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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 several years, e-commerce has rapidly evolved to become a combination of online and offline retail that is vertically integrated.  You can find numerous e-commerce companies selling various types of products and services. Their avenues of doing business are typically 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.  These companies sell products of various brands, while other companies, such as Zalando and ASOS, also offer products of their own brands.

With an ever-increasing level of marketplace competition, there is more and more overlap of the kinds of goods and services retailers provide. For example, while still primarily a gateway for third-party sellers, Amazon is increasingly developing and marketing its own brand of products.

 

Driving Forces Behind the E-commerce Evolution

The evolution of e-commerce since the turn of the century has dramatically impacted the daily lives of consumers and altered the standard operating structure of many businesses.  This evolution is mainly driven by forces in four categories:

 

1. Demographics

In developing countries such as China, urbanization has taken place in many areas, with people demanding better living conditions and driving higher consumer spending.  Another major marketplace trend is that of millennials becoming more dependent on mobile devices and the Internet to fulfill their entertainment and shopping needs.

 

2. Consumption

Changing consumption habits are a huge factor in the rise of e-commerce.  People put an increasingly high value on convenience, customization/personalization, and simplification in their online shopping experience.  They discover new products, sources of information, and different ways to access products and services to make their lives easier.

One trend is increasingly efficient delivery services, such as Amazon offering two-day free delivery of orders, including weekend deliveries(offered with its Prime membership) – a service that has recently been copied by Walmart.

 

3. Structural Shifts

There are structural shifts in the e-commerce industry as a result of changing consumption habits.  More and more companies are focusing on promoting and selling products or services directly to their target consumers on e-commerce platforms, through carefully tailored individual marketing programs.  Many consolidations have taken place among businesses in order to achieve economies of scale.

 

4. Technology

Portable devices such as mobile phones and tablets have become more widely used by consumers – both individuals and business consumers – to perform various functions such as browsing and interacting on social media platforms and searching for new information.  Technologies such as advanced customer 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 an interesting and – at the moment anyway – brand new experience for 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, but then leave (“bounce”) rather than going on to view other pages 
  • Order: A single checkout transaction, 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 other sites

 

Key Valuation Metrics

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

 

Customer metrics:

  • Active customers: Number of customers who have 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 provide word-of-mouth advertising by referring someone to the business

 

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 that when calculating gross profit
  • Sell-through rate: Percentage of inventory sold over a given 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, Taxes, Depreciation, and Amortization
  • LTV/CAC = (Contribution per customer * Average customer life) / Customer acquisition cost

 

More Resources

Thank you for reading CFI’s introduction to e-commerce. 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:

  • Startup Valuation Metrics (for internet companies)
  • How VC’s Look at Startups and Founders
  • Valuation Methods
  • Venture Capital

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