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Stand Still!

The lightning pace of e-commerce business developments forces retailers to hit moving targets at budget time

It’s the annual budget meeting at “e-retailer” WidgetsForAllOccasions.com, and every department from I.T. to fulfillment to marketing is targeting the same pool of resources with its own wish list. The risks of the budgeting decisions to be made are many: Spend too much on a program and WidgetsForAllOccasions.com could starve another area of business in need of attention. Spend too little and opportunities could pass it by. Spend on the wrong thing and the fictional e-retailer could be nailed by both scenarios.

When everyone has his or her hand up for funding, just how do e-retailers decide where to invest and when to hold off on spending? Industry veterans may remember the story of Boo.com, the fashion site whose tail as a cautionary tale is longer than its 18-month life as an online retailer. Caught up in the frenzy of the dot-com boom of the late ‘90s, it spent

hundreds of millions in venture capital money on advertising, marketing, and site bells and whistles, chasing sales that never materialized. It crashed and burned in 2001.

Internet speed

It’s an extreme case, but it does illustrate one budgeting strategy that’s been used with more success by other e-retailers: spend upfront to bring sales in and figure the revenue will follow. Amazon.com is a poster child of sorts for this approach, continually breaking ground with new features, functions and marketing programs. No one can deny Amazon.com has become an online sales powerhouse: at $8.5 billion last year, it’s No. 1 in the Internet Retailer Top 500 Guide. But all of that build-out comes at a cost, which leaves the company struggling to grow profits commensurate with its gargantuan sales.

Borrow and spend big upfront to reel in sales or fund growth out of profits as they are realized is but one decision e-retailers face when setting a budget strategy. And once a strategy has been formed and put in place, e-retailers at budget time still face the competing in-house resource demands of any other business. But there’s an industry-specific twist: technology, opportunities and the need to correct a faltering course all come around at a faster pace than in the offline world.

“Online retail’s a pretty dynamic place—you’ve got to be able to react,” says Darryl Cavens, vice president of marketing at online jeweler BlueNile.com. “Even a one-year budget can be a long timeframe.”

Because of that, e-retailers deciding where to invest and how to allocate funds may have to make decisions with less information than typically supports such decisions in offline businesses, says Susan Aldrich, senior vice president at research and consulting firm Patricia Seybold Group. “Less longevity, less track record, less information of any kind,” Aldrich says. “We all want ROI. But ROI is really expensive to figure out, even for what we already have, let alone what’s new.”

Cash flow strategy

The overarching budget strategy at Replacements Ltd. guides spending on operations at the web site the company launched in 1993. Replacements, a retailer of china, crystal and flatware, has funded its development into a $75 million company, including its web operation, out of its own cash flow. That’s at the directive of founder and CEO Bob Page, by profession a CPA, who started the company as a hobby business some 25 years ago.

Though the web site is now responsible for about 65% of the company’s sales, it doesn’t get a commensurate proportion of resources at budget time. The biggest chunk, about 50%, must go to operations, because Replacements’ fragile inventory—all 1.3 million SKUs—must be handled by hand rather than automated systems, meaning that about half of the company’s 500-plus workforce is in its warehouse.

Given heavy demands on the budget by operations on the one hand and the directive not to borrow money on the other, Replacements has to be creative with what’s left in order to get everything done on its web site. And that’s sparked some original thinking that might not otherwise have surfaced, vice president of e-commerce Jack Whitley says.

For example, though Replacements has more than 1 million SKUs, only about 10% of them are popular and sell regularly. With a low conversion rate for the larger part of its inventory, presenting photos of the entire catalog online became expensive as traffic scaled up to the current 25 million pages served per month. “So we’ve always looked for a way to do that technically in the most cost-effective way. And that fit in with Bob’s requirement that we not borrow to build out our infrastructure before sales came along. It has to support itself,” Whitley says.

To resolve that issue affordably, Replacements found a way to tap the same internal database its call center agents use to create product pages for the web site. Some 300,000 inventory pages representing all of Replacements’ stock are drawn out of the internal database in a batched process each night, providing a near real-time inventory display for the web site. “We didn’t have to invest millions in infrastructure to host the application servers needed for 2.5 million visitors a month,” Whitley says.

Creative cart

The budget strategy also drove some creative thinking for the shopping cart process. Six years before client-side applications started becoming commonplace, Replacements created a JavaScript-driven, client-side shopping cart that uses the customer’s computer to pull items out of the company’s inventory database and into the cart. “That saved us a lot on infrastructure costs. And distributing that application across the customers’ machines means around Christmas, when we have about 120,000 visitors per day vs. about 70,000 in August, our web servers really don’t feel it,” Whitley says.

With operational needs a given and some cost-saving innovation in web infrastructure, there’s enough money to fund online marketing and stay within the company’s self-funding mandate. Based on history, Replacements now can predict with fair accuracy that if it spends a designated amount of money in online marketing it will bring in a predictable number of customers, of which a predictable percentage will convert.

But what about the new ad venues with which it has no track record to make a forecast? The lightning-like pace of business developments in the e-commerce world means retailers who insist on full data before budgeting for something new may lose out. So Replacements takes a different approach. “We allocate monies at budget time for testing, and it’s not expensive. The beauty of the web is that you get rich feedback that tracks back into our internal systems, so we can test six to 10 new venues at a nominal cost,” Whitley explains. “We can see on a daily basis what ROI is. If it’s positive, we’ll spend unbudgeted money there because the sales are coming in ahead of budget as well.”

While Replacements has figured out how to get photos of all of its patterns and most of its inventory up relatively inexpensively, so far it has just said no to spending on popular rich media functionality that would, for example, enable customers to rotate online views of individual pieces. For one thing, that would require additional photos of a huge number of SKUs, a large cost in itself. For another, most of its customers already know what the china or flatware piece they are seeking looks like. “An application like that is nice and one day we will probably have it. But for the bulk of our sales, people don’t need to be able to spin the plate around for us to make the sale,” Whitley says.

He adds that Replacements’ self-funded budget strategy isn’t for every retailer, though it’s been right for Replacements If Replacements were willing to sacrifice profits for a time in the name of spending more to acquire more customers and sales, revenue could be higher than it is, he says. “But then we’d run into the issue of bearing more operational cost and having lower margins,” he says. “That’s not a strategy for our particular market niche that we’d want to try. We’re fairly profitable every year, and growing profits.”

Crank up the risk

Other online retailers crank a higher degree of calculated risk into budget allocation and growth strategy. But those budgeting decisions still live within a top-down corporate mandate. At BlueNile.com, that starts with a narrow focus on what the company is about.

“We want to be the best at diamonds. We don’t spend much time looking at strategic alternatives outside that area,” Cavens says. “Within that area we evaluate things as they come up and try to understand how they will affect our existing budget forecast.” Another driver of budgeting decisions is a corporate culture of frugality, learned as a survivor of the dot-com investment crash, Cavens adds.

So what does Blue Nile choose to spend on? As an Internet-only company, investment in the customer interface gets a high priority. The filter it applies to spending within that area is the degree to which a proposed expenditure would benefit customers directly, versus what would simply be cool to see on the site. Under that rationale, Blue Nile has spent to build the interactive diamond search functionality on its site into an industry-leading search tool while bypassing some features and functionalities found on other sites, according to Cavens. For similar reasons, on the back end a new phone switch at its call center likely will get funded this year after being in line for an upgrade for three years—if the company calculates the payback will be measurable improvement in the customer experience.

In e-retail it’s not uncommon for budget time to set up a conflict between investing in something fun and flashy vs. critical underpinnings deep in operations. “We see a lot of retailers going after things like online video or celebrity items. They may be fun and exciting, and we’d love to do them, but we don’t think they’d work for us. We don’t think they’d have the payback, for instance, that a new phone system would,” Cavens says.

To get at an ROI projection on any budget allocation it’s considering—not just marketing—Blue Nile assigns a dollar valuation; for example, exactly how much more efficient fulfillment would be with a new conveyor belt, or how much more revenue would be driven by improving customer service with the new phone switch at the call center.

Marketing to acquire customers and grow the business gets the biggest chunk of spending, with the target for the past several years set at about 4% of sales. That includes funds in the budget for testing what it deems its best new opportunities so as to be able to move on them speedily if need be. One example is Blue Nile’s recent move into international markets, with dedicated web sites now in the United Kingdom and Canada. The initial investment in the sites, though based on less research than it might have pursued in an offline environment, was a bet by Blue Nile that in view of how quickly a market can move online, the time to act was now vs. later.

The sites don’t yet replicate all the functionality on the U.S. site—for instance, sales are transacted in U.S. dollars rather than local currency. But now that Blue Nile has tested the market and satisfied itself that the demand is there, further investment in those sites will follow.

“We felt it was more important to get out there now, and then learn and adapt to those markets. A different alternative could have been to do a year of research, open a facility over there, put a marketing team and a customer service team in place there, and hope that the demand came. We took the other way,” Cavens says.

Platform pays off

Mike Golden knows a thing or two about building fast growth by creating one robust platform then using it as a base to launch multiple online properties. It’s a model that worked for outsourced e-commerce provider GSI Commerce Inc., which Golden co-founded as Global Sports Inc. and where he served as chief operating officer earlier in his career. And it’s a model that underlies budget allocation and spending at Home Décor Products Inc., where he’s been CEO since 2003. The company’s initial offering, home product site HomeClick.com, has been joined by niche sites AbsoluteHome.com, Barbecues.com, KnobsAndThings.com, Hechinger.com and PoolClick.com.

In spending to drive that growth, on a continuum between funding development out of cash flow as Replacements does and the “If you build it, they will come” model of an Amazon, Home Décor Products falls somewhere in between. The company has spent big on building the platform but less on building the brand to date, under the rationale that building the web presence attracts business to build a cash flow.

And so, in its earlier years, the company focused budget on building the central platform—not only the technology that powers the web stores but also applications such as analytics, call center operation, warehouse operation and “basically everything that gets touched by a sale,” Golden says. Historically, Home Décor Products has kept marketing expenses between 7.5% and 8% of sales; but with annual revenue hitting $100 million in 2006, Golden says he’s looking at boosting that to 9%.

“We knew we had to get to a certain size to really cover our operating costs, and based on the business plan we created it was about $100 million. We think now we can grow to several times that size without having to add a lot of bodies,” he says. That’s key because employees—alongside freight and marketing—have been the company’s biggest expense. If growth can come without an increase in staffing—an advantage Internet retailers enjoy over their colleagues in the offline world, where more stores of necessity means hiring more workers—that frees up more of the budget for marketing.

Evolving priorities

It’s also part of Home Décor Products’ business plan that as the company scales up, budget priorities change. Not only are more dollars going to marketing than in earlier years when the platform was still under construction, but the strategy driving allocation of marketing dollars is shifting as well, including a new look by the company at offline marketing.

“In the past, in terms of our marketing spend, we were more focused on being ubiquitous. Now we are focused on the bottom-line and optimization, on the things that drive efficiency,” Golden says. Among them, this online-only retailer is going back to a traditional marketing vehicle. Based on a test of 50,000 in-box catalogs for HomeClick.com over the past holiday season that drove an estimated $300,000 in incremental sales, Home Décor Products expanded distribution to 250,000 for a new paper catalog slated to launch last month; the expanded distribution includes 150,000 that were mailed for the first time.

“We’ve invested in the platform for seven years. We’ve built it. Now the goal is to identify incremental marketing spend to drive incremental sales. For us, that largely means looking offline,” Golden says. “We spent a decent amount of money on the catalog and we’re hoping for the best.”

First principles

The approaches taken by these e-retailers to allocating funds differ, but they all aim at a common issue plaguing the budget process at most companies. “There are always more good ideas than money,” Cavens says. “Maybe Microsoft’s the exception. But at any retailer, cost control is a challenge and we work within those constraints.”

While retailers try various ways of balancing that equation, Aldrich says one winning budgeting strategy is to start with the first principles of business—even online. “First principles went out the window when the Internet boom arrived in the ‘90s, but the rules of business never really disappear,” she says. “The old joke about selling below cost and making it up in volume didn’t work in 1980, and it doesn’t work now. You just have more uncertainties now than you had before.”

At its most basic level, that translates into assessing the biggest problems or opportunities and taking the budget there first. “In theory, you put your money where the biggest return is going to be,” Aldrich says. But retailers should tread carefully—even if they’ve developed a rule of thumb that says spending this amount of money on this aspect of the e-commerce structure will deliver this kind of return; ultimately that depends on how well they execute.

The next step is to build onto that frame of reference a more creative view that accommodates what’s new about retail in the online environment. “Here are your principles and the traditional way to think about things,” Aldrich says. “Then, open your horizons a bit and look at some of the trends and new business models and see if they apply to you.”

 
 

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