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Online store business model

Why read this? : We look at how the online store business model works. Learn how you plan resources, drive actions and track performance. We also dive into specifics on forecasting, positioning and cost management. Read this to raise your game at building an online store business model. 

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Online store business model

How this guide raises your game :-

  1. Learn how to forecast your share of your store’s customer universe. 
  2. Go through each line of an online store Profit and Loss to learn which KPIs to prioritise. 
  3. Learn how to manage the unique cost challenges of running an online store.

Our how to start selling online guide shows that with online channels like marketplaces and Print on Demand, you can start selling online quickly and work it out as you go.

But if you set up your own store, it’s usually best to plan your online store business model before you launch. 

You need to answer certain questions. For example, who’s your target audience? How will you meet their needs? What does their customer journey look like? How will you handle any issues which come up? And what will your profit and loss look like?

Glass jar knocked over on floor with coins spilled out onto the floor

Ready to test your knowledge?

What’s your starting level of knowledge about online store business models? Take the 2 minute, 5 question Three-Brains online store business model quiz and see how much you know about online store business models already.

Online store business model in the e-Commerce planning process

You find these answers as you go through the e-Commerce planning process. 

This starts with market research to identify the opportunity. You research your target audience and their needs. This covers both the product you sell and the service you offer. You also look at online shopper needs e.g. ease and convenience, range, price and product information. Shoppers expect these from their D2C experience.

Then you start to build your online store business model, to validate the opportunity. You work out how many customers you might attract (your customer universe), and how many you expect to get (your market share). Let’s look at how you work out these numbers.

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

Working out your online store universe

There are different ways to quantify your customer universe.

If you target mainly on demographics like gender, age or location, you can do secondary research to find out how many people are in those types of segments.

Government statistics sites like the ABS in Australia publish summaries of key demographics.

If you target behaviours like internet usage or online shopping, you can search online for research on those.

You can often find published reports like this one on the state of Australian e-Commerce.

Australian Bureau of Statistics Home page - headline statistics - Population 25.7m, Consumer Price Index 1.1%, GDP 1.8%, Average weekly earrings $1,711.60, Unemployment rate 4.9%

If you already sell via marketplaces, you can use the data you gather there to inform what might happen when you launch your own store. You can use your total number of customers and sales to estimate how big the market is.

Marketplaces share some aggregate data on users e.g. Gumtree shares they have 7 million+ users and 80,000 daily new listings. This can give you a benchmark as to what the total audience might be for your online offer.

You may also already have other market research which shows the total size of the market. Or, you can work it out from other sources. For example, if you’re a Business-to-Business service (B2B) in a specific industry, you could use the number of members of the industry Professional Association as an indicator of the total “universe”.

One short-cut tool you can use to estimate audience sizes for Business-to-Consumer (B2C) is the “audience builder” tool which comes with digital media channels like Facebook, Google and Instagram.

Example : pineapple pizza customers in Eastern Sydney

Let’s use an example from Facebook Ads Manager. Say we want to work out how many pineapple pizza customers we might reach for the Sydney Pineapple Pizza company example we share in this article.

In Facebook Ads, we enter the Eastern Suburbs of Sydney as a location and assume no age or gender bias in choosing pizzas. But, we specify that both “pizza” and “pineapple” must be within the target’s interests. Facebook Ads estimates that 40,000 people fit that description. So, that’s our universe estimate.

Bear in mind Facebook only covers about 60% of the Australian population. So, its forecast number is an estimated reach through the channel. It won’t include anyone not on Facebook.

If you plan to advertise your online store in other media channels, your universe might be bigger. While not perfect, it’s at least based on actual data. So, it’s a step ahead of pure guesswork.

Screenshot of Facebook Ads geographic targeting capability for Sydney Eastern Suburbs to show for a case study pizza shop

Estimating your share of the universe

In your online store business model, you next estimate how many customers you think you will get, out of those you could get. This is your estimated share. You should forecast this share month by month for the first 12 months as it’ll drive the top of your profit and loss. This share, both forecast, and actual once you launch, depends on several factors :-

  • competitive appeal.
  • advertising and media spend.
  • brand identity.
  • pricing and promotions.
  • newness of offer.

Competitive appeal

Your online store business model should outline your competitive strategy and advantage. How strong this is drives how much you’ll appeal to customers and how much share you can expect to get. 

You should factor in how superior or different your store offer actually is. Try to work out how many people will switch from a competitor based on what you offer. 1% of their customers? 10%? 50%?

Use market research to check your point of difference is meaningful to the target audience. They might like it, but it has to make them change their behaviour to buy from your online store instead.

Advertising and media spend

How much you plan to spend on advertising and media is another factor. Your target audience has to know your store exists and trust it’ll deliver. The more you spend, the more customers you reach. And while expensive ads aren’t always better, you’ll need to spend enough to create advertising that has an impact.

Brand identity

You should also consider the impact of your brand identity and how familiar it is to customers. New-to-market brands that customers don’t know take longer to grow than existing brands stretching into running their own store.

Pricing and promotions

You should also consider your pricing and sales promotion plan. If you’re more expensive than the rest of the category, you need a plan to support that.

For example, quality advertising, or exclusive and limited edition offers (see our advanced e-Commerce techniques article) can help support a premium price point.

But don’t overlook the impact of price discounting too. Short-term offers can drive quick sales, and encourage trial. They can build noise around your store at key selling times of the year.

Sale sign in white on a red window with outline of a person walking past in the background

Newness

There’s also the “newness” of the offer to consider. If you already sell in traditional channels, your customers already know your product, so buying online is only one more step for them to take. But if your product and your store are both new, then it’s going to take longer and be harder to drive share.

Reasonable share summary

Which factors come into play depends on your business’s context. There’s no set rule as to what a “reasonable” sales forecast is. But in general, 3 key trends typically emerge :-

  1. It’s better to be conservative in your initial forecast. That way, you can be surprised when you exceed it. That’s better than overestimating and being disappointed when it’s less than you thought.
  2. Online stores rarely launch with a bang. It takes time to build your presence on digital media channels. Whatever your initial timing forecast, double the time you think it will take.
  3. Most people focus on the store launch. And sure, it’s a significant milestone. But make sure you think beyond that too. You should plan more activities at regular intervals over the next 12-24 months. Don’t throw everything into the launch. Have something in reserve for after the launch.

Competitor review

As your sales are likely to come from persuading customers to choose you instead of a competitor, you should also review the competition’s strengths and weaknesses as part of your online store business model.

You should audit how competitors perform on the key factors which influence online customers to buy in your category. This helps you identify areas for improvement. And identify gaps where you can beat competitors. Use these to build your competitive strategy and define your competitive advantage

EXAMPLE : Finding a competitive position

Here’s an example from a previous online store launch project we worked on.

Some of the data has been altered to protect confidentiality.

There were 4 competitors here, and we wanted to find where to focus our efforts to drive sales for our new online store. 

We knew from market research, that 3 areas drove the customer’s choice of where to buy online :-

  • Price and delivery
  • Ease of shop
  • Services.
Online store business model - competitor review example including price and delivery, ease (clicks to buy) and offer - reminder, range, service

Price and delivery

With price, we saw that 2 competitors sold at the RRP of 29.99, while 1 went higher, and the other lower.

On delivery, 2 competitors could deliver on specific days. But it was always 2-3 days from the order date, never the same day. The other competitors only offered a 1-5 day delivery window. Delivery costs ranged from $7.95 to $11, with free delivery on orders over $100.

All this information was easy to collect. We visited their websites and did test purchases of a similar product.

We considered selling at a lower price point. But, this would have caused awkward conversations with the retailers. When you set an RRP, you need to abide by it in your own store.

Because of the supply chain complexity of this product, faster delivery wasn’t an option. As long as we could match what competitors offered, no one would be able to use this as a competitive advantage.

Ease of shop

Where we could definitely find an advantage though, was how easy we could make it to buy our products.

The retailers had many more products to sell. They were also trying to drive CRM sign-ups. This meant that new customers wanting to buy this product had to click many times to find, select and order the product.

We set up our store website to streamline and simplify this process. 4 clicks to buy rather than 16, for example. This reduction made the sale much easier.

Services

This particular product was purchased regularly, every 2-4 weeks, So, we offered a reminder / re-order service that none of the competitors did. Not quite a full subscription model, but as close as we could make it. 

As we designed the website, we also shared bonus expert content and live access to experts, that the retailers couldn’t match. This offered an extra level of customer service

So, our competitive position was to promote how easy it was to shop on the site, the reminder service, and the access to expert content and live contact.

Our main disadvantage was our store sold only our products. So it would always have a smaller range. The online retailers sold our products, and other products in the category.

So, we tried to minimise this as a barrier. We covered it in our FAQs and focused on highlighting the benefits instead. We made our online store the best place to buy our products. 

To give you a rough idea of how well this worked, the store exceeded its launch targets by over 300%. And an updated version of it still operates today, more than 5 years after the launch.

Set your 12 months KPIS - starting with sales and marketing

Another key area of your online store business model is the Key Performance Indicators (KPIs) you set. These should cover the first 12 months at least.

Start with your sales and marketing objectives.

To hit your sales (dollar) targets, you have to work out how many paying customers you need. You then work out how much those customers need to spend.

So, your sales target becomes customers x price.

This helps you then work back to build out your marketing plan and marketing KPIs. Because you can prioritise activities that will get you that many customers.

Archery target with arrows in bullseye to symbolise marketing targeting

A quick example

Say your aim is 100 customers in the first month after launch. The average online shopping conversion rate is 2 – 3%.

Let’s be conservative (remember that recommendation) and say a 2% conversion rate. That’s 2% of people who visit your store will buy. So, you can work out how much traffic you need to get those 100 customers.

It’s (100 / 2) * 100 or 5,000 visitors.

Knowing you need 5,000 visitors, you can then work out how many customers your advertising and media needs to reach, with a similar calculation.

Let’s say your advertising click-through rate is 1%. That means your advertising needs (5,000 / 1) * 100 or 500,000 impressions. So, 500,000 media impressions, to deliver 5,000 visitors to deliver 100 customers.

Of course, these are only rough calculations.

Your conversion rate may be higher or lower than the average. For new stores, it’s typically lower as people check out your store first. But, the better the online store experience, the higher the conversion rates.

Click-throughs from digital media are only one way to drive traffic though. For example, SEO and social media can reach customers without big spending. You can use cost-effective channels like public relations to drive awareness and run sales promotions to create interest and drive conversions.

Other KPIs

Once you have your sales and marketing KPIs, you can then look at broader KPIs for the store. Customer service KPIs, for example.  This could be to minimise complaints and / or returns. Or, delivering a certain percentage of products “on time and in full”.

Your website visitors and click-through rates are good digital performance measures. But, you can set others like bounce rate, time on site, returning customers and the percentage of customers who register.

You should also set up brand identity tracking measures. Measures like awareness, consideration, trial and loyalty can apply as much to an online store as they can to a brand.

And finally, you should also set some people or culture KPIs.

KPIs help the team delivering your online store business model know where to focus. They also help identify key e-Commerce capability needs where you need training. They let you, them and the wider business understand the internal impact that your online store business model will have.

Build a high-level marketing plan

Your post-launch plan should detail the key actions and activities that will support the store over the next 12 -24 months. We’ll go into this more later, but you’ll need an idea of likely marketing costs as part of your online store business model. 

You’ll need to know how much you’ll spend on advertising and media. You also need to know the cost of creating and running your store website. And finally, you need to know the rough costs of processing orders and deliveries.

Online store business model - P&L

Your next step is to put together these high-level sales forecasts and the rough costs you expect into a month-by-month and full-year profit and loss (P&L).

This financial model captures income and costs and gives you a view of profitability. Clearly, an important part of your online store business model.

From this P&L, you can do a break-even analysis. This is where you identify how long it will take to recover your set-up costs. After you do that, then you’re making a profit.

Bigger businesses can plan out 5-year P&Ls, but for smaller businesses, 2-3 year P&Ls are usually enough.

Close up of woman's hands holding a bunch of dollar bills and in the process of counting them

But as a bare minimum, you should have your first 12 months P&L by month planned out. Let’s look at what to cover in this P&L in terms of your online store sales and costs.

Online store sales in the P&L

So, the first line in your P&L is Gross Sales. This is the total amount of income you get from selling your products. 

In simple terms, it’s the number of units you sell multiplied by the selling price. Note, that the selling price covers the product price and any extra delivery fee.

It can also include any other income you generate from selling. e.g. extended warranties and other types of upsell. All of these you capture on this line.

You then calculate any deductions that need to come off, before you can count the revenue as “yours”.

Wallet with credit cards

These deductions are usually sales taxes and transaction fees. When you subtract these from the gross sales, you are left with your net sales. So far, so good.

Online Store costs in the P&L

Now, it gets harder. Because you have to work through all the costs associated with setting up and running your store. Let’s start with those deductions before net sales. 

Sales tax

Sales tax is a % deduction paid to state or national governments on every transaction. It’s based on where the sale takes place, and where the buyer and seller are located. If this is all in the same country (or state in the US), it’s relatively straightforward to calculate.

It gets trickier when sales take place internationally. In that case, the buyer and seller are in different tax locations. So, who do you pay tax to, and who pays in these situations?

You should research how it works in your home market, and speak to tax consultants if you aren’t clear on your obligations. The topic is well covered online, and it just takes patience to read the details. It’s most common to pay tax in the country where you’re based, but different laws apply in different countries.

You want to also make sure, you avoid paying double taxes. Many countries have these reciprocal tax agreements in place, but often you need to register to take advantage of them. You also need to be aware, that tax laws and rates are subject to regular change.

And finally, you should be aware that when you sell to consumers in the USA, it can be even more complicated as sales tax differs between states.  

You must work out your tax obligations. Make sure you register with the relevant tax authorities, and keep records of transactions. Seek professional advice, if you have concerns, or are unclear on what to do on tax.

Transaction fees

Also, before your net sales line, you need to account for any transaction fees.

Most online payments are via credit cards, or payment services like Paypal. The companies behind these services charge a percentage fee per transaction, typically 1%-3%.

In addition, when you use payment gateway software to manage the transaction as per our e-Commerce functions guide, they also charge a fee, usually 1%-2%.

So, you can find the total of these fees might take 2%-5% off the gross sales value. 

Person paying for an e-Commerce purchase as they hold a credit card up in front of a laptop

Deductions before gross profit

There are 3 main costs to consider before you get to your gross profit.

These are the direct operational costs associated with the production, storage and shipping of the product. They’re the costs that if you did nothing else, you’d still have to pay on each transaction.

Cost of Goods (COGs)

Production costs are usually called Cost of Goods (COGs). This is the cost of all ingredients, materials, packaging, and any other items which are part of the finished product.

Warehouse and delivery

Warehouse and delivery costs are the costs associated with storing and shipping products to the customer. They’re how much your warehouse and delivery company charge you to manage orders.

They can include goods-in handling, any repackaging requirements, transportation costs, and any admin costs associated with undelivered or returned items.

All three of these costs are normally variable costs. They vary in direct relation to the number of items sold.

So, let’s say your COGs is 10 dollars per item. You sell 10 items – total COGs is 100 dollars. Sell 100 items, it’s 1,000 dollars. And so on. It’s usually shown as a % of the sales price.

Pallets of boxes wrapped in cling wrap in a warehouse

Deductions before net profits

You should then capture all remaining costs associated with marketing, selling and operations.

Advertising and media

These are often fixed costs.

They don’t vary in relation to the amount sold but stay the same, no matter how many you sell.

For example, advertising and media costs. You know how much you’ll spend on these in advance. 

If you plan to spend $1,000 to drive 100 sales, and you only get 10 sales, you’ve still spent the money.

Though you know how much you’ll spend,  you don’t know the sales value you’ll get back. For that, you have to evaluate your advertising’s impact on sales and profits

Outdoor billboard with writing that says this will drive $1m in sales - probably

Development

Your online store business model also has to include any development costs associated with marketing technology. This includes all costs to set up and maintain the store. It can include software licenses, agency fees, hosting fees and other costs associated with online store websites.

Overheads

Finally, you also need to include any overheads. These are mainly the “people” costs associated with running the store. So, any salaries and super / pension contributions, for example. But they can also cover items like insurance, utilities and other administrative costs.

The challenging question of net profit

At the simplest level, your net profit is what’s left after you take away all your costs from your net sales. But, if accounting was that simple, then accountants wouldn’t get paid so much.

So, here are some more complicated areas you’ll need to consider to refine your online store business model.

Transaction and logistics fees affect your net profit percentage

At the top of the P&L, the transaction and logistics fees are very different from what you would see when you sell the same product to a retailer. Your net sales when you sell to a retailer will be a lot less than when you sell direct, as the retailer takes a trade margin, so they can profit on the difference between trade price and retail price.

With selling to retailers, there is a logistics cost per item, but it’ll be significantly less than the same item sold D2C.

Think about it. It’s a lot cheaper per item to ship 1,000 units in a truck to a retailer’s warehouse than to ship those same units to individual customer’s homes.

As most profitability calculations are based on the profit / net sales, the different factors that come into play in an online store business model can create some funky maths at the top of the P&L.

Example : Sell to Retailer vs Sell D2C

Let’s have a look at an example, from a previous project we ran. (with some data changed to protect privacy).

First, note that there’s no tax line in this example. Some products are exempt from sales tax, which was the case here. But, it also helps keep the model simpler to understand, if you ignore the tax.

On the left, the retailer takes 6 dollars on the $30 gross (retail) sale. So, your net sales value is 24 dollars. Your logistics cost is 1 dollar, and your COGs are 10 dollars.

This leaves you with 13 dollars gross profit on the sale. Or, a 54% gross margin, as it’s 13 / 24 dollars.

Easy, right?

Online store business model - Cost breakdown retail vs D2C

On the right though, the deduction is only 1 dollar which covers the credit card and transaction fees. Your net sales value is 29 dollars. 5 dollars better than with the retailer.

But your logistics cost is 4 dollars, and you then have the same COGs of 10 dollars. This leaves you with a 15 dollars gross profit on the sale. So, your net profit is 2 dollars better than selling to a retailer.

But from a profitability point of view, it’s a worse percentage. Because it’s 15 / 29 dollars or 52% gross margin.

Funky maths

Funky, right? 

So, even though you make $2 / item more on the sale, an accountant will still tell you it’s less profitable. You make 2% less profit on your selling price. 

This sort of calculation can freak out some accountants, who are used to more traditional setups. The way around this is to show that you aren’t comparing like for like when comparing an online store to an online retailer. 

The logistics cost is different. With the retailer, it’s a relatively fixed cost per unit you pay. But with the online store, you can “charge” the customer as part of the cost of them buying the product from you.

You need to work out the true net sales price. Focus more on the absolute rather than the percentage gross profit.

The challenges of the delivery fee

The above model used an average delivery cost per unit to keep it simple. But working out your average delivery cost to do this type of calculation is surprisingly hard. 

Unless you only sell one type of product to one geographic area, there will ll be a wide difference in delivery costs across orders. These are affected by factors like :-

  • order sizes.
  • product weights.
  • packaging requirements.
  • delivery coverage.
Food delivery cyclist on busy nighttime street

You also need to think carefully about how you communicate the delivery price to the customer, and how much of it you ask them to pay. As per the model above, your net sales income is higher as there are no retail margins to pay. But you still have to cover the extra costs for the delivery. So, you’ve got a few options :-

  • Customer pays RSP plus full delivery price – this maximises your income but potentially makes the overall price paid by the customer too high.
  • Customer pays RSP plus subsidised delivery price – this reduces your income but makes the overall price paid by the customer more acceptable. 
  • Customer pays RSP but no delivery fee – you absorb the delivery fee and take it out of the extra net sales income. This makes the selling proposition very appealing to the shopper (free delivery), but it could also drive switching from other channels. You need to work out the impact on profitability.

Check out our managing the e-Commerce delivery cost article for a more in-depth review of how to work through these sorts of decisions. 

Online store costs – there’s more!

Almost, but not quite yet done with costs.

So far, all we’ve talked about is managing the profitability of one order. And really all we’ve talked about are the variable costs per order.

Think about all the other costs. Marketing spend to drive traffic. The cost of building your website. Returns and refunds. paying for your operations team. You have to pay for all these from the income generated by your online store after you’ve paid the variable costs. These are all fixed costs. They don’t change by volume.

For more on the financials, check out our case study example article on an actual e-Commerce profit and loss

Post-Launch and Ongoing Challenges

Next, you’ll enter 2 distinct new phases in your business model. First, comes the post-launch phase where everything you thought was going to happen gets challenged. Once the store goes live, it becomes less predictable. See our separate article on some of the e-Commerce issues you’ll face in this phase. 

Then, there are even more ongoing challenges you’ll face. Check out our managing an online store for more on that. 

Online store business model conclusion  – Scale, get creative or outsource

Setting up and running your own online store sounds exciting at the start.

But as our review of the online store business model shows, it also poses many challenges.

None are impossible. But the more you plan, and the more you know, the more likely you’ll grow.

We’ve mainly focussed on the financial elements in this guide. It’s an e-Commerce platform, after all. Your store has to make money to survive. 

So, the commercials should be one of your biggest areas to think about.

But they won’t be your only area to think about. 

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

Think beyond the commercials

But you shouldn’t underestimate the value of breaking the hold that retailers have on access to your customers. Cutting out the middleman gets you closer to who is buying your brand. You get to speak to them directly, understand them better, and build a better overall customer experience.

It’s important to master all the costs involved though. Generally, this works best when companies go one of two ways.

If your idea is strong enough to scale, a lot of those high costs per order will come down. Having scale means you negotiate better delivery rates from your delivery partners. When your online store sales go up, your operating resources like staff and warehousing won’t increase at the same rate. You’ll be able to spread costs across more units to improve profitability.

As you scale, you might want to look at partnerships, particularly in the back-end. e.g. complimentary (or even competitor) products that could be sold through those same channels to help you spread your fixed costs?

Be creative or outsource

Your other alternative is to be creative or to outsource.

There are companies already doing delivery, who you could piggyback on. (See our last mile article article for more on this). In our pizza delivery example, this could be a Deliveroo or an Uber Eats type company. They’d collect the product and get it to customers quickly. You’d expect to give up some margin from selling direct. But you’d be handing much of the delivery and customer service challenges over to someone else.

There’s a lot to cover in the online store business model. But, it’s usually time well spent. When your store is live, you tend to be more reactive as you deal with customers. So the more you plan, the less reactive you’ll be when something happens.

After all, as the famous saying goes, fail to plan, and plan to fail. For the effort it takes to set up and run an online store, you should definitely be planning to win.

Three-Brains and e-Commerce

We’ve worked on many e-Commerce projects and have good experience in planning, working with online retailers and building online store websites. We know how to connect these expertise areas back into driving your brand marketing and growing your sales. 

Contact us, if you want to know more about how we can support your e-Commerce to grow your business through our coaching and consulting services.

D2C Online Store Status dashboard - Four column headed strategy and plan, the store, order to delivery and operations
Click to download the pdf

Downloadable D2C status dashboard

There are many jobs to do in D2C. You have to define your strategy and plan. Work out the sales and marketing. And also set up the whole operational side of the business. It can be complex.

That’s why we’ve created this project dashboard to show a simple one-page summary of the key actions required to set up and manage a D2C online store. Download it here or from our resources section. 

Powerpoint and Keynote versions of this document are available on request. 

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