Rising advertising costs means falling profits for the ecommerce advertisers.
March 1, 2019 6 min read
Opinions expressed by Entrepreneur contributors are their own.
I have been a long-time fan of the ecommerce industry. As offline retailers were struggling to compete with online retailers, many large chains went out of business, and an increasing amount of consumer buying moved online. For a long time, ecommerce startups were printing money in what felt like a “can’t lose” industry. But, like with any gold rush, empowered by ecommerce platforms like Shopify — that made it quick and inexpensive to get your online store up and running — ecommerce attracted a bunch of competitors trying to get their products discovered.
But, what happens when millions of ecommerce stores are fighting to get discovered on only three primary websites — Google, Facebook and Amazon — where consumers are looking for potential shopping solutions? All hell breaks loose, wreaking havoc on your cost of customer acquisition and your bottom line profits. This means the only long term winners in ecommerce are, you guessed it, Google, Facebook and Amazon. These three keep raking in all the highly-profitable advertising dollars while the ecommerce businesses themselves are starting to struggle to make a profit. Allow me to explain.
The growing ecommerce industry.
The ecommerce industry in the U.S. was worth approximately $500 billion in 2018 and has been one of the fastest growing areas of the economy. This big market has been attracting tons of large retail corporations and startup entrepreneurs that have been trying to capture their piece of the pie. What started off as a handful of ecommerce sites in the infancy of the internet has grown to more than one million ecommerce businesses in the U.S. alone — and growing daily — each competing for consumer attention.
The rising costs of getting discovered.
How to do you get consumer attention? In today’s market, that largely means being present on the big three websites. But, there is a limited supply of positions on the first page of those website search results, which means with limited supply and growing demand, the price of getting discovered keeps going up and up. That, in turn, means the cost of acquiring a new ecommerce customer is quickly increasing, eating into the profitability margins of ecommerce businesses.
To me, it is quickly becoming a race to the bottom for the ecommerce businesses, many of which can no longer drive a profit on their first sale. They now must cross their fingers that they have a quick and frequent repeat sale cycle to make their profits from the second and third transactions down the road. This may work well for a consumable vitamin business, but doesn’t work so well for a non-consumable mattress business, for example.
Google, Facebook and Amazon capturing all the profits.
As costs keep going up and up for the ecommerce businesses, that means advertising revenues keep going up and up for Google, Facebook and Amazon, making them the real money-makers. Said another way, if advertisers are willing to invest up to one third of their revenues into consumer marketing agency efforts, that is more than $150 billion of largely free and clear profits for the three big websites to share between themselves. At the same time, ecommerce businesses will struggle to break even as their marketing agency costs continue to soar to higher and higher levels. Pretty picture for Google, Facebook and Amazon. Ugly picture for the ecommerce businesses.
An iExplore case study — costs up 10X.
Let me provide an example here. When I was running iExplore in 2000, I could buy a Google “adventure travel” search click for $0.25, competing against a handful of competitors. Those clicks would net me around a $200 cost of acquisition per new customer, or around 20 percent of my $1,000 gross profit margin. This is a very healthy bottom line profit margin. Fast forward to today, that same click may cost $2.50 (10x more), as hundreds of competitors are now fighting for the top positions on those keywords. This means my cost of customer acquisition has grown to $2,000 today. And, instead of driving an $800 profit on the first sale, I am now losing $1,000 on the first sale. A pretty grim reality, to say the least.
Making a deal with the devil — AKA Amazon.
Google and Facebook clearly present their marketing agency challenges, but Amazon is even worse. More than half of all shopping searches start on Amazon, but there is a price to pay for that distribution. Amazon charges about a 15 percent revenue share to get promoted on their website, assuming you do your own fulfillment. The fee rises to around 25 percent if you need Amazon to do the fulfillment. And keep in mind, this is before Amazon fully exploited their ambition of building a Google-like advertising marketplace to ensure your products get discovered on their platform.
When you layer marketing agency costs on top of the distribution and fulfillment fees, there is going to be no profit left for anyone except Amazon. And, if you were hoping for repeat sales to drive your long term profits, good luck, as Amazon does not allow you to share in any of the customer records created. They are Amazon’s customers, not yours, and you are not allowed to repeat market to them anywhere except on Amazon. All-in-all, a great win for Amazon, and strong kick in the gut for the ecommerce businesses.
If you are one of the lucky ecommerce businesses driving a healthy profit today, enjoy it while it lasts. It is only a matter of time before new competitors learn of your success and try to enter your market. We’ll see what your profits look like in a couple years, after the flock of competitors start fighting for position around your keywords. And, this will be the case in nearly every category of ecommerce, so it doesn’t really matter what products you sell.
So, for all you ecommerce lovers out there (myself included), I have these cautionary words of wisdom for you — think twice before getting into the ecommerce business. If you want to win long term in ecommerce, stop thinking about what products you are trying to sell, and think more about how you can profitability grow your business without relying on Google, Facebook and Amazon — word of mouth, direct mail, smaller websites — with proprietary or patented products only found on your website. Or, better yet, think about how you are going to build a new fourth competitor to the big three sites. This is where the real profits are long term, without having to deal with all the merchandising, warehousing, markdowns and other headaches that come with running an ecommerce business.