Patrick's Programming Blog

eCommerce Business Models

Patrick Rauland
ECommerce Business Models

Before you open an eCommerce store you need to do three things:

  1. Choose an eCommerce Business model
  2. Choose who you're selling to
  3. Choose a product to sell

Today we're going to focus on selecting a business model. There are a number of different business models. Some of them like Dropshipping are very easy to get into and require zero startup capital. Others, like Manufacturing, require a huge investment of your time and money up front but give you other advantages down the line. We'll look at these models:

We'll look at who to sell to (ex. B2B or B2C) and look into specific products in a future post.

Dropshipping – Business Model #1

The first model is dropshipping and if you're new to e-commerce you might not have any idea what I'm talking about. Because for the most part it's invisible to the customer.

A dropshipper is someone who doesn't actually hold any inventory. They have an online store and they accept orders but they don't do any fulfillment (shipping the products to the customers). Instead they receive an order and then pass along that information to another company who sends the product directly to the customer.

So as a customer I might buy an umbrella from you for $10.00. Your store automatically orders that same umbrella from your supplier and sends it to me for $8.00. You as the drop shipper get to pocket the difference. Oftentimes you'll see dropshippers for manufacturers who don't want to do any marketing. They just want to make goods and they'll use dropshippers, resellers, or others to move their products.

Benefits for Dropshipping

Low barrier to entry. You don't need any starting capital. You could start an online store for $30, accept orders, and pass along that information to your supplier who fulfills the orders. Unlike many other business models you don't have order minimums or need to get a loan from the bank to get started.

No fulfillment or inventory management. You'd be surprised how much work it is to organize hundreds or thousands of boxes. Even if you have a giant garage it's a lot of work to find the right products, pack them up, and send them out. And you also don't have to worry about managing inventory. You don't have to count items and save up money for another large shipment from China.

Location independent. Because you don't manage any physical products you can run your business from anywhere. That's huge. I'm a big fan of being able to work from anywhere and dropshipping makes that easy.

Scalable. One of the best parts of a dropshipping business is that it's very scalable. If you get twice as many orders as normal you don't have to hire extra workers. You just make more money. Eventually you'll need to hire more customer support representatives but you're not as impacted by scale as other business models.

Drawbacks to Dropshipping

Low barrier to entry. For those those astute readers you may have noticed that Low barrier to entry is both an advantage and a disadvantage. It's great for you to get your foot in the door. It's not-great when everyone else can also get in the door. It means as soon as the community discovers a profitable niche anyone can start selling the exact same product and drive your sales & margins down.

Low Margins. To make things worse margins for dropshipping are already razor thin. This will depend from supplier to supplier and industry to industry but you'll probably see around 20% margins.

So if you sell $100 worth of product you keep $20.

And that $20 needs to cover all of your business expenses like customer support, website maintenance, marketing, pay-per-click, and complicated shipping…

Complex shipping. You might be lucky enough to work with one supplier. But even retail stores need to work with multiple suppliers to get all of their product. You'll likely want to work with a few different suppliers to offer all of the products your customers want. The downside is that you'll have to handle complicated shipping logistics. If you have an order with 4 items and each comes from a different supplier that's going to be 4X as expensive as an order from 1 supplier.

Then you have to decide if you want to pass that cost onto your customer or if you want to eat the cost. [High shipping prices is one of the biggest reasons customers leave the checkout](LINK) so many dropshippers decide to eat the cost of shipping which can very quickly turn slim margins into nothing.

To mitigate this you'll want to spend time finding a supplier that can supply as much of your inventory as possible.

Lack of control. It's great that you don't have to manage employees shipping products. It saves you a lot of time. But when they do something wrong and you get blamed for it? That sucks. As a dropshipper you have to accept that many things are out of your control.

With a good supplier expect 1-2% of orders to have mistakes and for you to offer a full refund. With a bad supplier it could be higher than 2% and you'll have to live with the bad reputation so pick your supplier carefully.

Successful Dropshipping Stores

One of the most well known dropshippers is Wayfair. They have warehouses for products but back in 2012 most of their products were shipping directly from suppliers.

90 percent of their products are still being shipped directly from their suppliers

It's a staggering feat of computing that is capable of coordinating the order flow and logistics of the more than 4,000 suppliers that ship out an average of 93,800 items each week

It's impressive they can coordinate between 4,000 suppliers to offer anything under the home goods umbrella. They've built infrastructure around those suppliers to more effectively manage them, shipping logistics, returns, etc. When you want to offer everything under one category and you don't have a spare billion dollars (but really who doesn't) dropshipping may be the way to go.

You may decide to grow from there and have your own manufacturing facilities and warehouses. It gives you an opportunity to test a niche before investing more capital.

Another well known store is TrollingMotors.net. Not because of the trolling motor market but because it was sold by Andrew Youdarien who talked about it on his eCommerce podcast & blog.

On his store's 3rd year in business the owner made $65,000 from the store and there's no telling how big it is now.

The growth of trollingmotors.net. Source: eCommerce Fuel

Caption: The growth of trolling motors.net source: eCommerce Fuel

As you can see from the growth chart this store actually lost money it's first year. The owner invested a lot in programming and SEO and that took time and money.

After that first year he was able to automate so much of the business.

It takes approximately two hours a day to run TrollingMotors.net. Pat, my sales manager, handles all the operations for TrollingMotors.net

So if you can take three years to build a company to generate $65,000 for only 2 hours a day then go for it. 🙂

Reselling – Business Model #2

Reselling is the arketype of e-commerce and retail in general. The reseller buys products from wholesalers, distributors, and manufacturers and they sell them through their own store.

One of the most common types of e-commerce businesses is a reselling model. You have your own website where you accept orders & fulfill them yourself. You also have to store the products yourself.

Benefits to Reselling

Customer Interest – If you know your niche you already know which products are in demand. You aren't spending a ton of money on R&D to develop new products. You're taking what already works and you're selling it.

Single Source Fulfillment – Since you're storing and fulfilling orders that means you have greater control over shipping costs. And since it will likely all come from one warehouse you can experiment with upsells & cross-sells to get users to add more to their cart so you maximize the profit with each order.

Larger Margins – When you get products at a low cost (usually 50% MSRP) you have some room to play with your margins. You can offer discounts, spend money on pay-per-click advertising, and other tactics to get the sale. Larger margins means you can experiment and change your business strategies over time.

When you have slim margins and the market changes you can't do much to respond to the change. Larger margins means flexibility which can save your business when something unexpected happens.

Experiment on Demand – If your store starts growing you can expand into other areas. Since you aren't inventing new products you just have to find a reseller who already offers these products and stock them. You can then run experiments and see how much profit you're generating and how much interest there is in these new products.

Malleable Overhead – Resellers have incredible flexibility when it comes to overhead. They can choose to run very lean and outsource fulfillment or they can keep it in house.

If you want to keep overhead low you can use services like Amazon FBA or other 3rd party logistics (3PL) companies to store & ship your products. It will eat into your margins but will keep your business completely remote so you can work from anywhere in the world. Or if you want to run your own warehouse & shipping setup you can do that too. This can lead to higher margins for you so you make more with each order but it will take time & energy to manage.

With retail you have the choice to build your own infrastructure and make more money per order or outsource it and run a lean and efficient machine focusing more of your time & energy on your products and marketing.

Drawbacks to Reselling

No Branding – When you are a store selling someone else's products you risk another store coming along and selling the same products and threatening your business. If you sell Apple computers and another computer store opens down the street they can sell the exact same product and put pressure on your business.

To mitigate this you need to add value to your products in some way:

Capital Intensive – To be a reseller you need to have capital to buy products at a low price with the goal of reselling them at a much higher price. To buy products at a low enough price you usually need to buy them in huge quantities or order a wide array of products from the same distributor.

As an example I can purchase a small card game printed on demand for $10 but if I order 1,500 games from a distributor for $5 each. If I sell the game for $15 I'll make drastically different amounts:

So you might be able to make twice as much money with you buy in bulk but it requires an upfront investment of $7,500. And most people don't have a spare 8 grand to play with.

Managing Cashflow – Since capital is so important with reselling you need to plan large purchases from suppliers and time those so you have enough cashflow to pay your other bills. You'll need someone on your team who is good with projections and understand how fast you'll get product in, how much it will cost, and how long it will take to start money a return on that investment.

Successful Reselling Stores

We all know about Best Buy, Home Depot, and Walmart of course which all do a fair about of reselling (and other business models like white labeling which we'll cover shortly). There are smaller stores in specific niche's like:

California Fly Shop – they are avid fly fishers and cater to fly fishers. It's a small niche in a specific geographic region. They combine a large assortment of niche products with expertise to help fly fishers. As you can imagine you get infinitely better advice from people in this store (or even just on their site) than you would shopping at a general outdoors company.

My Snacks – You want unique snacks? This is the place to go. That's what they specialize in. They don't go after the whole food industry they go after one tiny piece which in this case is snack enthusiasts. The buy from a ton of different companies to have all of the snacks you want to order in one place.

HoopsKing – a site about teaching your kid to be the best basketball player. It has a lot of informational products about how to train your kids to be great at basketball and sells the physical tools that compliment their information products. They make their own information products but they resell all of the equipment.

Reselling is a great way to get into e-commerce and maybe someday create your own products. It isn't as defensible as white labeling or creating your own products but it has a lot more margin and flexibility than drop shipping.

White or Private Labeling – Business Model #3

When you go to a grocery store and you see the name of the grocery store on a can of food that's called white labeling or private labeling. It's where someone else makes the product and they put your label on the product at the end. And it's a step between reselling and creating your own product.

Benefits of White / Private Labeling

Private labeling is very similar to reselling so most of the benefits & drawbacks are the same. But there's a few extra benefits that are worth pointing out.

Branding – the biggest benefit is being able to do your own marketing and branding. You can create your own name, description, choose images, etc etc. Anything you want to do you can.

Loyalty – One of the things that comes with building a brand is that you'll get customers loyal to that brand. If you resell sun glasses it will be hard to keep loyal users. If you private label great sunglasses people will remember you and you can market to them and get another sale from them.

Avoid Price Comparisons – since you aren't reselling the exact same product your potential customers can't compare prices as easily. I know plenty of consumers who look for a SKU and then do a search for the cheapest version of that SKU. When you private label you can make your own SKU or not have one at all.

Greater Margins – When you're selling a brand name those generally cost more. If you sell a similar (white labeled) product for the same price you'll be able to keep a much bigger slice of that revenue.

Drawbacks of White / Private Labeling

Again – many of these are the same as reselling since they're so similar. But there are a few extra considerations.

Build A Brand – One of the harder things about private labeling is it forces you to create your own brand. If you sell sun glasses you have to convince users that your sun glasses are just as good as another brand. If you were to resell Oakleys you don't have that problem. People already know they're quality sunglasses and if you have good pricing making the sale won't be as hard.

Building a brand is hard work and it can take a long time. But it's usually worth it for some of the benefits above. But if you're looking to make a killing in the next year it's not the right strategy for you.

Capital Intensive – since private labeling includes the manufacturer adding your logo to the product this is more capital intensive than reselling products. You might have to order 5 or 10 thousand units 6 months before you need them.

When you resell products there's a lot more flexibility to buy products on a shorter notice and you don't need as huge quantities. These requirements will vary industry by industry but typically white labeling a product requires a bit more capital & time.

Successful White Labeling

One of the whitelabeled products at Floyd's Barbershop

Floyd's Barbershop – I go to a mens barbershop called Floyd's. They do great haircuts and at the end they always offer to gel your hair. They use their own private label gel. So if you want that exact gel (and I usually do since I know nothing about gel and just want to buy it without doing hours of research) you have to get their gel.

It's private labeled so even though I probably could find a very similar product somewhere else I'm just going to get theirs since it's easy

The Chocolate Therapist – One of my favorite local stores is The Chocolate Therapist. They focus on the health benefits of chocolate and writing and educating people.

They got started private labeling a local chocolate shop's product. They sold books and education on their site and they also offered chocolate they certified and sold under their own label.

Many years later they were profitable enough to buy that chocolate shop and now they make their own chocolate. In this case private labeling created a money making machine that eventually let them grow into a much bigger company.

Presto! – One of Amazon's household cleaning brands is Presto! Instead of recommending users buy Bounty or some other expensive brand Amazon can direct users to their cheaper option. Customers can still buy Bounty but for users who want to save a little Amazon has a cheaper brand and Amazon makes more money off of it as well I'm sure.

Manufacturing – Business Model #4

Manufacturing is one of the most challenging models because it not only requires huge capital investment to buy thousands of units but you also have to spend time and money developing a product from scratch. Having said that it's one of the most defensible models. If you create a hit product you'll be able to reap the rewards for a long time before someone can come close to copying you.

Benefits to Manufacturing

Unlimited Imagination – One of the best things about manufacturing your products is that you can do just about anything. Do you want to make a mattress with a hole in the middle so you can cuddle your romantic partner? Well when you manufacture your own products you can actually do that.

Cuddle mattress from XKCD

In all seriousness having this flexibility means you can control everything. The color, size, shape, the packaging, etc. If you have a specific experience in mind designing your own product and getting it manufactured is the only way to do it. otherwise you have to live with other people's choices.

Intellectual property – When you manufacture your own products you have access to all three types of intellectual property: copyright, trademarks, and patents. And you can use these to protect your brand and product. Trademarks protect you from other people using your logo, copyright prevents others from stealing your designs, art, and other creative elements. And the most powerful are patents. If you invent a new feature you can patent it and have a monopoly selling that product for years.

Long Process – If you don't have a patent it's still very hard for someone to copy you. If you start selling the new hotness and someone wants to copy you they'll have to reverse engineer your designs, find manufacturers, get quotes / samples, select a manufacturer, order products, wait for them to arrive, and then finally start selling them. This could easily take a year for someone else to copy what you did. And in that time you could improve your product and dominate the market.

Manufacturing is a long process which can be a good thing to protect what you've built.

Drawbacks to Manufacturing

Prototyping – One of the harder parts of manufacturing is actually making the product. It's not just coming up with the idea but executing on that idea. How do you make a design and how do you turn that design into a prototype? Some creators get stuck on this step even when they have a good idea. You need to have access to the tools to make a prototype.

Some industries have professional prototyping services. Since I'm interested in the board game space I found a company which prints games on demand which is perfect for my needs.

If you don't have a prototyping service for your industry hopefully you can find a makerspace where there are 3d printers, laser cutters, hand tools, and a community around design.

Language barriers – When you're working with a manufacturer there's a good chance you'll be working with someone in China (the costs are drastically lower). But working with China involves some extra complexity in terms of shipping, customers, and most challenging of all language.

As you're refining your design with the factory or just trying to explain your design you'll run into language barriers. And if they interpret something incorrectly you could have a complete broken product or a subpar product.

One thing you can do to mitigate this is work with a manufacturer that has native english speakers on staff. I've gotten quotes from multiple factories and I've had the best communication with a manufacturer with native english speakers. Even though they might cost a little bit more it's worth it when you're dropping $10,000 on a manufacturing run.

Branding – As mentioned earlier when you sell your own thing you need to develop a brand. And if you're developing something novel like glasses that help colorblind people see the full color spectrum (see EnChroma below) you have to do a lot of work. People have to know who you are and they have to believe your product works.

Costs – There are manufacturing costs for thousands of units and R&D costs. The R&D costs including prototyping. There's also a huge time factor. If you come up with a great idea today. It might take 2 years to get it online to accept that first dollar.

Successful Manufacturers

Hickies makes elastic shoe laces that you can add to any shoe and prevent you from having to tie your shoes. They have a patent on this technology and they are absolutely crushing it on their own site as well as on Amazon.

EnChroma makes glasses that let color blind people see colors they can't normally see. They had trouble getting people to purchase their pricey ($350) product until they started included multi-color balloons with their product and their customers started sharing unboxing videos which convinced people the product works and the company started to grow.

Ripple Rug one cat owner realized their cat was playing with a folded up rug with holes in it (they accidentally created a prototype!). They figured other cats would also like to play with a toy like that. So they manufactured it and started selling on Amazon.

EnChroma and Hickies have patents which gives them a huge amount of protection. And since it took years of R&D – especially for EnChroma – to develop the technology that is a fair trade off. A limited monopoly for a short period. For the Ripple Rug they've build a brand on Amazon and on their own site and they're a go-to cat toy. Someone could copy them but they already have a huge brand and a ton of reviews on Amazon.

Licensing – Business Model #5

There another business model that's worth bringing up even though it isn't technically ecommerce. And that's licensing. If you can create products but you don't want to deal with manufacturing you can sell or license your ideas to stores / manufacturers. There's a person in Denver who does this. He's created 10+ products and sells them to companies who can use his products.

They can skip years of R&D and have a patent and he gets a big pay check and doesn't have to run an online store.

I bring this up for people who really want to invent products. You can always start inventing a product and look into manufacturing and other costs and then decide that's too hard. You can still sell or license your design.

One of the more well known licenses is KFC's Popcorn Chicken. They didn't invent the way to create that popcorn effect. Someone else invented it (yes you can invent novel ways to cut meat) and licensed it to KFC.

Conclusion

There's a lot of ways to make money online. And there is no right way. You'll have to look at what you're good at, how much time & money you're willing to invest, and what you feel good doing to determine what business model you want to use.

Also consider that you can always transition to a new model. The Chocolate Therapist did that. They sold their own books and white labeled chocolate. They eventually had enough money to make their own chocolate (they actually bought the original white labeler!). So this doesn't have to be a decision that lasts forever. You can always try something and then pivot.

Once you pick a model that works for you you can start drilling down into specific products you want to sell and who you want to sell to. We'll cover that in future blog posts.

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