Entrepreneurs build businesses to satisfy a need. That could be a product, (a shirt), a service, (dry cleaning), or an experience, (a restaurant meal). Also, most business builders hope their business creates both current income for themselves and their employees, and long-term wealth for the owners.
To build income, the sales of the business must exceed its costs. It’s that simple, though oftentimes hard to do. There are lots of business models that do that. Sell many items or services over and over at a low price (thumbtacks, dry cleaning, McDonald’s Happy Meals); sell fewer items at a slower pace each at a higher price (shirts, hotel rooms, Applebee’s); sell one or two items or services at a high price (diamonds, dinners at The Capital Grille, investment banking services). Any of those models can make money on a yearly basis.
But a deeper question is how to have the business build wealth. It is not just by making a profit each year, because some profits are valued more than others. And that’s not just because of the different multiples different industries command. Profits are more valued if they are defensible and repeatable. To truly build wealth and long-term value in a business one should create a defensible business strategy.
There are the two business models that work:
- Selling many times to the same customer at good margins. (Think costume jewelry.)
- Selling high-margin, high-priced items as one-time purchases. (Think diamond jewelry.)
These two strategies can be modified for any market, product or service. Are you selling rowboats or battleships? If you sell rowboats, are they mass-produced or custom-made. If they are custom-made, what advantage does it have over mass-produced?
Having a working business model is good, but to build wealth, you need a defensible strategy. In Warren Buffet’s lexicon—a moat.
There are only three ways to build long-term defensible value in an e-commerce business:
- Own the ultimate customer and build long-term lifetime value through repeat purchases. By owning the customer I mean the following:
- Have the customer think of you as their personal supplier,
- Have your brand stand for something consistently and uniquely, and
- Have the right to market to customers at the time and place of your choosing.
2. Control the source of traffic to your website. A branded site that generates traffic by SEM [search engine marketing], offline paid advertising or email, catalog or paper circulation can control the flow of traffic by increasing or decreasing the budget. Own the marketing.
By contrast, relying on SEO [search engine optimization] marketing and marketplace traffic, while cost-efficient, puts one in the hands of the other monopolists, Google or Amazon. Every year when Google changes its algorithms, or Amazon changes prices, one’s business becomes vulnerable.
3. Provide the customer a unique experience that Amazon, Wayfair or eBay cannot replicate. This is usually through either:
- Offering unique and proprietary merchandise that evolves over time;
- Providing a service they can’t replicate—such as personalization;
- Building a community and content that adds value in a specific, targeted way.
Competing on price or selection are long-term losing strategies when pitted against the resources of an Amazon, eBay or Wayfair. They hold every advantage. Their selection is bigger, their prices are lower, and their delivery is faster and cheaper. Compete on areas where you can win. Curating and developing unique products. Providing a service they don’t. Making a human connection and educating.
Another losing strategy involves too much success in one aspect of the business. The most common failing I have noticed is relying too heavily on one vendor, one marketplace, or one customer. Sourcing any more than 20% of one’s revenue from any one party creates concentration issues. As it dramatically increases the risk of the business, savvy investors stay away from any business with customer or vendor concentration. Any change of heart by that party, be it the marketplace or your best customer—for any reason—has the potential to tank a business with concentration.
Too many entrepreneurs think short-term sales and profits build a business that creates wealth. It doesn’t. A defensible strategy built on a responsive customer list, continually updated, desirable proprietary products, and the ability to manage demand, builds value. Short-term sales and profits build income, but not necessarily value and wealth.
Mirus Capital Advisors is an investment bank.