Measuring E-commerce firms’ performance

The week began with the news of the online grocer PepperTap closing its grocery business to become a pureplay logistics firm (see here). And we just read that SnapDeal is recalliberating its performance metrics (read here). So, what exactly is the problem and what can we do about it?

The investor obsession with GMV

Throughout the world, venture capitalists and other investors have used the metric of Gross Merchandise Value (GMV) to measure the performance of E-commerce firms. Everyone manages what they are measured on. So, all E-commerce firms focused on increasing their GMV, that is increasing the gross value of their sales. What this obsession with gross sales does to firms is that there is significant incentive to pursue what I call as “profitless growth”, where only the topline matters, with no attention whatsoever on all other parameters. Especially so, when the entire industry thrived on deep discounting and low customer switching and multi-homing costs. Focus on just one parameter like the GMV might be valuable when the business just sets up to measure the initial traction amongst the target customer groups, but continued focus on the single parameter can lead to misplaced strategies.

Evolving other measures

After all, E-commerce is also a business that needs to provide sustained returns to its shareholders. As with all for-profit businesses, good measurement of performance should include a variety of metrics that reflect the organization’s priorities and strategies. For a consumer focused multi-category retail business, it would be prudent to measure performance on the following four parameters – (a) gross and net (of returns) revenues; (b) gross and net margins; (c) customer addition, loyalty, and attrition; and (d) distribution of sales across categories in line with the firm strategy/ priorities (merchandising mix).

The bane of COD

The boom of Indian Ecommerce industry and its reach to tier II and tier III towns in India could be attributed to the industry adopting “cash on delivery” as a means of payment. With the proliferation of mobile phones and 3G/ 4G coverage across the country, customers with smartphones, and with no access to any digital transaction platform (like a credit card/ debit card/ wallet) can easily buy goods online. And pay for them when they actually receive them through cash. The impact of this on Ecommerce companies is three-fold: adding more number of customers, providing time for customers to actually make up their mind – they could actually return the goods when they arrive with no liability at all (see the recent Flipkart ads), and larger investments in working capital for the industry (either the platform or its suppliers, or both). Therefore, it is imperative that the E-commerce firms measure not just their gross merchandise value, but include the GMV net of returns, or Net Merchandise Value (to account for returns).

E-commerce = discounts

The primary selling proposition of E-commerce firms in India have been around deep discounts. While the idea of a zero-inventory marketplace model (that Amazon pioneered over a decade and half ago) does provide sufficient economies of scale and cost advantages, competitive discounting in the Indian E-commerce industry has over the years shaped customer expectations to the extent of equating online buying to deep discounting. Therefore, measuring gross and net margins of the entire firm is imperative.

Spreading Commerce to the “hinterlands”

The first line of defense Ecommerce firms take umbrage to when someone accuses them of being focused on a single parameter is that “the industry is in its infancy, and we need to broaden our net”. True that the low penetration of E-commerce in India provides a big opportunity for growth, we need to define appropriate metrics to measure the firm’s performance on that front. It is therefore important that firms measure the total number of transactions (as a proxy for volume sales in the offline world), number of active customers (as a measure of customer concentration – or an ABC analysis of customers), number of new customers added (not registrations but at least on transaction), average GMV per customer (as a measure for identifying high-value customers), average contribution per customer (gross profitability), and the proportion of customers whose GMV increased over the past period. In addition to this, we need to also factor in the cost of acquiring customers (CAC), and derive the long term value (LTV) of customers to evaluate performance. As the firm matures, it should strive to bring the CAC lower than the LTV.

PepperTap’s source of worry (read the article on YourStory.com here) was its rapid expansion to new towns where the costs of servicing was far higher than the LTV of the customers in those geographies. As they cut down on the number of cities, their performance improved. Therefore, it is imperative that Ecommerce firms measure and report their CAC and LTV of their customers as a key performance metric.

Alignment with strategic priorities

For a multi-category retailer, the distribution of its sales, costs and margins across categories is a critical parameter to monitor. Firms may prioritize certain categories over others as per their market position and strategic priorities. Successful firms therefore need to measure and monitor their performance across categories, and benchmark against their intent and priorities.

Creating a holistic dashboard

In sum, E-commerce firms would do well to measure, monitor, and report their performance on the four categories of parameters including (a) the traditional GMV, and a GMV net of returns; (b) overall gross margins and net margins for the firm; (c) total number of transactions, number of active customers, new customers added, average GMV per customer, average contribution per customer, proportion of customers registering increase in contribution over the past period, and the cost of acquiring customers; and (d) distribution of GMV, GMV net of sales, gross margins, net margins, number of (net of returns) sales, and CAC & LTV numbers in each category.

Interesting times lie ahead for the industry, as the golden tap of venture capital finance dries up, leading to reduction in discounts and possibly consolidation of firms to leverage the traditional scale economies of a zero-inventory marketplace model.

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Author: Srinivasan R

Professor of Corporate Strategy at the Indian Institute of Management Bangalore. All views are personal. The views and opinions expressed here are of the author, and not those of the Indian Institute of Management Bangalore; and are not intended to endorse, harm, malign, or defame any individual, group, or organisation.

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