This article is part of our Valuation by Business Model series, in which we provide you with information on what makes your particular business model unique when it comes to valuation. For more in-depth reading on valuation, see our post How to Value a Website or Internet Business. To get a valuation from our expert team, click here.
E-commerce is often the first business model that comes to mind when people think about monetized websites. That’s because the concept is simple, and it’s a process we’ve all been through: visit a website, see some great products, buy said products.
This makes e-commerce websites an attractive asset for buyers, because it’s a familiar and approachable business model. However, that doesn’t make it easy to put a dollar value on them.
In our six years of helping e-commerce owners sell their websites, we’ve learned a lot about what factors affect the value of this business model. Here’s what we’ve discovered:
Order Fulfillment Should Be Passive
You can have great traffic and groundbreaking products, but if you don’t have a streamlined fulfillment process then your business is going to be less attractive to a potential buyer. Today there are plenty of third-party fulfillment services that can make packaging and shipping orders easy and inexpensive. One of the more popular versions is Fulfillment by Amazon, commonly referred to as FBA.
If an owner happens to have a warehouse and handles fulfillment internally but has successfully removed themselves from the operation, fulfillment has a neutral effect on valuation. There are aspects to in-house fulfillment (e.g. ability to add personal touches to packages, more control and insight into the process) that could benefit a business. However, even if operations are hired out, owning or renting warehouse space and managing the process is likely to be more time consuming than using a third-party service.
Given the choice between using a third-party service and running your own fulfillment, you should choose a service. This makes the business much easier to transition to a buyer and often reduces your time involvement and can often improve shipping times/reduce costs.
Reliable Product Source is Important
Having a product line that stands out among a sea of items for sale online is key. However, if your inventory mainly consists of rare or curated items, you’ll want to ensure that a buyer will be able to reliably secure inventory well past the deal closing. Otherwise, you’re looking at a lower valuation.
In order to determine the reliability of your product source, you should consider:
- Does the product require some expertise to obtain?
- How likely is it that your current supplier will go out of business or stop selling a core product?
- If that happened, how easy would it be to order the product(s) elsewhere?
If you answered yes to the first question and negatively to the second two, your product source is likely a problem that will have a negative effect on valuation. If you’re not sure, you may want to talk to your supplier about their history and goals for the future to gauge how reliable they’ll be in two to three years’ time.
Whenever possible, you should have a contract with your supplier to ensure that you’ll receive your products for a specified length of time. It’s even more beneficial if you can get exclusivity on your core products to limit competition.
Product Uniqueness Can Be a Strength
As discussed above, you don’t necessarily want a product that’s hard to find. However, a unique product – maybe one you’ve developed yourself – can be a big driver in value, particularly if you have patents or protections on it. While a somewhat intangible value driver, a high-quality product that’s shown to have lasting popularity can make for a very attractive acquisition.
Branding Can Add Value
The strength of the e-commerce brand and its reputation can play a significant part in the valuation process, as customer loyalty is harder than ever to foster. This is particularly true in saturated niches, such as fitness. A strong brand can lead to repeat sales, which is desirable.
The age and strength of the brand is a key differentiator and valuator for an e-commerce business. This can be assessed through traffic and financial fundamentals, but online reputation and customer feedback can also play a minor role in the valuation process When valuing an e-commerce site, we look at both the quality and quantity of customer reviews to determine whether they’re faked or manipulated.
Stored Inventory May Be a Hindrance
Stockpiling inventory has its benefits, but only if your products are difficult to find and your storage capacity isn’t limited. Otherwise, extra inventory can be a costly lump sum that gets added onto a sale price – without giving the seller extra profit.
For example, if you’re running a business that makes $2,000 per month and you have an extra $50,000 in inventory stored away, that could easily double the sale price of your business. A high asking price makes the business less attractive, maybe even infeasible, to buyers looking for a $2,000 per month acquisition. In the end this could mean that you’ll need to accept a lower multiple if you want the business to sell.
Gross Margin Must Be Healthy
An experienced buyer will know that e-commerce businesses tend to have lower profit margin when compared to content websites or SaaS operations, but gross (and net) margins still need to be wide enough for a buyer to feel comfortable taking over.
Low profit margins are a sign that a business may be competing on price alone, rather than brand uniqueness or perceived value. So while it’s still possible to make money with this type of e-commerce, you’re up against multi-billion dollar online retailers that have the economy of scale advantage.
Organic Traffic Plays a Role
As with all online businesses, organic traffic to your site will play into the valuation because it’s a signal of how optimized your site is and how easily customers are able to find you. This is the case with about three-quarters of monetized sites. (The remainder often rely on paid advertising, whether through their FBA fees or because they sell high-margin items that necessitate more power – i.e. money – behind the search engine.)
You’ll want an analytics profile that shows steady traffic coming from a diverse set of keywords, and a backlink profile that suggests a high-authority site. The image below shows a website that gets a steady amount of traffic.
On the other hand, you want to try and avoid an analytics profile that is inconsistent and doesn’t provide steady traffic day in and day out. The image below is an example of a bad analytics profile.
When looking at both paid and organic, your conversion rate and average order value are both important metrics. For paid, they determine how much you can afford to pay per visitor. For organic, these metrics give you a more general idea of how much you could spend on future advertising and marketing, while still maintaining a profit.
Mobile optimization can also be a factor, as buyers will be looking for sites that are future-proofed. The future of e-commerce is mobile device use – smartphones and tablets. Good navigation, ease of use, and optimized checkout processes are key to capturing mobile customers, and buyers will be assessing this aspect of your business.
Product Concentration is a Fine Balance
This is a major point of evaluation with an e-commerce business. If 80 percent of your site’s revenue is coming from one product, that means the value could be almost completely wiped out if that product becomes unavailable or loses its appeal.
At the same time, you don’t want a wide range of products each accounting for a small percentage of income, because that makes inventory management more complicated. This means there’s more room for error in both stocking supply and fulfilling orders, and, in turn, more owner involvement required.
As such, we recommend that e-commerce owners identify their core products and stock little more than those, leaving some room for expansion in case customer tastes change.
Final Thoughts
There are a number of factors that drive the value of an e-commerce site, and it’s always best to look at the holistic view. Operations, product and source concentration, traffic and branding all play a role. However, only an experienced advisor can give you an accurate valuation, so get in touch with us today to talk to one of our valuation experts.
Thomas Smale
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