5 Questions for Evaluating E-Commerce Viability
There are hundreds of startups trying to be the next Warby Parker, but history shows that 90%+ of e-commerce companies will fail. What separates the successes from the failures?
Here are five things I look for to figure out if an e-commerce startup is a good opportunity:
- Does it have defensible, scalable acquisition channels?
- Is it operating in a category that is well-suited to brand building, and if so, has it built a brand that people love and trust?
- Is it selling a unique product that not everyone can offer?
- Does that business have network effects?
- Are there economies of scale that can be captured ahead of later entrants?
1. Customer acquisition
Let’s unpack each of these, starting with customer acquisition. It’s unsustainable to rely heavily on paid acquisition channels to grow, as the margins end up being bid away.
Instead, does the company have unique, scalable ways to reach new consumers, e.g. a devoted community who spreads the word, or exclusive distribution channels?
Dollar Shave Club’s launch video was a major accelerant for customer growth and cost just $4,500 to produce. While viral videos aren’t an uncrossable moat, it was an advantage that helped build up brand awareness cheaply and enabled them to reach scale before their competitors.
Brand defensibility exists for a lot of companies — but not all product categories are suited to building strong brands, and brand defensibility is also difficult to assess in the time frames that map to venture investing.
Brand defensibility works better in categories where there is a big emotional component to the purchase, where a sense of identity or community is intertwined with the brand, e.g. categories like health, cosmetics, or anything aspirational.
Whitelabel a Glossier, Chanel, or La Mer product, and chances are women won’t covet them nearly as much, even if the contents inside are the same. I’ve spoken in depth about the shifting power balance between brands and aggregators and where the opportunities are in this realm of e-commerce.
Does the startup have defensibility in terms of creating a proprietary product that others don’t have the ability to create? This could be derived from better design, deeper customer understanding, or manufacturing moats.
As an example, Hubble Contacts found that the vast majority of the contact lens market is controlled by a few manufacturers. Hubble was able to establish exclusive supplier relationships that blocked other contact lens startups from scaling in the US.
4. Network effects
There are various flavors of network effects in e-commerce. Marketplaces, for example, improve with more buyers and sellers. But even a single retailer or brand can have network effects. Stitch Fix’s algorithms for predictions and recommendations improve each time a customer reviews the items their stylist chose for them, leading to greater retention and lifetime value.
5. Scale effects
Amazon is the archetypal example of a retailer that thrives on economies of scale. As a startup example, Rent the Runway purchases expensive designer apparel and accessories and amortizes that cost over multiple rentals from different customers.
With greater scale, Rent the Runway can increase utilization, expand its inventory, and lower prices, making it harder for another clothing rentals startup to compete.
Not every company will be a “yes” to all of the above, but more of these being true can indicate a stronger opportunity.
There are also interactions between these: strength in one regard can compensate for the absence of another. A manufacturing moat in a large category means establishing a beloved brand is less important. A strong distribution advantage can be investible in and of itself.
Of course, building a great company and making investment decisions is more nuanced than just these five factors. It’s apparent that there are still a ton of exciting opportunities left to build great e-commerce companies. I’d love to chat if you’re working on one — get in touch!