IBA, as the premier business brokerage firm in the Pacific Northwest, is firmly established as a respected professional service firm in the legal, accounting, banking, mergers & acquisitions, real estate, and financial planning communities. Periodically, we will post content from professionals on the IBA team with knowledge to share for the good of owners of privately held companies & family owned businesses. The following blog article has been provided by Vishal Punj of IBA. Mr. Punj is a successful entrepreneur, MBA degreed professional who combines his corporate, academic, and personal business experience to provide quality representation with superior customer service to his business sale clients.
Important Metrics in E-Commerce M&A Transactions
Pandemic or not, specific industries have always held a certain allure with potential buyers of businesses. This has always been true for businesses with an E-Commerce component in the technology focused Pacific Northwest. However, during the last two years, with the COVID-19 pandemic, this interest has been heightened. In this article I will outline some key metrics to track as you prepare your online business for a potential sale. This is by no means an exhaustive list, but rather a high-level overview of what to expect from us as topics for discussion in an initial meeting as we seek to understand your business.
Every industry has its own unique set of metrics that are used to gauge the health of the business, with E-Commerce comprising everything from eBay to a retailer selling vintage jewelry online those metrics can be fairly wide ranging. However, whether you own a B2B, B2C, Dropship, Subscription, Wholesale, Rent and Loan, Freemium business model and/or something else there are certain metrics that the majority of E-commerce businesses have in common:
Average Order Value (AOV) – The formula for calculating AOV is revenue divided by number of orders. If your business sold $1,000,000 worth of product last year over a total of 25,000 orders, then your AOV for 2021 was $40. I always like to look at this figure on a monthly basis over the course of a year to track the seasonality of a product or service. Taken a step further you can observe how the AOV changes as your profitability margins fluctuate during the year. The AOV won’t mean a whole lot to a buyer if the business isn’t selling product at reasonable profit margins, so basic business valuation fundamentals still apply. I advise many of my clients to track AOV alongside inflation and adjust prices accordingly. If your AOV is unchanged from last year and you haven’t accounted for the current inflation rate of 7% your business might not be doing as well as you thought.
Customer Retention Rate (CRR) – We all know it costs less to retain a customer than it does to acquire a new one. CRR measures the rate at which you keep customers over time. The formula is (# of customers at the end of a period) – (# of new customers acquired during that time)/(# of customers at the beginning of the period) X 100. If you had 2,000 customers at the beginning of 2021 and ended the year with 2,100 customers after having won 1,500 new ones during the year, your CRR would be the following: (2,100 – 1,500)/2,000 X 100 = 30% CRR. Remember that this figure has to be taken into context. A 30% CRR for a SaaS (Software as a Service) company means there is a lot of room for improvement. In other industries it can convey strong customer loyalty. Last month, IBA completed the sale of Tom Bihn (www.tombihn.com), a backpack, travel bag, and business attaché manufacturer based in Seattle. It was a solid company tracking toward eight figures in annual revenues with a reputation for quality design, superior materials, and market leading customer service, but what made the company stand out amongst its peers was it’s approximately 40% CRR.
Customer Acquisition Cost (CAC) – Calculated by dividing all the costs spent on acquiring more customers by the number of customers obtained during that period. As an example, if you spent $100,000 in marketing and advertising costs last year and as a result acquired 5000 customers, your CAC is $20. On it’s own the CAC means nothing, so as a starting point it makes sense to first figure out what the average CAC in your niche should be. This is especially helpful if you are thinking your business would be a great acquisition target for a larger firm. Naturally the goal is to reduce the CAC while driving up all other metrics. Cultivating online advocacy is a great way to accomplish this. Tom Bihn did a great job of this via their Facebook site where their customers post, review and comment on each other’s purchases (all organic and unpaid). https://www.facebook.com/TOMBIHN/community/
Conversion Rate – Conversion rate measures the percentage of users to your site who take a desired action. If 10,000 people came to your website last month and 200 users purchased something from it your conversion rate is 200/10,000 = 2%. Keep in mind that simply purchasing something from the site may not be the desired action for your business. It has to be relevant to what you want them to do.
Customer Lifetime Value (CLV) – Not all customers are the same, and they shouldn’t be treated as such. Is it worth it to spend $1,000 on customer X vs. customer Y? Which is better for my business in the long run? CLV helps an owner address this question. Various nuances of the CLV formula exist, but I always find myself going back to the following version: Customer revenue per year times Duration of relationship (years) minus Total cost of acquiring and service customer = CLV. If customer X brings in $10,000 per year, tends to stay with you an average of four years, and cost you $1,000 to bring in the door and $250 per year to service, your CLV = $10,000 X 4 – $1,000 + ($250 X 4) = $38,000. You can repeat this exercise for customer Y and accordingly figure out the highest and best use of your marketing dollars.
Last quarter I sold an E-Commerce business that sold exotic plants, insects and habitats. It was a great business that blossomed further as the pandemic continued. Interestingly the number one concern was the distribution of revenue across the various platforms. What percentage of revenues come from Amazon, eBay, Shopify, etc? A simple Google search for ‘Selling on Amazon’ will provide plenty of content describing Amazon referral fees, seller account related fees, FBA (fulfillment by Amazon). Having access to the world’s largest retail store is powerful but is it worth the roughly 20% or more you’d be giving them? Furthermore, do you have a product/service that can be easily replicated by Amazon itself? These are the types of questions a buyer will be asking early on in the process.
Just as in the example of my client’s business, the pandemic has been a boon to E-Commerce. But is the growth sustainable? Here’s where the metrics discussed above can help. For the past year and a half I’ve been working with entrepreneurs to uncover relevant metrics both pre and post pandemic. Let’s say in 2019 the business had a CAC of $15 and a CRR of 75%, and in 2021 the CAC was $20 with a CRR of 90%. Sure, it’s costing the business a bit more to acquire the customer but the customer is also staying with the business longer. In this way the metrics can serve as a valuable tool to be used in a narrative to explain why your business is a compelling acquisition target.
Lastly, whether you plan on exiting the business or not, using these metrics on a consistent basis force you to ask tough questions about your business. Let’s say your AOV has remained unchanged at $40 in 2021 from 2020. While staying strong at $40 isn’t a bad thing, a smart entrepreneur should be working to increase that figure over time. My exotic plant, insect and habitat company client observed this and decided to slightly discount the price of a habitat if combined with the purchase of a plant or insect. The result was a corresponding increase in both AOV and CRR as the same customers would later come back to purchase additional plants and insects to make full use of the habitat they previously purchased.
If you have questions relating to the content of this article or selling a privately held company or family business Vishal Punj would welcome the opportunity to talk with you. Mr. Punj can be reached at (425) 454-3052 or vishal@ibainc.com.
IBA, the Pacific Northwest’s premier business brokerage firm since 1975, is available as an information resource to the media, business brokerage, mergers & acquisitions, and real estate communities on subjects relevant to the purchase & sale of privately held companies and family owned businesses. IBA is recognized as one of the best business brokerage firms in the nation based on its long track record of successfully negotiating “win-win” business sale transactions in environments of full disclosure employing “best practices”.