for this business that broadly followed the e-Commerce planning process.
We started with a focus on existing online retailers. We already had online sales from those customers, so the quickest win accelerating those sales.
The product range we sold had a relatively fixed, niche audience in Australia. But it was also popular overseas, and so there were on-going peaks and troughs of supply and demand.
This unpredictability caused many problems.
This struggle to keep a consistent sales and supply line going (damn, those accountants again) meant that building relationships with online retailers was a constant challenge.
They, quite rightly, were focussed on the day to day operation of hitting their sales numbers. They wouldn’t give up time to talk about anything that might be different or build a better customer experience.
And Pure Player wise, there were only a couple of niche players around at the time.
It was before the days when Amazon set up its physical operations in Australia. So, there wasn’t a lot of other sales channel options. So, that’s when we started to consider adding D2C in to the mix. And that meant creating a Direct to Consumer business model.
There were a lot of barriers to overcome on the overall project, but in this article we’ll focus on the barriers we met working with the finance team.
Freak warning #1 - D2C conversion rate
Connect with online shoppers. Commercialise the offer to drive sales and profits. And, bring some control to the challenges of supply and demand.
But this category had never had a D2C offer before. There was no precedent or existing data to pull on to inform the business case. For something that’s totally new, where do you start?
How many customers do you think you can get?
So let’s tackle business case challenge number one. How many customers did we think we could get?
The top of the profit and loss is driven by the number of customers you attract and the price they pay.
We obviously had control over the price. It was our store after all. This was the same RRP as our retail customers charged. Plus, we were set up to add better customer service and a wider range. We didn’t want to be a price competitor.
In fact we made of point of NOT price discounting because that would put us in direct competition with the retailers. Our competitive strategy was definitely more differentiation that cost leadership. .
With all that in mind, how do you work out how many actual customers you think you will get?
Here’s the thing. Doing your first e-Commerce forecast is hard. There’s no easy way to work out how many people will buy.
This is about predicting customer behaviour, and customers are unpredictable. Now, before all the statisticians start coughing loudly and talking about using regression models and econometric modelling to statistically predict future trends, remember, this was a brand new channel.
No data. None. Zero. Zilch.
How do you predict the future then?
Forecasting sales with no historic sales data
Our way was to look at what other data we could source to work out the total potential market.
We had website traffic data from our branded websites. That gave us a idea of how many customers might visit our online store.
And with some Google research, we found industry benchmarks for conversion rates of visits to sales.
Our conversion forecast was 2%. We found all sorts of forecasts ranging from <1% to 10% but the median seemed to be 2%, so we went with that.
But that was the first thing which freaked out the accountants.
A 2% conversion rate.
So 98% of people visiting your store won’t buy, they asked us. That’s hard to grasp if you’re new to e e-commerce. It sounds so wasteful and inefficient.
You have to explain that people visit websites for all sorts of reasons. They don’t always do what you want them to do.
Maybe they’re just checking out your prices? Like the widely reported concept of showrooming.
Maybe they want to check delivery areas and delivery costs? And they don’t like what you offer. Good value on delivery regularly comes out high on what online shoppers want. But it’s a hard one to deliver.
And maybe those non-buying visitors are just your competitors checking out what you’re doing?
Freak warning #2 - Percentage margin calculation will have a higher denominator
Here comes challenge number 2 to freak out your accountant. It’s a doozy.
In most business, the finance or accounting team will obsess about the profit percentage or ratio of cost / selling price.
While the total amount of sales is obviously important, the percentage profit you make on a sale is a good indicator of your business efficiency.
Better to sell $1,000 of products at 20% profit, than $10,000 of products at 1% profit.
So far, so good.
But what happens in most businesses who sell on to retailers, is they calculate the profitability not on the price the end consumer pays, but the price the retail customer pays them.
So, if your product costs $10 to make, you sell it to a retailer for $20, and a consumer pays $30 to buy it from a retailers, your profit is the $10 / $20 the retailer pays you. 50% margin.
The $10 the retailer makes isn’t part of your business, so it’s ignored by accountants. This is a basic principle in traditional profit and loss accounts.
The D2C denominator is what the consumer pays
You can see where this’s going, right?
Let’s take the same scenario with D2C.
Your product costs $10 to make. You sell it direct to the consumer for $30. Now, you’ve $20 at the top of your P&L where you only had $10 before. You’ve $20 profit out of $30 or 66% margin.
That’s better right?
Except it isn’t, because you don’t have $20 profit at all. It’s an important point. You DO NOT have $20 profit in this scenario.
That $10 you effectively paid the retailer got the product in to their warehouse. It covered the cost of getting the product from their warehouse to their store and then out and delivered (on the last mile) to a customer.
And retailers who manage thousands of products have spent years making sure the efficiency of that system drives the lowest delivery cost per item they can get.
By selling direct, you need to manage and pay for all of those things yourself. And as we discovered, $10 would be a pretty good delivery cost per item.
We’ve found it to be more in the $15-$20 range per delivery when you have low volume orders.
But let’s say you could cover those delivery costs for $10. That’s sell for $30. Less costs to make of $10, and costs to deliver of $10.
So, $10 profit left.
To an accountant, you’re now LESS profitable.
Because you’re making $10 from $30 income (33% margin) with those $20 in costs.
Remember the benefits of the Direct to Consumer business model
If this sounds like a bit of a mindfuck, imagine when our accountant who was supporting us on the very first Direct to Consumer business model sprung this on us at 6pm the night before we were due to present the final business case to the board.
Let’s just say a considerable amount of fucks were given that night building a story in to the business model. And we can summarise it as this.
Look at all the other benefits you get with Direct to Consumer.
Because there are a lot.
Ownership of customer data. Customer connections and the opportunity to build unique customer experiences. Less dependance on the retailers. Speed to market. Test and learn capability. E-commerce capability building in your business.
Are you going to throw all of those benefits away because of an accountancy rule of what should and shouldn’t be in your P&L?
In the end, our actually very supportive finance partner helped us get the case approved by pointing out that the D2C forecast sales were so small in year one, it would have no actual impact on the total business profitability percentage number.
This was actually what the board were more interested in.
Most of the board didn’t think it would take off. But they were interested enough in it to let us run it as pilot to see what would happen.
And it also raised the question, that if an item costs $10 to deliver, who pays for that?
Freak warning #3 - Delivery charges and costs sit where?
And here’s where it gets really crazy with your accountant. As if your Direct to Consumer business model hasn’t freaked them out enough already.
Let’s say to keep the profitability up, you decide the customer should pay $10 shipping on top of their $30 sale. This put your total ‘income’ up to $40 and your costs at $20 – back to our 50% benchmark.
Except now the consumer is paying $40 for something they can buy in a store for $30. You have to update your order forecasts to reflect this.
So, you go back in a loop to find the price and delivery point which will generate the most unit sales at the best profit.
And here’s the thing.
Delivery costs change depending on where you have to deliver the product. It’s way cheaper to deliver to the Sydney CBD than to some remote cattle station in the Northern Territory.
And you don’t really know where your orders will come from unless you put on some geolocation blocks on your site. And your delivery charge is normally based on weight and a per delivery charge.
So if you have a couple of items that aren’t heavy and can be shipped together, your delivery charge will be the same as it would be for sending a single item.
How to build your Direct to Consumer business model and not freak out your accountant
Confused? We were too, and it took a couple of sessions with our accountants to nail the story down so that everyone got it. Here’s the 3 key messages we landed which got us through those conversations.
Comparing D2C on net profitability percentages with traditional channels isn’t a fair comparison. Because of where the selling price and the delivery charge sit on a profit and loss, it’ll always look less profitable on a percentage basis.
On an absolute net percentage basis, it can be very attractive. And there’s a lot of financial benefit when it comes to things like cash flow from D2C.
You get paid right away by a D2C customer and don’t have to wait 30, 60, 90 days like you do with a trade customer. Accountants love cash flow and it’s a great balance to the profit percentage challenge.
Holistic business model
And if you look at the D2C business model holistically – and isn’t holistically, a great passive aggressive, can’t argue with that word in the world of business term? – there are so many extra benefits to running a D2C channel as we shared earlier, that someone else will get in there first.
And who wants to be remembered as a laggard rather than a leader when it comes to digital transformation?
Most of the board had little to no idea what digital transformation was at the time by the way. But we knew they wanted to be leaders rather than laggards in this area.
Hint that someone is a laggard in digital. It’s a real motivator for them to get off their arse and do something.
Conclusion - Direct to consumer business model
If your business seeing the benefit of selling D2C, we hope our experience of building your profit and loss and direct to consumer business model rings a few bells for you.
We hope you crafted a strong story that worked with the accountants in your business.
But if not, we can help you build your D2C business case. We can help you work through the challenges in setting up a great e-Commerce culture.
Though we’re marketing, creative and e-commerce creators at heart, we love building business cases. We love getting accountants on board.
Check out our skill guide on online store business models for more on this. Or contact us, if you want a D2C business model that won’t freak out accountants. Even though, we secretly quite enjoy the idea of freaking them out. Everyone needs a bit of unpredictability in their life to make things interesting. That applies to accountants too.