Online store business model

In this guide, we look at how to plan, organise and track performance, so you can build your online store business model. Before you launch, how do you forecast demand and find gaps in what your competitors offer? What sort of costs do you need to factor in, so you can measure profitability? And post-launch, what resources do you need to keep your online store going? Read our guide to find out more.

$$

Online store business model

How this guide raises your game.

  1. Ways to identify the total potential audience for your online store and to forecast what your share of that audience should be.
  2. A walk through an online store Profit and Loss, so you understand likely costs and how to keep track of your online store performance.
  3. Learn the importance of planning for the post-launch phase, and our thoughts on how to scale up online stores.

If you choose to take the “full” strategic planning route for your online store, rather than going “fast” to sell online, an important step is to define your business model.

You need to answer questions like who is the store for? What will you actually do to meet their needs? How will you keep it going? And, will you actually make any profit?

So, let’s start to answer these questions by looking at the e-Commerce planning process.

Coins spilling out of a jar to symbolise marketing and e-commerce costs

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

In our guide to the e-Commerce planning process, we cover the importance of market research to identify the opportunity in the market. And, we cover briefly, the type of criteria and decisions you need to consider to validate the opportunity.

With your own online store, this opportunity identification and validation phase takes on more complexity.

You need to consider a number of factors to build your online store business model.

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

The opportunity identification gives you a picture of your ideal target audience. You’ll understand their needs at a product level. And, the importance of their online store service needs like ease and convenience, range, price and product information.

But for your online store business model, it’s not just a question of defining your target audience. It’s also how many of them there are. And how many of them you can expect to attract.

This is the potential universe of customers for your online store. The absolute maximum you could possibly attract.

But obviously, you’ll have competitors going after that same target audience. You won’t get every customer in that audience. You’ll only gain a share of that audience.

How to work out the size of your online store “universe”

There’s a couple of different ways to quantify your total potential audience.

If you target mainly on demographics like gender, age or location, you can carry out secondary research to find out how many people fit into those demographic segments.

Government statistic sites like the ABS in Australia will often publish summaries of key demographics.

If you target on key behaviours such as internet usage, or online shopping habits, you can search online for answers to these specific questions. You can often find published reports like this one on the state of Australian e-Commerce.

 

Australian Bureau of Statistics homepage

If you already sell through marketplaces, you can use the data you gather there to inform what will happen when you launch your own online store. You should look for total number of customers, and the total number of sales and sellers to make some estimates on how big the market is.

Marketplaces do give out aggregate data on users e.g. Gumtree share that they have over 7 million users, and 80,000 daily new listings. This can give you a benchmark as to what the total audience might be, if you sell through that channel.

Depending on the context of your business, your market research might already show you the total size of the market. Or, you’ve worked it out from other sources.

So, if you are 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 that comes with digital media channels like Facebook, Google and Instagram.

Example : How many potential pineapple pizza customers in Eastern Sydney?

In this example from Facebook Ads Manager, let’s assume we want to validate how many customers we might reach for our fictitious Bondi Beach Pineapple Pizza company. (We set up this “business” in this article)

In Facebook Ads, we enter the Eastern Suburbs of Sydney as a location, and assume no specific age or gender bias in choosing pizzas.

But, we specify that both “pizza” and “pineapple” need to be within the target’s interests.

Facebook Ads estimates 40,000 people fit that description. So, that’s our estimate of the potential universe.

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

 

Facebook Ads - Pineapple Pizza Bondi example

If you plan to advertise your online store in other media channels, your universe might be bigger.

While not a perfect solution, it’s at least based on actual data. So, it’s a step ahead of pure guesswork.

How to estimate your potential share of the universe.

In your online store business model, knowing how many customers you could get, needs to be followed by your best estimate of how many customers you will get. Unless, you’ve found a totally new to market solution, your actual number of customers will be a percentage share of the total potential customers.

You should aim to estimate how many customers you will get month by month for at least the first 12 months. Once you launch, and get an idea of real customer numbers, you can refine your forecast to make it more accurate.

How many customers you actually get (your share of the universe) depends on many factors.

Competitive appeal

There’s the appeal of your products and your store, obviously, but also how that appeal compares to competitors. Your offer might be good, but if your competitors are great, you won’t get sales. The more competitive the market, the longer it takes and the harder it is to gain share.

You need to consider how superior 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%?

Check your market research shows that your online store 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 needs to know your store exists, and trust that it will deliver. The more you spend, the more customers you reach. And while expensive ads aren’t always necessarily better, you will need to spend enough to create advertising that delivers impactful and relevant messages.

Brand identity

How clear your brand identity and how familiar with it your audience is, is yet another factor to consider. New to market brands that are unknown will take longer to grow than brands that already exist, but are stretching in to running their own store.

Pricing and promotions

You need to consider your price point and sales promotion plan. If you are significantly more expensive than the rest of the market, you need a plan to justify and support that.

So, for example, premium advertising, or exclusive and limited edition offers can be a great way to support a premium price point.

But don’t discount the need for price promotions too. Short-term offers can be a way to drive quick sales, and build noise around your store at key points in the calendar.

Red Sale Sign

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

One, some or all these factors can come into play, depending on your business context. There’s no hard and fast rule as to what a “reasonable” sales forecast is.

But in our experience, here’s our top 3 things that work way more often than not.

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

Competitor review

As your source of business is likely to come from persuading your target audience to choose you over one of your competitors, it’s worth reviewing the competition’s strengths and weakness as part of your online store business model.

If you know the key factors which influence customers to buy online in your category, you can audit how key competitors perform on those factors. This helps you identify areas where you need to make your own store better. And it can identify gaps where you can be better than the competitors.

EXAMPLE : Finding a competitive position

So, check out this example from a previous online store launch project we worked on. Some of the data has been changed or removed to protect privacy.

There were four existing competitors in the market, and we wanted to find where to focus our efforts to drive sales for our new online store. 

We knew from market research, that three key areas drove the target audience choice of where to buy online.

Price and delivery, ease of shop and services.

Online store business model - competitor review example

Price and delivery

So, on price, we saw that 2 of the competitors sold at the RRP of 29.99, while one went slightly higher, and another slightly lower.

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

All of this information was easy to collect. We just visited their website and ran a test purchase of a similar product in the category.

We did consider selling at a lower price point. But, this would have caused awkward conversations with those four retailers. And if you set an RRP, then you kind of need to abide by it on your own store.

Because of the complexity of the supply chain on this product, faster delivery was not an option for launch. As long as we could match what competitors offered though, then 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 other four retailers had many more products to sell. They were also actively trying to drive sign-up to their CRM programs. This meant for a new online shopper wanting to buy this product, they had to click many times to find, select and order the product.

We were able to set up our store website to streamline and simplify this process. 5 clicks to buy compared to 17 clicks for example. This click reduction made it much easier for the shopper to buy.

Services

This particular product was one which was purchased on a regular basis, every 2 to 4 weeks, So, were able to offer a specific reminder / re-order service that none of the competitors could do.

Because we designed and hosted the website, we were also able to place additional expert content and access to live experts, that the competitors would struggle to provide.

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

So, we made plans to “pacify” or reduce this as a barrier. We covered it in our FAQs, but otherwise chose to highlight our benefits as the most important things for the shopper to consider. We made our online store the best place to buy our product. 

Unfortunately, we can’t share the exact results for privacy reasons. But this store exceeded its launch targets by over 300%, and an updated version of it still operates today, more than 5 years after we launched it.

Set your 12 months KPIS – starting with sales and marketing

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

You should start with sales and marketing objectives.

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

So, your sales target becomes customers x price.

Archery target with arrows to symbolise target audience

This helps you then work back to build out your marketing plan and marketing KPIs. Because you can target activities that will get you to those number of customers.

Let’s look at a quick example.

Let’s 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 in our estimate (remember that recommendation), and say your conversion rate will be 2%. That’s 2% of people who visit your store will actually make a purchase.

So, you can work out the number of visitors to your website you need to get those 100 customers.

It’s 100 / 2 * 100 or 5,000 visitors.

And from knowing that you need 5,000 visitors, you can then work out how many potential customers your advertising and media need to reach, with a similar calculation.

Let’s say your advertising click through rate is 1%. That means your advertising needs to teach 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 rough and ready 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, if you build a great online store experience, you could end up with higher than average conversion rates.

And click-through rates from advertising and digital media are only one way to drive traffic to your store. SEO and social media for example can reach consumers without vast spends. You can use cost-effective channels like public relations to drive awareness, and set up sales promotions to create interest and drive conversions.

Other KPIs

Once you know your sales and marketing KPIs, you can then look at broader KPIs for the store.

It’s common, for example to set customer service KPIs. This could be the number of complaints. Or keeping returns below a certain percentage of total sales. Or, a certain percentage of products is delivered “on time and in full”.

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

You might also want to 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 might also want to set some people or culture KPIs.

For the team who work on your online store business model, KPIs can help them prioritise where to focus. They can help identify skill development areas where you can build training. They let you, them and the wider business understand the internal impact that your online store business model will have.

Build out a high level marketing plan

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

You’ll need to know how much you plan to spend on advertising and media to hit your sales targets. You also need to know the cost of setting-up and maintaining your online store website. And finally, you’ll need to know roughly, how much it will cost to manage 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 on profitability. This is obviously an important part of your online store business model.

From this P&L, you can work out 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 your store is operating at a profit.

 

Coins spilling out of a jar to symbolise marketing and e-commerce costs

Bigger businesses can plan out five year P&Ls, but for smaller businesses, this is probably excessive. Two to three year P&Ls are usually fine. Because, circumstances always change, and Year 3 or Year 5 will likely look very different.

But as a bare minimum, you should have your first 12 months P&L by month planned out. Let’s look at what needs to be included 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 your receive from selling your products. 

At the simplest level, it’s the number of units you sell multiplied by the selling price. Note, that the selling price is the price of the product and any additional delivery fee you charge.

It can also include any other income you generate from selling. So, if you sell extended warranties on your products, or other types of upsell, you capture it all at this line.

Wallet with credit cards

You then calculate any deductions that need to come off, before you can count the revenue as “yours”. These deductions are primarily sales taxes and transaction fees. We’ll come back to these in a second. When you subtract these from the gross sales, what you are left with is the net sales.

So far, so good.

Online Store costs in the P&L

Now, is when things get more difficult. Because you have to work through all the costs associated with setting up and running your store. Let’s start with the deductions before you get to your 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 straight-forward to calculate how much this is.

Where it gets more tricky is 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?

First off, let’s be clear. We’re not tax advisors. We do advise you to research this topic though, and speak to tax consultants if you aren’t clear on what your obligations are. The topic is well covered online, and just takes some patience to work out where you need to pay tax. It’s most common to pay tax in the country, where you are 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.  

It’s important that you calculate what your tax obligations are. Make sure you register with the relevant tax authorities, and keep good records of transactions. Seek professional advice, if you have concerns, or are unclear on your tax requirements.

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 we cover in guide to e-Commerce functions, they also charge a fee, usually 1% to 2%. So, you can find the total of these fees might take 2% – 5% off the gross sales value. 

Deductions before gross profit

There are three 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 are the costs that if you did nothing else, you will still need to pay on each transaction.

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. These are the costs which your warehouse and delivery company charge you to manage all 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.

That mean they vary in direct relation to the number of items sold.

 

Warehouse palet

So, if your COGs is $10 per item, and you sell ten items, your total COGs is $100. Sell 100 items, it’s $1,000. And so on. This means they are usually represented as a % of the sales price.

Deductions before net profits

All remaining costs associated with marketing, selling and operations then need to be captured.

Advertising and media

These are often fixed costs. They do not vary in relation the amount sold, but stay the same, no matter how many you actually sell.

So, for example advertising and media costs.

The amount you spend on advertising and media is usually fixed in advance. If you plan to spend $1,000 to drive 100 sales, and you only get 10 sales, you’ve still spent the $1,000.

Development

With your online store business model, you also need 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’s 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 will 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 it is to ship those same 1,000 units out 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.)

So, firstly, you’ll note, there’s no tax line in this example. In actual fact, 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 on the $30 gross (retail) sale. So, your net sales value is $24. Your logistics cost is $1, and your COGs are $10.

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

Online store business model - Cost breakdown retail vs D2C

Easy, right?

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

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

But from a profitability point of view, it’s actually worse on a percentage basis. Because it works out at at $15 / $29 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 tends to freak out some accountants, who are used to more traditional set-ups.

The way round this is obviously to be clear that you are not comparing like for like, when it comes to comparing an online store to an online retailer. 

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

So, you need to work out what the true net sales price is. And, focus more on the absolute rather than the percentage gross profit.

Getting to the bottom of delivery fees

Another complication is that your delivery fee as a % of your net sales might not be the same on every order.

It can change depending on how many items are in an order, and the delivery location. 

Logistics suppliers will normally charge a “picking fee” on every order they manage. But if a shopper orders one item or ten items, the picking fee will normally stay the same.

So, if the picking fee is let’s say $1, when you sell one item, it’s $1 per item. But if you sell 10 items, it’s $0.10 per item.

The last mile cost - food delivery guy on a bike with food in backpack

But to make it even more complicated, if the customer does order multiple items – let’s say ten again – there’s going to be extra packaging costs to send those out. A bigger box, or some way to attach items together. Trying to get to the bottom of these sorts of costs can be difficult.

Weight and location

Logistics and delivery suppliers will also often vary their charges by the weight of the package. (rather than the sales price of the package) But again, with multiple orders, you need to try and work out how the weight will change, and whether this will make any difference to the delivery cost.

These companies will also charge different rates depending on the location of the delivery and how fast it is to be delivered. On the whole, major metro city areas in the same country are the cheapest and fastest areas to deliver to since logistics networks are set up to support these hubs.

But if you need to deliver to more remote areas, or internationally, costs can soon go up.

You also need to factor in extra charges such as breakages, unfulfilled deliveries and returns if the consumer is unhappy with the goods. All these will eventually hit your P&L. It can be challenging to keep track. It’s important to monitor all costs coming in from your logistics partner and negotiate clear fee agreements.

Deliveries will probably cost more than you think

Which brings us to our next challenge.

In our experience, most new online store owners tend to underestimate their delivery costs.

That’s because they look at the logistics company rate card and work from that. But this doesn’t cover all those other costs we mentioned above, like breakages and returns.

You should add a good 20 – 25% on your rate card delivery costs to allow for these sorts of extra costs.

Even with a relatively simple model for a small D2C store, delivery costs can soon add up. For example,  if you were to use Australia Post’s current ‘standard’ offer, a small satchel delivery under 5Kg would cost $8.95 plus the cost of the satchel. And it takes 2 to 5 days to deliver within the same state. On our $30 item above, this would be almost 30% of the gross sales price, which is very high.

If you work with specialised courier and delivery services like DHL for example, the price per item delivered can be even higher. In our experience for small to medium sized packages, the delivery cost would be in the range of $12 to $20 per order.

In return though, they’ll often offer additional and bespoke services. So, express delivery, or the ability to deliver to specific time slots.

If your product requires specialised shipping – say, it needs to be transported at a certain temperature or it’s fragile, you may need to use these specialised services.

Fragile delivery

Online stores supply chain inefficiency

The reason these costs seem high, is that online store deliveries are actually a very inefficient way to move goods from a supply chain point of view.

In comparison retail stores are very efficient. Trucks full of goods go to the store. The customers come to the store (at their own expense) to buy and pick up those goods. The delivery cost (truck, driver, fuel) is spread across a large number of products.

When you deliver to an online shopper’s home though, you have a driver delivering location by location, small packages. That takes much longer to deliver. The delivery costs is spread across a smaller number of products. The cost goes up proportionately per item.

This last mile cost as it’s often called, can be one of the most challenging aspects of your online store business model. You can read more on that subject specifically in this article.

Do you charge for delivery, or do you absorb it into the price?

There’s three ways to view this question.

Online shopper

From an online shopper point of view, it’s important that you are clear and honest about shipping costs. It might be tempting to offer a lower headline sales price, and then make up the margin through charging for shipping costs. But consumers are generally very savvy about this type of approach, and are not fooled.

It’s unlikely to work.

What this means is either you need to include the price as “includes shipping” or “excludes shipping” so shoppers don’t get any surprises. If the delivery charge is likely to vary wildly between locations, try to work out how you can automatically fill in the right delivery charge, when the customer fills in their location details.

A few extra options like express delivery or insurance are OK. But, avoid overcomplicating it. The more options you give, the more confusing it is for the shopper. And, the more likely they are to abandon the purchase.

For lower value purchases, it’s more common to add an extra delivery fee. On higher value purchases, there’s more margin, and it’s easier to absorb the delivery cost.

The competitive position

You should also look at how competitors charge for deliveries.

What’s the norm in terms of delivery price, how it’s charged and the different type of delivery options?

Unless, you can better them with your logistics set-up, it’s normally better to try to match the competition. Follow the category norm, so it’s easier for the consumer to compare your offer with your competitors.

Your aim should be to make communication of the delivery fees (if any), clear and easy to find. You should try to automate the calculation, so the customer does’t have to do it. 

The accounting view

However, from an accounting point of view, how you position the delivery charge creates some interesting questions.

If you sell at your RRP and absorb the cost of delivery, this cost of delivery needs to be less than what you would have given away as retailer margin. Because, if it’s more, then your online store business model will show it as a less profitable channel than online retailers.

If you add a delivery fee on top of your selling price, this raises your total income. But, that income will go towards covering the cost of delivery that you pay to your logistics supplier further down the P&L.

It can throw off profitability calculations, as we showed in our example above.

Creative thinking about delivery

It can sometimes feel like there are so many ‘extra’ costs in delivering products sold through an online store, that it will never be profitable.

But, clearly many business do it, and do it well. So, how do you approach managing those costs?

This is where you need to start getting more creative with your thinking.

The specialist delivery companies normally charge the delivery cost per order rather than per item.

Post it on wall with light bulb illustration to highlight creative problem solving

So if you can get a customer to order two or three items, then the cost of delivering those will be the same as if they had ordered one item. But that means the cost of delivery per item is lower. It is spread across multiple items.

Example : pizza delivery

So, let’s say we are selling pizzas. Let’s say we work out it costs $16 to deliver an order, our pizzas sell at $25 and the cost $10 in ingredients and staff costs. If we absorbed all the delivery cost on this order, we’d make a $1 loss. $25 – $10 – $16.

But instead, let’s say we ran a promotion where if you buy four pizzas, you get free delivery. The delivery charge would still be $16, since it’s per order, not per pizza. That means the delivery cost per pizza drops to $4 as each pizza takes a share of the cost.

So, when you can persuade people to buy 4 pizzas, you make $11 profit per pizza. $25 – $10 – $4.

Mind you, that’s a lot of pizza to order to get free delivery. And, it’s making us want to order pizza.

But, it’s unlikely one person on their own at home would order four pizzas. But there are other circumstances where some people will happily place these bulk / mass orders

You’ll find a lot of online shopping is actually done by small businesses and organisations buying in bulk. People who are buying on behalf of a group. Like children’s centres. Or old people’s homes. Or prisons, or police stations. All genuine examples we’ve come across in the past.

This is also why most online stores offer free delivery when you spend over a certain amount (usually anywhere from $50 to $100) because they can absorb the delivery charge into the order.

Sydney pineapple pizza company - created on canva

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.

The marketing spend to get people to visit the site. The investment in building the shopping website. The cost of returns and refunds. The cost of the team who will run the operation for you.

You need to pay for these activities out of the income generated by your online store, after you’ve paid the variable costs. These are all fixed costs. They do not change by volume.

We cover how you do these activities in more detail in the section on managing an online store. But when it comes to how much these cost, it’s easier to look at an actual example.

Online store business model – example P&L

This is an example P&L we took from one of the first stores we worked on. We’ve adjusted and rounded off some of the numbers.

But, the numbers are all within the ballpark of what it might take to set up a full D2C business, and how much sales and profit it might generate in the first year.

Don’t get too hung up on the numbers themselves though. Because every country, category and competitor will be different.

But, do follow through our process as we talk about how to read this P&L from an online store business model point of view. 

Online store business model - P&L example

Step 1 – Forecast gross sales

So, let’s start with gross sales. Remember from above, this is units sold x price. In this example, assume all units sell for $30.

So, here, if you look under the P&L at the volume forecast, we’ve estimated month by month how many items we believe we can sell.

For simplicity, we’ve kept it to 2 skus, but it could easily be more. Each sku will have a different sales pattern, so here, Sku 1, we expect to be more popular than Sku 2. We make an assumption that the first few months sales will be low. It takes time to build awareness of the store, and to generate demand from customers.

So, in this example, we’ve only sold 80 units cumulative in the first 3 months. That’s less than 2% of what our forecast for the total year is. We’ve made an assumption that those early customers come back and buy more later. And, that we get more sales through word of mouth and the cumulative impact of our marketing efforts. By month 12, we’re forecasting 2,000 units a month.

Of course, there are a number of variables to consider.

So, for example, you might see more demand at seasonal event times like Christmas and Easter. Your product may be seasonal and sell more in winter or summer. You might decide to boost your advertising at certain points, and would look to forecast more units sold.

In this model, we’ve assumed a relatively stable price with no big price promotions. But, we could have easily decided to include price discounts in certain months and increase the number of units.

Step 2 – Calculate deductions to identify net sales

We’ve assumed a 10% sales tax rate, and an initial 4% per order credit card and transaction fee charge. So, for months 1 to 6, 14% of our gross sales number is taken off to reach the net sales number.

However, we’ve assumed that as sales start to take off, we might be able to negotiate a better deal on the credit card and transaction fees. Especially with payment gateways, they will often offer volume discounts. The larger the number of orders you put through them, the smaller the percentage they will take per order.

So, in this case, as we start to generate more sales, we’ve made an assumption in months 6 to 12, we can reduce the credit card and transaction fee to 3%, so the total deductions drop by 1% to 13%.

There will be no change in the sales tax, as this is non-negotiable.

Step 3 – Cost of Goods, Warehousing and Delivery (Variable costs)

Cost of Goods will vary widely between products and categories. But, as a general rule of thumb, your selling price should be at least three times your cost of goods, to give you enough ‘space’ in your P&L to cover the other costs associated with selling, and to still make a profit.

Given the unit numbers are relatively low, we’ve assumed Cost of Goods stays constant. But, it is possible if you generate more and more sales, that you might find economies of scale to reduce this percentage. You might be able to negotiate savings on buying raw materials by buying larger quantities. Or, you might be able to do longer production runs to deliver efficiencies.

Warehousing and delivery costs usually vary depending on the amount of volume you put through them. There may be some fixed costs with warehousing, such as rent or paying for utilities. But, for simplicity in this model, we kept both costs variable.

Similarly to the fees percentage reduction above, you may be able to negotiate better deals with warehousing and delivery suppliers, when your sales start to take off. It wouldn’t be unreasonable to factor in a small percentage cost saving once your sales hit a certain level.

In reality, your deals with warehousing and delivery suppliers would be more likely to be on an annual basis. So, any better terms would come in Year 2.

Step 4 – Advertising, Development and Overheads (Fixed costs)

Your final set of costs relate to more indirect costs that you pay for, irrespective of whether you sell no units or 1,000 units.

You need to account for marketing costs to spend on advertising and digital media to bring people to your store. It’s safe to assume you might spend most of this when you launch your store. And, then continue to drive activity through the year.

So, in this example, we spent $3k on our initial launch. And then kept our monthly spend at a percentage of our forecast sales. We started at 20% of sales into advertising, and gradually rolled it back to 10% by the end of the year.

For newly launched stores, this would be a common shape of spending on advertising. 20% of sales going back into advertising would be expected to drive significant growth. And, once you are more established, 10% is a more common percentage to drive steady sales growth.

For more well-known online stores with a stable demand, we know of cases where the percentage of advertising to sales can even drop down to 5-7%. Though, anything less usually isn’t enough to drive enough sales.

Post launch

When you are in the planning and build phase for your online store, it is easy to become really focussed on the launch of the store. It’s obviously an important step. But, it’s important to remember, it’s only the first step on your online store business model.

Once, your store is live, it becomes an on-going operation, open 24/7, 365 days a year. You need to be able to plan how you are going to manage the store in these conditions.

Though we have a separate guide on how to best do this, there are a couple of key factors to consider in the context of your online store business model.

Three brains e-Commerce symbolic open shop sign

Accountability and decision-making

Though you’ll develop a P&L and investment plan before you launch, there is little to no chance that you’ll be 100% accurate in your forecast. It’ll need to adjust over time. It will get more accurate as you gather real sales data, and understand the reality of your online market.

But this unpredictability can throw out some challenges. You’ll have set KPIs for example, but what happens if you miss them? What’s the difference in action if you miss them by 1% vs 10% for example?

Your online store business model should make clear who is accountable for the performance of the store.

It should make clear the plans if the store underperforms, and what would be the signals that the store is not delivering. Many online stores fail, so it’s important to plan ahead for this contingency. You don’t want it to happen, but it’ll help if you have an exit plan, if the worst happens.

However, with accountability needs to go empowerment to make decisions. The person who is accountable should be the decision-maker. It should be clear in the online store business model, who makes what decisions. And, how are they carried out.

If you use agencies or other third-parties, you also need to make clear what accountabilities they have, how you will evaluate them, and what resource support they need to provide for you. And you need to work out what costs come with this, and how you include them in your online store business model.

Slow start planning

It’s important to take a long-term view. Many people expect things to happen fast online, but sales from new online stores tend not to be one of them.

Online shoppers need to feel they can trust your brand identity and your store offer. It takes time to build this trust. You may well find that it can take weeks before you get your first sale. And, even after a few months sales might still be low.

Our first store, even though it had a good level of investment only took 25 orders in the first 3 months. But by month 12, it was taking over 2,000 orders a month.

Sprinter on their markets ready to go

Make sure anyone involved in the store understands this.

The “launch” can feel like a big event, but when it takes 3 months after that for sales to start showing, people can become impatient. They might feel that the store has ‘failed’. You need to push this longer-term view, and also plan ahead to what you do in the months after launch.

It’s often worth holding back some advertising budget, for example to run in later months in the year to give the store a boost.

Managing resources in an unpredictable environment

It’s important to be clear in your online store business model, all the tasks that need to happen, and who is going to do them.

You need to plan ahead for how long tasks take, how much they will cost, and how you will know if they’ve been done properly.

We cover most of the functional skills you need to manage an online store in another article, but you need to factor in to your online store business model, that your sales are likely to be quite unpredictable for the first year.

How will you adjust your resources to meet peaks and troughs in demand? If your sales unexpectedly take off, this can put extreme pressure on existing team members. But, if sales don’t take off as expected, that means teams will be sitting around with nothing to do.

You should identify key people, who need to be available, no matter the level of sales. So, someone to run your media and maintain and update the website, for example. 

But you should also contingency plan for these peaks and troughs. Can you plan to hire temporary workers into your customer service or warehousing teams if demand takes of? Are there other say digital marketing activities that could be done, if sales don’t take off?

Backlogs

As you planned the store launch in your online store business model, it’s likely you had more ideas than you could feasibly implement. It’s impossible to do everything at once. But, you could re-look at these ideas after the launch, and implement them at a later date. This becomes your backlog of ideas to improve the online store experience and grow sales.

This approach comes from agile methodology which we discuss in our guide to marketing technology. It becomes a series of activities and tests that you run in short bursts (called ‘sprints’) to add better functionality, design or just generally to improve the overall experience of your online store.

This helps create a feeling with shoppers that your store is staying fresh. It helps to build confidence. This regular updating of the experience also helps with your search performance. It signals to Google’s algorithms that your store is an active site, that is being regularly updated.   

Refine and update your activity calendar

You can build these sprint activities into an overall activity calendar for your online store. This helps to identify key times of the year when you may need more resource. And, other times when you can focus on maintenance.

The activity calendar is something we cover in more detail in our guide to brand activation.

In this case, the online store becomes your “brand”, and you need to plan ahead when you will run media campaigns, sales promotions and update services for example.

 

Calendar

You’ll have a need to keep driving awareness and consideration for your online store. This needs a solid plan to support it. This will help you keep track of who runs each activity, when it needs to happen, and how you will track and measure it.

Check you meet your legal obligations

When you sell direct, it’s important to remember that you have a number of legal obligations. Most of these relate to digital data such as maintaining privacy and following anti-spam rules.

But you also need to check the retailing legislation in your market, especially with relation to consumer rights. If consumers make complaints, or ask for refunds, you need to make sure you have the right process in place to do this compliantly.

You should have a clear returns policy and system, and outline these on your online store website.

Law - scales of justice

It can also be helpful to have a risk analysis.

Think ahead as to what bad things could potentially happen. The warehouse catches fire. Your product makes someone ill or sick. There’s a data breach in your customer data. A retailer complains that you are now competing against them, and plans to stop stocking your product.

All these types of things can and do happen to even the best planned online stores.

Work out how likely these things are, and how impactful they would be on your business.

Then, work out the key things you would do to manage those risks, if they were to happen. You should always have a plan B, in case something happens to your Plan A.

Test and learn

And finally, and probably most importantly, work out how you are going to keep making your online store better. The worst your store will ever be is on the day you launch it.

Keep testing the experience as if you were one of the target audience yourself. Check your digital data regularly to see what’s working, and if there are any issues. Ask your customers for feedback. They can rate the service on the site, give reviews, or if they’ve signed up for your CRM program, you can contact them and incentivise them to give feedback.

Keep an eye on how competitors respond. Do they make regular updates? Can you see how they are improving their experience? Is there anything you could / should try to counter what they do?

Map out the process of how an order goes through your business. Look for ways to make each step better.

e.g. what has to happen on the site? what details do you receive? who receives them? what do they do with them? how do they handle unusual orders? what needs to happen for the order dispatched? how is the payment confirmed? etc

The fewer steps you need to manage an order, the more efficient your online store will be. The happier your potential customers will be.

You can read more about the types of activities you can do to test and learn at each stage of the e-Commerce experience, in our guide to managing an online store.

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

Setting up and running your own online store sounds exciting, but as our review of the online store business model shows, it also comes with a lot of challenges to overcome.

None are impossible, but the more you plan, and the more you know, the more likely you are to 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. 

Three-brains online shop screenshot

Think beyond the commercials

But thinking more philosophically, don’t underestimate the value of breaking the hold that retailers have on accessing your consumers. Taking out the middleman is a significant way of getting closer to your consumers. You get to speak to them directly, understand them better, and build a better overall customer experience.

It’s important to get your head around all the costs involved though. In our experience, we’ve seen it work best when companies go one of two ways.

If your idea is strong enough and you can generate enough 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 those costs across more units bringing better profitability.

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

Be creative or outsource

Your other alternative is to be creative or to outsource.

There are companies already doing delivery, where you could piggyback on their existing model. We cover this opportunity in our last mile article in our blog section. 

In our pizza delivery example, we would look at a Deliveroo or an Uber Eats type company, who could collect the product from us and get it to customers quickly. We’d expect to give up some of the margin from selling direct. But we’d be handling a lot of the delivery and customer service complexities 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 will tend to be more reactive as you deal with customers. So the more you can plan ahead, the less reactive you will 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 have worked on many e-Commerce projects and have good experience across strategy, working with online retailers and building D2C stores. We know how to connect these expertise areas back into driving your brand marketing and growing your sales. 

If you want to know more about how we can support your e-Commerce to grow your business through our coaching and consulting services, click the button below to send us a message.

We can coach you to reach the top of your competitive game.

D2C Online Store Status dashboard
Click to download the pdf

Downloadable D2C status dashboard

Setting up an online store needs you to define your strategy and plan, work out the sales and marketing and also set up the whole operational side of the business including the finances and the delivery / supply chain model. It can be complex to manage.

That’s why we’ve used this project dashboard to great success in the past to have a simple one-page summary of the key actions require to set-up and manage a D2C online store. Download it here or from our resources section. 

Powerpoint and Keynote versions of this document available on request. 

Latest e-Commerce blog posts