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Introduction to E-commerce

Commercial transactions of goods or services conducted over the internet

What is E-commerce?

E-commerce refers to commercial transactions of goods or services conducted over the internet.  Over the past years, e-commerce has evolved to become a combination of online and offline retail, which is vertically integrated.  You can find numerous e-commerce companies selling various types of products and services, and they are usually divided into three main categories:


E-Commerce business model


Some of the major players in the e-commerce industry, such as Amazon, Alibaba, and eBay, are well known by the public and own a large proportion of the market share.  The companies sell products of various brands, while other companies like Zalando and ASOS also offer products of their own brands.


Driving Forces Behind the E-commerce Evolution

The evolution of e-commerce in the past decade has dramatically influenced the daily lives of consumers and operating structure of businesses.  This evolution is mainly driven by forces in four categories:


1. Demographics

In developing countries such as China, urbanization has taken places in many areas where people demand better living qualities and drive higher consumer spending.  On the other hand, millennials are becoming more dependent on mobile devices and the Internet to fulfill their entertainment and shopping needs.


2. Consumption

Changing consumption habits is a huge factor in the rise of e-commerce.  People highly value convenience, customization, and simplification in their online shopping experience.  They discover new products, information and different ways to make their lives easier.


3. Structural shifts

There are structural shifts in the e-commerce industry as a result of changing consumption habits.  More companies begin to promote and sell products or services directly to their target consumers on e-commerce platforms.  Consolidations have taken places in businesses to achieve economies of scale.


4. Technology

Portable devices like mobile phones and tablets are widely used by the majority of people around the world to perform various functions such as browsing social media platforms and searching for new information.  Technologies such as advanced analytics help e-commerce companies improve their business operations and better understand consumer behavior and preferences.  Moreover, artificial intelligence (AI) and virtual reality (VR) are becoming a trend in e-commerce because they provide brand new experience to customers.


Key Terms in E-commerce

  • Site traffic: The number of visitors to a site 
  • Conversion rate: The percentage of customers who place an order relative to the total number of site traffic 
  • Bounce rate: The percentage of visitors who enter the site and then leave (“bounce”) rather than staying to view other pages 
  • Order: A single checkout which may consist of multiple items 
  • Churn: The annual percentage of customers who stop shopping at the site 
  • Organic search: Traffic from search engines that is not paid for 
  • Paid search: Traffic from search engines that is paid for 
  • Affiliates: Paid traffic from another site


Key Valuation Metrics

Below is a list of customer and financial metrics which e-commerce businesses use frequently in their financial models and valuation.


Customer metrics:

  • Active customers: Number of customers who ordered in the last 12 months
  • Churn: Percentage of customers who are no longer active at the end of 12 months
  • Average order value (AOV): Number of items per order times the price of the items
  • Lifetime value (LTV): Net present value of contribution market per customer
  • Customer acquisition cost (CAC): Cost to acquire new customers
  • Total addressable market (TAM): Annual value of all goods or services in the market
  • Average revenue per user (ARPU): Total revenue divided by the number of users
  • Net Promoter Score (NPS): Indication of how likely customer is to refer someone


Financial metrics:

  • Gross merchandise value (GMV): The value of all goods sold on a site
  • Gross profit or margin: Shipping or fulfillment might be included in the cost of goods sold for e-commerce businesses, so we need to consider it when calculating the gross profit
  • Sell-through rate: Percent of inventory sold over a period of time
  • Enterprise value (EV)/active customer = (Equity + Net Debt) / # of active customers
  • EV/Revenue = (Equity + Net Debt) / Revenue
  • EV/Gross Profit = (Equity + Net Debt) / Gross Profit
  • EV/EBITDA = (Equity + Net Debt) / Earnings Before Interest Tax, Depreciation and Amortization
  • LTV/CAC = (Contribution per customer * Average customer live) / Customer acquisition cost


More Resources

CFI is the official provider of the Financial Modeling & Valuation Analyst (FMVA) certification program for financial analysts. To continue advancing your career, these additional resources will be helpful:

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