Ecomom's aggressive discounting culture should be a cautionary tale for all of ecommerce

By Sarah Lacy , written on February 18, 2013

From The News Desk

I'm hoping this will be my last post about the sad demise of Ecomom. In case you are new to the story, Ecomom was a once promising ecommerce startup that told investors it was going to start liquidation last week following the tragic suicide of its founder and CEO Jody Sherman.

This came just weeks after jobs were slashed, promising the new economics would allow the company to keep operating. It seems no one knew just how bad Ecomom's finances were -- just months after raising $5 million in venture capital. We've been trying to get to the bottom of the mystery.

But at the end of the day, this is more than just the story of one company's demise: It should be a cautionary tale for the whole ecommerce 2.0 sector. My understanding is what felled Ecomom is going on far and wide right now, and has since ecommerce's earliest days.

Since we broke the news of the company's liquidation last week, reports from investors and Ecomom employees have continued to trickle in about just what went wrong. While we've had confirmation from a few parties that there was some large purchasing mistake that was the final straw in killing the company's cash position and triggering covenants on a $1 million line of debt, we've also heard that there was far more to the story than any single mistake.

For one thing, it wasn't simply an error on a purchasing form, a la an extra zero. That could have been easily reversed. Rather, it has been characterized as an aggressive gamble on how much inventory the site could move, coming from higher ups in the sales and marketing team.

And it's important to emphasize, this deal alone didn't tank Ecomom's finances. Rather, multiple sources inside and who have invested in the company have described it as the final straw of an aggressive culture that had taken hold within the upper ranks of Ecomom. The company had gone from scrappy, lean roots to betting heavily on growing the top line as fast as possible. While no one seemed to grasp the extent of the toll this was taking on Ecomom's finances, we've heard there was some concern inside the company that these escalating sales weren't close to profitable and wouldn't be sustainable.

You don't need the company's financials to get a glimpse of what was going on. If you Google "Ecomom" and "coupon" you find 73,000 results. Many were run through daily deals sites. This one on PlumDistrict is one of the more egregious. It offers $100 of product for just $40, with free shipping, and when you consider the healthy 50 percent that most deal sites take, the economics are even worse. As one investor characterized it to me, it's like selling a dollar for $0.20 -- venture capital dollars at that, which aren't limitless in today's era and can come with a steep cost.

This doesn't mean Ecomom was being managed poorly. If people lured in by these offers were to become repeat customers, that's not a bad price to pay to acquire them. But the economics of Ecomom imply that not enough did -- or they didn't before the money ran out, when this final purchasing blow wiped out much of the remaining cash. This has been a widespread learning: The general complaint many merchants have had of the Groupons of the world was they brought in discount-obsessed couponers, not repeat buyers.

Ecomom isn't alone in these kinds of tactics -- not by a long shot. And the company should be a cautionary tale for a lot of ecommerce vendors who VCs increasingly gripe are just using venture capital to merely "buy revenue." Tech sites meanwhile, should be wary of getting too excited when reporting a startup's top line numbers, when we don't see the balance sheet and understand the cost they're coming at. If we have learned anything from Groupon, it's that simply having enough money can fuel top line numbers... for a time.

Ecomom comparatively raised much less than many ecommerce companies out there, so its problems may have just shown up faster than others. Several VCs have expressed skepticism that there's any science in social commerce as so many companies have hoped, and that the only real way to acquire customers is still Google keywords which startups just can't complete on. My sense is if follow on rounds dry up for ecommerce in general, we could see a lot of companies burning through their cash position, quickly just as Ecomom did.

People throw around the term "buying revenue," and the truth is it's a bit in the eye of the beholder. Josk Kopelman explained it well at our PandoMonthly in February when he said:

At the end of the day the lifetime value of the customer has to be more than you spent to acquire that customer. Otherwise you’ve built the e-commerce equivalent to a Ponzi scheme.

In general, what I think you’re seeing, is that many and most of these companies are growing fast because they believe that the lifetime value of a customer is greater than what they’ll spend on marketing.

The key question that companies ask is how far ahead they’re willing to fund it. Do you need to recuperate the marketing cost on their first purchase, their second purchase, or the 15th purchase? In other words, in the early days of a startup one man's aggressive revenue buying could be another man's long-term view of the market.

(We discussed this at our ecommerce CEO Supper Club as well, so we'll have more on this topic from the CEOs of Warby Parker, Thrillist, Birchbox, and One Kings Lane later this month.)

And it's not as if ecommerce companies haven't been rewarded for the practice in the past: Look at Amazon's price-matching programs that span nearly every industry from publishing to electronics. And look at Amazon's margins. The company is almost 20 years old and is arguably still doing this.

Similarly, Zappos long forsook profit margins to make sure customers had a Nordstrom-like shopping experience. Zappos' insistence on free shipping and free returns not only challenged Zappos' bottom line, it hurt the profitability of the entire sector as that became what customers expected.

In the case of Amazon and Zappos, the playbook worked. But there were thousands of others in the late 1990s that went belly up with this strategy. The hope with ecommerce 2.0 has been that a movement away from commodity and towards brand, curation, celebrity, and content could all up the margins once again.

Sherman's vision with Ecomom was certainly not about commodity and more about building a trusted life-long relationship with customers. From his investor letter just after Amazon purchased in the fall of 2010:

It is no secret that has built a big business out of selling high volume / low margin consumables. It's also no secret that Amazon was clearly going straight after them with the introduction of Amazon Mom -- another foray into the high volume / low margin consumables business.

But that's not the business in which each of you invested.  You invested in a curated ecommerce company that is focused on building a high lifetime value tight relationship with moms and families -- leveraging their strong social inclinations and fostering trust and loyalty by providing a destination for them to make purchases that are safe to put in, on, and around their families.  In short, you invested in a company with a very differentiated strategy from those who are focused on high volume / low margin.  Our value proposition, as repeated to us by our customers, is that we make them feel safe.  They know when they come to EcoMom that we have done the research and filtering of products for them.  The only thing about us that is even remotely "Amazon-like" is our fanatical focus on an amazing customer experience -- which is really more "Zappos-like" (a company which most of you know was purchased by Amazon last year). Given this vision, one can see why Sherman felt the lifetime value of a customer would be substantial. It's hard to know how it would have played out differently had Sherman stayed alive. Perhaps he could have raised more money? Pivoted? There are parts of this story we'll never know.

Still, like most things about this story, many investors have been surprised to find out just how unprofitable a lot of Ecomom's sales were. Sherman started out very lean and scrappy, as he describes in this interview with Jason Calacanis on This Week in Startups.

In the site's early days Ecomom was marketing through creative promotions and affiliate links with mommy bloggers that carried very little discounting at all. One investor I spoke with remembered talking to Sherman when he discovered daily deals and began playing around with them. The deals he was offering back then were still very traditional and conservative.

At some point that changed. Perhaps it was the pressure or promises made when he raised the company's last round in the fall. Over the last year the tone of investor letters changed and started to trumpet aggressive top line growth. No one -- not even the company's senior management -- seemed to realize just how aggressive it was getting. And apparently, this final purchasing move as directed by sales and marketing was what wiped out what was left in the company's coffers.

No one will ever know if Sherman knew the company only had weeks to live. His director of operations, who took over as president after his death, clearly had no idea how dire things were, nor did investors. That is clear from the bizarre and sudden communications that went from "We're going to continue building Jody's vision" to "We're liquidating our assets" in a matter of weeks.

While Sherman was seen as a direct leader who'd experienced failure before and was not too proud to admit a mistake, this bit from that same interview with Calacanis is telling of his mindset. It's also extremely common in the startup world as Francisco Dao wrote in his excellent post for us just after Sherman's death "The Show":

JS: The other thing about entrepreneurs is that it doesn’t even come into our thinking that we might fail.

JC: Being delusional, egotistical, quixotic and pigheaded is what it’s all about.

JS: How many days do you sit around and say, OMG my company is going to fail today. It probably never occurs to you. I’m sure you’ve had bad days, but never bad enough to say, ‘I’m shutting my doors tomorrow.”

JC: I’ve had bad days yes. It is my philosophy and commitment to actually get it across the finish line for my shareholders and employees. The CEO title sucks because you’re ultimately responsible.

JS: Any when you’re having a bad day, you still have to put your game face on, because the people in the other room can’t know.

JC: They can’t know that you’re bummed out. If the leader’s not inspired to storm the beach, it’s going to be a bloodbath. Fake it ‘til you make it.

JS: My worst day is nobodies business. I’ll figure out how to deal with it later. I think that people, who think that way, kinda alter reality until it becomes reality.

JC: I think that’s what delusional people do.

JS: I don’t know if it’s delusional, but it is irrational. As a final note, my reporting on Ecomom has had one aim: To cover the death of a high-profile, once promising company and to bring to light one of the challenges of building an ecommerce company. I have never cited my reporting as speculation on why Sherman took his own life. Even knowing all of this, it doesn't square with the Sherman I knew.

We trade in facts here. That's why we've relied heavily on shareholder documents and multiple interviews of those who witnessed Ecomom's business practices. I've seen other reporters emailing investors and friends of Sherman's to try to get "confirmation" that these reports of Ecomom struggles are why he took his own life. Personally, I find that disgusting.

While a debate about the pressures of entrepreneurship is healthy, as other blogs seek to exploit this topic for page views, I just want to remind everyone that none of us know why Sherman died. None of us know the exact pain or pressure he felt. There is only one source on that, and he is unreachable.

[Image courtesy xbettyx]