Why increasing revenues can be bad for startups
Fortune 500 enterprises and startups alike face constant pressure to increase revenues. Naturally, that’s not surprising. Ultimately it’s why we found startups in the first place. Meanwhile, investors want to be a part of growing companies, and smart employees want to be part of the next big thing, not the last. But this intense pressure to grow often pushes management into unhealthy and risky decisions. Take, for example, the demise of Ecomom.com following the tragic suicide of its founder/CEO, Jody Sherman.
Ecomom was a once promising ecommerce startup that had raised more than $10 million in venture capital financing to become the “Zappos of eco-products.” Desperate to meet aggressive revenue targets, it embarked on a deep discounting strategy that led one of its customers to comment on his Facebook page: “With the crazy deals always happening at Ecomom, I wondered how they made their money. I guess they didn’t. Very sad…” Like many retailers, Ecomom hoped that its discounting would be offset by lower cost of goods sold from buying merchandise in larger quantities. Unfortunately, this rarely happens.
I struggled with whether or not to dissect Ecomom so soon after Jody Sherman’s passing. He was a dear friend of mine, and, like many, I was shocked when I heard the news. Ultimately, I decided that I needed to. Jody’s tragedy has further reinforced my commitment to helping retailers grow their businesses in a sustainable manner. In fact, I started 500friends because I ran into a similar problem as Jody at the previous startup that I co-founded. I had to lay off hard-working team members before I had turned 21. Competing with Amazon and Walmart is never easy, but I see it as my job to help retailers not only survive but to thrive.
Besides relying on the old trick of deep discounting -- which may increase the number of customers but dampens margins and hampers profitability -- some companies attempt to grow by spending more on customer acquisition. Bidz.com is an “eBay for jewelry” that succeeded in attaining almost $100 million in sales by continuously increasing its acquisition budget, until it became unsustainable at $50 per new customer. After investors realized this, the stock continuously declined until it traded for barely above $0.25 a share. The company was eventually taken private for $0.78 a share.
Juicing the topline by lowering prices and increasing customer acquisition costs is generally unsustainable. Before focusing on growth, companies must first ensure that the fundamentals of its business are sound -- that the lifetime value of a customer is a manageable multiple of its customer acquisition cost. Amazon is the poster child for of a barely profitable company whose revenue growth is sustained by its high customer lifetime value. In 2012, Amazon’s core retail business generated more than $48 billion in sales. The fact that 30 percent of online shoppers research Amazon before buying, compared to 13 percent for Google, suggests that Bezos & co. are kicking ass in this area. It would be nearly impossible for Amazon to grow at almost three times the rate of the ecommerce industry if its growth was driven solely by new customer acquisition.
Sustainable growth isn’t only a concern for retailers. Demandware is a business-to-business-to-consumer commerce site that powers the backend on-demand digital commerce for brands ranging from Pacific Sunwear to L ‘Oreal. Like Amazon, its revenue growth depends on a high customer lifetime value. In 2012, its subscription dollar retention rate exceeded 100 percent and customer churn was less than 5 percent. This means that increases in revenue are more likely to persist over the long term. In fact, Demandware’s customer base is so healthy that even if it were to completely eliminate its sales and marketing budget, revenues would continue to grow (albeit much slower than 40 percent). This is one of the reasons why Demandware is currently valued at 10-times revenues.
Is there a path for up-and-coming brands like Ecomom to embrace responsible and sustainable growth in an environment where investors reward rapid top line expansion, new employee candidates join the “next big thing,” and consumers have been trained to expect discounts?
Yes, because Ecomom had part of the answer. It had a unique “personality,” wonderful product curation, and a fanatical focus on customer service. At first, it capitalized on these strengths, building an authentic voice on its company blog and social media channels, donating food for every purchase, and launching a relevant loyalty program that went beyond simply rewarding the transaction.
Unfortunately, though, as an organization it had already assumed a culture of discounting. Even its loyalty program fell victim, essentially becoming nothing more than a rebate program rather than a strategic commitment to increasing customer lifetime value. Ecomom should have been thinking about segmentation, personalization, and creating additional engagement opportunities. Specifically, it should have tailored its communications to its top quartile of members to focus on exclusivity and recognition (not more discounts) and created and incentivized additional customer engagement opportunities (things like writing reviews, connecting their social media accounts, referring their friends, etc.)
Less tragic, but no less impactful versions of the Ecomom story are currently playing out across the retail landscape. Retailers who desire to build long-term sustainable businesses need to be bold and stop pandering to short-term growth targets by perpetuating a culture of rampant discounting.
The price of getting this wrong is just too high.