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Direct to consumer business model – freak out accountants

5 piles of coins with the word aargh written over the top of them

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Why read this? : We share the challenges of the direct to consumer business model. Learn how D2C’s financial drivers can 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 the owner of our own direct to consumer (D2C) online store, we know one of the biggest concerns in this area is the finances.

Keeping a close eye on your profit and loss matters a great deal.

Unless you do your own business finances, chances are you have a finance team or accountant looking after the numbers. And at some point, they’ll want to validate your direct to consumer business model.

5 piles of coins with the word aargh written over the top of them

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 finance teams and accountants.

Let’s face it, they 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 like to get into the detail of the numbers, right?

Direct to consumer - always start with the consumer

As the old saying goes, money makes the world go round. Accountants are important in any business. But you have to remember where the money comes from. It comes from customers. You put them first, and only when you satisfy them can 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. Or predictable.

Just ask the toilet paper companies how their forecast accuracy went during Covid-19. 

Even sales and marketing people who are normally more used to disruption struggle with the D2C profit and loss (P&L). That’s why this week we share business model lessons from our very first D2C store. There were lots of lessons worth sharing. 

Our first direct to consumer business model - some context 

We’d put together an overall e-Commerce strategy and plan using 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 was accelerating those sales.

The product range we sold had a relatively fixed, niche audience in Australia. But it was also popular overseas, so there were ongoing peaks and troughs of supply and demand.

This unpredictability caused many problems.

e-commerce planning process - The 5 key steps of the e-commerce process

The struggle to keep a consistent supply going meant challenging relationships with online retailers. They were focused on the day-to-day operation of hitting their sales numbers. They didn’t want to talk about anything that might be different or improve the customer experience.

In terms of Pure Player, there were only a few small players around. It was before Amazon set up in Australia. So, there weren’t many other sales channel options. That’s when we started considering doing D2C. And that meant building our direct to consumer business model. There were many barriers to overcome with this, but we’ll focus on those driven by the finances.  

Freak warning #1 - D2C conversion rate

Our choice to set up a D2C online store website was part of our overall strategy to connect, commercialise and control.

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. So where do you start with something totally new?

Three brains e-Commerce online purchase with credit card

How many customers do you think you can get?

This brings us to business case challenge number one. How many customers did we think we could get?

The top of the profit and loss is driven by how many customers you attract and the price they pay. We decided the price as it was our store after all. This was the RRP we gave our retail customers, but we offered better customer service and a wider range. We didn’t want to compete on price.

In fact, we made of point of NOT price discounting as that would put us in direct competition with the retailers. Our competitive strategy was more about differentiation. 

With all that in mind,  how do you work out how many actual customers you think you’ll 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 use to estimate the potential.

We had website traffic data from our branded websites. That gave us an 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 from <1% to 10% but the median was 2%, so we went with that.

Google hmne page on a Samsung phone lores

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 surprising if you’re new to 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. They’re unpredictable.

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 hard to do. And maybe those non-buying visitors are just competitors checking you out?

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 businesses, the finance or accounting team will obsess about the profit percentage or ratio of cost / selling price.

While total sales are clearly important, the profit percentage you make on a sale also matters. It’s a sign of your business efficiency.

Better to sell $1,000 of products at 20% profit, than $10,000 of products at 1% profit. 

Close up of old style Texas Instruments calculator

What’s key here is that most businesses that sell to retailers calculate the profitability on the price the retail customer pays them, not the price the shopper pays.

So, if your product costs $10 to make, you sell it to a retailer for $20, and a shopper pays $30 to buy it from them, your profit is the $10 / $20 the retailer pays you. 50% margin. Awesome.

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 shopper 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 it’s only your gross, not your net profit. You’ve still got other costs to cover. 

That $10 you effectively paid the retailer got the product into 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 have to manage and pay for all of those things yourself. And as we discovered, $10 would be a good delivery cost per item. It was more like $15-$20. 

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.

Food delivery cyclist on busy nighttime street

Remember the benefits of the Direct to Consumer business model

If this sounds like a bit of a mindfuck, imagine when the accountant 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 to the board.

Let’s just say a considerable amount of fucks were given that night to come up with a new story. In short, the headline was to 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 dependence 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 finance partner helped us get the case approved by pointing out that the D2C forecast sales were so low in year one, that it wouldn’t affect the total business profitability percentage.

This was 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 a 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.

Close up of a delivery driver handing over a cardboard box delivery to a customer

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 Outback cattle station.

And you don’t know where your orders will come from unless you use geolocation blocks on the site. Plus, 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 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 finance to nail the story down so everyone got it. Here are the key messages we landed to get through those conversations.

Unfair comparisons

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.

Cash flow

On an absolute net percentage basis, it can be very attractive. And there are lots of financial benefits 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 30-90 days as 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, there are so many extra benefits to D2C that if you don’t do it, someone else will get 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 idea what digital transformation was at the time anyway. But we knew they didn’t want to be considered as laggards in digital.

Conclusion - Direct to consumer business model

If your business is planning or doing D2C, we hope our experience of building a profit and loss and direct to consumer business model helps

We hope it helps you craft a strong story to share 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.

Screengrab of Three-brains Shop - headline says "merchandise to raise your game"

Check out our online store business models guide for more on this. Or get in touch, if you want a D2C business model that won’t freak out accountants. Even though, we like the idea of freaking them out. Everyone needs some unpredictability in their life to make it interesting. Even accountants.

Photo credits

Coins in small piles (adapted) : Photo by Ibrahim Rifath on Unsplash

Credit Card / Laptop : Photo by rupixen.com on Unsplash

Google Tablet : Photo by PhotoMIX Ltd. from Pexels

Calculator : Photo by Ray Reyes on Unsplash

Food delivery cyclist : Photo by Brett Jordan on Unsplash

Delivery – driver handing over package : Photo by RoseBox رز باکس on Unsplash

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