Why Run an Online Store

It’s strange, after reading of the demise of another competitor, one would wonder why you’d bother to build an online store.  That’s a very good question, and certainly one that I’ve asked myself a number of times.  The profit margins are extremely tight, with both customers and competitors always looking to lower it even further.  There are quite literally competitors in Canada who sell products at a loss – as part of their business plan.  So, why bother?

Love of the Industry

Let’s be truthful here, most of us could be working in another industry / another business and making significantly more than what we are earning doing this.  Heck, from speaking with a lot of B&M owners, the profit levels at B&M stores can be significantly better too.  Knowing the industry, at least you don’t need to learn the product  (as much) as with starting out in an industry that you don’t know.

Low Capital Costs on Startup

This is a tricky one – it’s easy to start-up the business with much less capital than most brick & mortar stores.  Most online stores start running out of their houses / apartments, keeping stock in their spare rooms or living rooms and shipping orders out every few days.  So, instead of $50 or 100k, you probably can start up at $20 or $30k.  Or even less….

Flexible Hours

It’s easier to fit an 80 hour week for an online store than a B&M store around other life commitments.  It’s still not uncommon for me to get online at 11pm and start working after spending the evening with my family.  You can still go out in the evenings, hang out with friends for a bit and then go home and work more on an online business compared to a B&M store.  You put in the same ridiculously long hours, but they are more flexible.  And when you’ve got family obligations too, that can be extreemly important.

Introvert Friendly

If you aren’t a people person, running a B&M store is going to be significantly more difficult. I know, for myself, that there’s only so much interaction that I can deal with at any one time.  Working in an online store puts a ‘wall’ between you and the constant amount of customer interactions, so it’s a lot more introvert friendly.  Answering an e-mail is so much eaier than talking to a person.

Scalability

This is more a theoretical idea than one that I’ve seen yet, but it should be possible to scale an online store much easier than a brick & mortar store.  At a certain point, you’ll max out the sales per square foot that a B&M store can handle at which point you’d have to either move to a larger location or build a second store.  With an online store, your physical location is much less important so moving should be less of an issue while purchasing should be ‘simpler’.  After all, when restocking a game, if you have to restock 10 copies or 2, it’s still a single line on the invoice and search.

I write about the challenges we face as an online store more often than the advantages, so I thought this list might be a nice counterpart.  If you can think of something I’ve missed, feel free to chime in.

Public vs Private Companies – the Web Battle

You might know (or not) about the recent posting from Amazon on their Q2 results – a US$7 million loss on revenue of $15.7 billion.  You probably didn’t know of Geeknet’s (Thinkgeek’s parent company) loss of US$1.5 million on revenues of $22.0 million  Public companies – you got to love them.  They keep churning out losses and most people shrug their shoulders and figure that these are ‘growth’ companies, thus a few losses for a few years (or a decade or two) are fine.

The Data

Here’s a quick comparison taken from their Q2 financial releases.  Note, Geeknet rolls the entire cost of fulfilment & COGs (stated as Cost of doing business) into one number which is the number I used for the % provided.

Amazon Geeknet (Thinkgeek)
Revenue $15.7 billion $22 million
Loss $7 million $2.5 million
Growth 22.30% 24%
CoGs 71.40% 79.96%
Fulfilment 11.20%
Marketing 4.10% 8.72%

Amazing isn’t it?  In both cases, just paying for their goods and shipping costs approximately 80% of the revenue they take in.  That’s 20 cents on every dolllar dedicated to just making sure they have stock and can ship it to you.   Never mind the cost of acutally getting customers or the operating cost of running the site.

Let’s put it another way – you earn $40,000 a year (gross).  To generate enough money to just pay for your salary using the 80% metric, you’d need to generate $200,000 in sales a year.  Just to pay your salary.

Private Companies (us)

As you can guess, there is no way we could survive on margins like that.  Until recently, Amazon made losses year-in, year-out. Geeknet is still in that stage it seems.  Privately financed companies like us (i.e. small businesses) just do not have the level of capital required to sustain such a business model.

We have to build a business with a better margin from the get-go, which requires us to do things differently from the Amazons and ThinkGeeks of the world.  And in Canada, that means we have to have higher prices due to the lower number of customers available in total.

That’s not to say it’s not possible or viable for private companies to run losses – it’s obvious that we can and have.  However, we have a finite set of funds, while public companies often have a huge cash egg and have access to even more capital if the initial amount isn’t sufficient. Our investors (if we have any) are also often more demanding and have much shorter timeframes.

The Result

At Starlit Citadel, we actually charge the cost of shipping (unless you hit the Free Shipping threshold).  We provide discounts, but we keep our discounts at a level that provides a higher margin on COGs.  We have to basically run a business that is meant to make a profit – soon.  Not one that will make a profit in 5 or 10 years, but one that will do so in 2 or 3 years.

And once we do make profits, we often have to invest it back into the business…

Lending In Canada

Over the last few years, at various times we’ve gone to the banks and looked at government grants or financing to help grow the business. It’s not that we need the money to survive, but capital (loans, etc) help us take risks to grow that we might not be able to / willing to do so without that back-up of additional capital.

In the last 6 years, the amount of external capital funding we’ve received through countless hours of applications and research? $0

Grants in Canada

I’ve mentioned before that unless one falls within very specific boudaries; receiving a grant is extremely unlikely.  The grants out there are created to either:

  • aid what is considered a disadvantaged class
  • provide employment and business growth for ‘high value’ businesses

E-commerce businesses and game stores do not fall into that category.  Instead, you need to be in a ‘sexy’ category to get a grant, which is why there are a ton of people chasing high tech dreams of social media / technological success and few actual e-commerce businesses.

Banks, They Are Not Your Friends

Perhaps its just an external point of view, but it seems banks in the US are much more willing to broker actual loans for businesses than Canadian banks.  Worst, what banks and the government want you to take loans out on or are willing to finance have very little to do with what is good for your business; but what is good for them.

As an example – it’s easier for me to get a loan to purchase a commercial warehouse than it is for me to get a loan to pay my rent.  In the first case, the bank feels they have an asset they can take in the event of a default; so they are happier to make the loan.  My ability to repay the loan is secondary in this sense and any inventory assets are not part of this equation.

Best Not Be Sensible

Another strange aspects of getting a loan from a bank is the need for personal assets.  More importantly, they desire personal assets that are not in RRSPs / TFSAs.  Both of those savings instruments are shielded by law from a loan guarantee; so even though it makes the most personal sense to conduct your investing / savings in those vehicles; if you need to see a bank for a loan it’s actually more sensible to have your funds in a non-secure account.

Dear Government…

Banks aren’t really here to help grow the economy.  Their goal is to make as much money as possible, which means reducing the total risk.  So, yes, even if a business is potentially worth investing in, if there aren’t any capital assets banks don’t want to deal with them.  Worst, in my view is the fact that our Canadian banks are happy to continue with the status quo since there just isn’t any competition for them.
This is where the government and government programs are supposed to come in.  Yet, there really aren’t any out there in Canada, or if there are, it’s nearly impossible to locate.  Changes in our tax rates, hiring credits (that appear, at best a year later) and super restrictive grants (e.g. the Get Youth Working Program) make great headlines, but do very little to stimulate business growth.

And we wonder why Canada is consistently behind the US and other countries in terms of innovation and business investment.

 

Growth is Expensive

Everyone talks about how cashflow and how much money you require when starting a business.  It’s drilled into the head of many new businesses how expensive it is to start; the need for sufficient capital so as not to fail.  What people don’t talk about as much is how expensive actual growth is.

The Harsh Reality

When you first start; most of your needs and the work that can be done can be handled by a single person.  As you grow; you find it harder and harder to complete all the tasks necessarily to run a business with just 1 person.    Instead of entering 1 order, 1 invoice, 1 payroll per week; you’re now looking at 100 orders, 10 invoices to enter.  Instead of just shipping 5 – 10 orders a week; you now have to manage 20 orders. You’re growing; but it’s putting a strain on your business.

The Mathematics of Growth

Let’s focus on just inventory.  Say you have 100 products, each of which you keep 2 items  in-stock.  Each of those products you buy for $20.  That’s $4000 in capital that you ‘keep’ in-stock at any time.  Now, let’s assume you get 1 order for each of those 100 products a week (i.e. 100 orders for 1 item);  you actually have 1 item per product (100 items total) in-stock – a happy medium in case of sudden surges so long as you re-stock once a week.

What if you grow to 200 orders for 200 products? Well, if your initial goal was to keep a full week’s worth of inventory on-hand at any one time; you have to increase your inventory by 200 products – another $4000 in capital.

Now, if you take our normal margins into account, that means to build up $4000 in gross profit; we’d have to sell $8,000 of product – $12,000 in Gross Sales.  That’s a very expensive proposition; especially when you take into account this is Gross Profit – not Net.  There’s still a lot of costs; some directly associated (e.g. storage, shipping, processing charges, etc). that need to be paid for.

As I said; growth is expensive.

More Complexity

Let’s add a few more thoughts.   With growth in sales, you’ll need more:

  • space to store your new inventory
  • boxes to ship the new orders
  • employee hours to handle the shipping
  • bookkeeping time to input the longer inventory lists and no. of orders
  • customer service hours to handle the additional questions
  • etc.

The worst part? Some of these costs have to be front-loaded.  You might see a slow increase in sales; but you still need to start stocking up additional inventory before the sales materialize to get the sales.  You might have to hire an employee full-time and find ‘make-work’ for him till sales improve sufficiently to justify him shipping only. And so forth.

Finding the Balance

Finding the balance between necessary growth; planned growth and available resources is difficult.  If you don’t plan for the growth; the friction of insufficient resources will result in unhappy customers and employees.   Yet finding the funds for growth can sometimes be difficult , requiring sacrifices in your plans and goals.

Funding a store

I’ve recently been thinking a lot about different funding models, after a huge dose of the Dragon’s Den.  By the way, for all of you wannabe entrepreneurs, that’s a great show to watch.  Lots of good wisdom thrown around, with some really hard questions asked.  Questions that any entrepreneur should have to answer at some point.

It takes about $100,000 to start and run a store from my view point.  Figure about $30-40,000 in stock including a ‘slush’ fund for unexpected demand for games.  About 2 years operating expenses and $40,000 or so for 2 years worth of salary.  That should see you through the bad times and the unexpected costs till you see some good growth.

That being said, very few people have that amount on-hand.  There’s a variety of funding sources available, and I’ll list them here with my comments.

Government Loans & Grants – there are a few grants out there; mostly for women, visible minorities (generally First Nations) and those under 30.  Ditto with loans.  If you fall  outside of those categories, it’s difficult to get your loan or grant; but the amounts and the interest rates makes it quite worthwhile to look into.  Your Small Business Centre in your city will be able to help.

Employment Insurance – here’s an interesting fact.  If you are fired (or otherwise end up on EI); you can apply for a business development program.  They put you through a course that helps you develop your business plan while you are on EI and you have up to 52 weeks I believe to develop the plan & start the business.  However, if you already have an existing business, you are ineligible for this plan.

Bank Loans & Lines of Credit – at the very least, you should get a Line of Credit.  Cashflow is often uneven; so having the ability to quickly dip into the LOC to cover bills is really useful.   Just realise that with bank loans & LOCs, you require a good credit report and the willingness to sign your life away.  And even if you do, you might be required to put up further collateral (e.g. a GIC deposited with the bank, your house, etc.) before they will extend a loan to you.

Visa & Mastercard – I’m not joking.  They are often your best supporters.  Sure you sign away your life as well, but they don’t ask for collateral and can loan you even more than your bank would be willing to.  In Canada, a business credit card generally sucks.  Your rates are often higher as are your yearly fees and you get less cashback / reward points.  However, the side benefits can make it worthwhile for some people (car rental insurance, specific bonuses for traveling, etc).    If you intend to use your personal credit cards, definitely look into increasing your credit limit at least a year beforehand.  That allows you to go through 2 cycles of increase requests, which gives you a good bump.

Self-funding: What it says.  The money you take out from  your personal savings.  My only comment here is that it’s worth deciding how much you’re willing to invest and what the limit is.  A spouse is very useful for setting limits here.  On a secondary note – consider making a formal agreement with the company (if you incorporate) indicating the loan amount(s) and the interest rate you charge.  While you might get taxed on this ‘income’; it also increases your company’s expenses.

Friends & Family: How friends & family help fund the business depends on the organisational structure chosen – if it’s an incorporated business, a partnership, etc.  In an incorporated business, you can issue shares (voting or non-voting) for the amount invested.   You then have to decide how they will get their money back (e.g. buyout clauses and dividends).  If you’re going down this route, talk to the professionals.  There’s quite a few options, and shareholder agreements are very important at this stage.

Direct loans on the other hand are simpler.  I’m not sure how it works if you’re self-employed; but with a corporation;  they get inputted like any other loan.  You’ll want to formalise the loan again (loan amounts, the loan term and interest rate paid – generally comparable to 3rd party loans) both to make it official as well as to reduce anxiety and confusion.  It’s worth noting that in the event of a bankruptcy, lendees will always be paid first before shareholders.

My personal take on loans from friends & family is to tread very carefully.  The fastest way to poison relations is over money.  Unless all parties understand that there is a HIGH risk of failure, things will likely end badly.

Angel Investors: True Angel Investors generally look for a higher return on their investments.  However, random acquaintances who are willing to invest could be considered ‘Angel’ investors, and these are potentially the best kind.  They don’t have an emotional stake in you; so they are viewing the business through a more clinical eye.  The actual method of investment (equity or loans) depends again on company structure and your deal with them.

Venture Funds: Just don’t bother.  The board gaming business is not one their interested in.   We’re too mature, there’s nothing new or exciting or ground-breaking here to provide them a good return.

Okay, that’s all I can think of right now.  Did I miss any?