Online store business model

Why read this? : Your online store business model shapes how you plan, organise and track performance. We share key information, skills and process you need to build a robust model. For example, learn the important of forecasting and positioning. Learn about all the different costs you need to manage. Read this to get your online store business model into good shape.

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Online store business model in the e-Commerce planning process

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

With your own online store, this validation phase becomes more complex as you build your e-Commerce strategy and plan. You need to consider many different factors within your online store business model.

The opportunity identification gives you a view of your target audience. You’ll understand their needs at a product and service level. Service level needs in e-Commerce covers areas like how you deliver 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.

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. (Taken from a case study 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.

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

You also need to factor in the clarity 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 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’re 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 overlook the impact of price discounting too. Short-term offers can be a way to drive quick sales, and drive trial. They can build noise around your store at key selling times of year.

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.

It’s better to be conservative in your initial 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.
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.
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. You need to build your competitive strategy and create your competitive advantage.

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 the confidentiality of the project.

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
Services.

Price and delivery

So, on price, we saw that 2 of the competitors sold at the RRP of 29.99, while one went higher, and another 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 dollars, with free delivery offered on purchases over $100.

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

We considered 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. Not quite a full subscription model, but as close as we could make it.

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. 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 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 minimise 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.

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 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 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 you’re making a profit.

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.

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 you work out your tax obligations. 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 per our e-Commerce functions guide, they also charge a fee, usually between 1% and 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.

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.

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

So, for example advertising and media costs. This is planned in advance. You know how much you’ll spend.

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 need to look at your advertising evaluation impact on sales and profits.

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’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 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 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?

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 actually worse on a percentage basis. Because it works out at at 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 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 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

In the above model, we’ve used an average delivery cost per unit to keep it simple.

But actually working out what your average delivery cost is to do this type of calculation is surprisingly hard.

Unless you only sell one type of product to one geographic area, you have to consider there’ll be a wide difference in delivery costs across the range you sell.

These costs are affected by factors like :-

order sizes.
product weights.
packaging requirements.
delivery coverage.

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

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 – In this case, 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 of this on your 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.

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.

For more on the financial aspects, check out our article where we walk through a case study with an actual e-Commerce profit and loss.

Post Launch Challenges

Next, you’re about to enter two 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, and so we’ve written a separate article on some of the e-Commerce issues you’ll face in this phase.

Then, once you get more used to it, there’s even more on-going 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 when you first start out.

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

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.

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’ve worked on many e-Commerce projects and have good experience across 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.

Downloadable D2C status dashboard

There’s many jobs to do when it comes to D2C. You need 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 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.

Online store business model

Online store business model

Ready to test your knowledge?

Online store business model in the e-Commerce planning process

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

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

How to estimate your potential share of the universe

Competitive appeal

Advertising and media spend

Brand identity

Pricing and promotions

Newness

Reasonable share summary

Competitor review

EXAMPLE : Finding a competitive position

Price and delivery

Ease of shop

Services

Set your 12 months KPIS - starting with sales and marketing

Let’s look at a quick example

Other KPIs

Build out a high level marketing plan

Online store business model - P&L

Online store sales in the P&L

Online Store costs in the P&L

Sales tax

Transaction fees

Deductions before gross profit

Cost of Goods (COGs)

Warehouse and delivery

Deductions before net profits

Advertising and media

Development

Overheads

The challenging question of net profit

Transaction and logistics fees affect your net profit percentage

Example : Sell to Retailer vs Sell D2C

Funky maths

The challenges of the delivery fee

Online store costs – there’s more!

Post Launch Challenges

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

Think beyond the commercials

Be creative or outsource

Three-Brains and e-Commerce

Downloadable D2C status dashboard

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