In my previous post, Why Leave A Six Figure Corporate Job For Internet Entrepreneurship?, I wrote about the various business ventures I have tried and tested over the years. One of those ventures was the creation, establishment, growth and sale of an e-commerce business. In this post, I want to lay out the details involved in how I first realized the opportunity, the formation of the business idea, the search for my supplier, the establishment and growth of the business, problems encountered and lessons learned, as well as the exit strategy that resulted in the $250,000 sale of the business.
Although this post is focused on my e-commerce business, the process and the underlying concepts and lessons learned can be applied to any business. I have paid the price to learn from mistakes, as well as reap the rewards of my actions. I hope you find some value in my experience on this entrepreneur’s journey.
The Epiphany / Realization
My e-commerce business was an online discount seller of designer fragrances. I like designer products – I consume them and tend to stay on top of recent trends in fashion. This is the reason I was able to identify the opportunity when it presented itself to me.
The realization of my idea started on an international trip when I was working as a consultant in mergers and acquisitions. My work took me all around the world and during one of these trips I was pleasantly shocked to see the prices at which designer perfumes and colognes sold for in some markets overseas.
These were the very same products that we are used to purchasing in malls and department stores here in the United States of America. The prices of these bottles in China for example (1.7OZ, 3.3OZ, 4.4OZ, doesn’t matter) were almost a third of the prices we are used to paying in the United States of America. Why?
In America, the cost of doing business is very high. We have the second highest corporate income tax structure, and soon to be the highest as soon as Japan reduces its rates this year.
In addition, the malls and department stores that we buy from have large fixed costs and an overhead structure that they have to pass on to us – the consumers. What happens as a result is that we – the consumers – end up paying a price three or sometimes four or more times higher than what it would cost us to buy the fragrance from a smaller, “low-cost business” establishment.
So how can an online company like mine offer designer fragrances so much cheaper? Essentially by cutting as much of the supply chain as possible, and lowering the cost of doing business (i.e. by operating online).
Since the cost to the consumer increases the minute the product leaves the manufacturing warehouse, by selling directly to the consumer, online companies are able to cut most if not all middle-men involved in the process and therefore the unnecessary costs of doing business, to provide the consumer with the product at heavily discounted prices.
Facts About The Designer Fragrance Industry
Realizing that there might be an opportunity to exploit in this industry, I began further research. I asked why should only a few be able to afford a 3.4OZ bottle of Armani for $89.99? Why can’t everyone access this fragrance at half the price? I realized they can, and the answer is e-commerce (buying and selling on the internet). I surfed the web and found many online stores that allowed individual consumers to purchase genuine designer merchandise at much lower prices.
In further pursuit of this idea, I came to learn that designer merchandise is a high-demand market. I could have guessed that, but research further reinforced this and provided some concrete numbers which I had no idea about.
The cologne and perfume industry is approximately a $25 billion industry in North America that is forecast to grow exponentially. I also learned that there is a tremendous amount of brand loyalty, which is essentially loyalty of consumers towards a particular cologne or perfume. A big reason for this is popular celebrity brands and endorsements of such brands.
That said, consumers are always seeking bargains on designer merchandise, which normally come at a hefty retail mark-up. In response, an opportunity in the designer merchandise market had been identified by some key wholesalers and distributors of designer accessories (such as purses, belts, eye wear, perfumes and colognes to name a few.)
These key players identified a niche in the online space of “e-tailing”. E-commerce stores (Internet websites that sell to individual consumers) were established to cut out the middle-”men” involved in the supply chain of designer merchandise in order to offer “luxury” products at “commodity” prices. In other words, rather than rely on stores to sell the designer products, entrepreneurs were designing websites that delivered the products straight to the consumers, at a significantly lower price.
And as I researched the supply side further, which involved talking to merchants, I started to realize that many small retailers were gravitating to these online businesses to procure their inventory for resale in their stores due to the low-cost pricing structure the portals offered. However, shipping costs were making the deal unfavorable on many occasions.
I also heard a recurring problem faced by resellers, which is the lack of attention and communication from the wholesaler (the main supply source). This makes sense. Why would a large distributor care about Mom’s little perfume shop down the street when they have huge malls and department stores to supply to?
The Cost Components Of The Supply Chain
One might ask, how is it possible to sell luxury products so much cheaper? The short answer is it is very much possible and evidence of it can be observed everywhere around us today (i.e. E-bay and Yahoo stores). Part of the explanation is that these products are cheap to begin with.
By “cheap” I do not mean inferior quality but rather they do not cost that much to produce. Anyone who has taken an operations management class in business school has learned that a product is marked up by an approximate average of 75% from the time it is manufactured to the time it is purchased by the end consumer. That means that if a bottle of designer perfume costs Carolina Herrera $25 to produce, then it is sold for $100 at your local department store.
Why the $75 markup on one small bottle of perfume? Manufacturers typically deal with distributors, who distribute their products to jobbers and wholesalers, who in turn resell the products to the end seller (i.e. malls & department stores).
Many times there are multiple wholesalers involved throughout the product’s life-cycle. Everyone involved in the supply chain has to make their share of the profits, this is accomplished by marking the product price up each time it exchanges hands.
The product is marked up the most when it reaches the end seller. This is because most end sellers are large brick and mortar buildings that have the burden of monthly rents to pay, utility bills and other business expenses such as insurance and taxes, among several others.
The beautiful showcases, air-conditioning, marble floors and free product samples that you see in stores aren’t free after all. All these costs are passed on to and paid for by you, the end consumer that walks into a mall and purchases a bottle of designer perfume for $100 that costs $25 to manufacture.
Unfortunately this fact is forgotten in our practical day-to-day lives in which our impulses take over our shopping habits. Some shoppers simply do not know how the high price is arrived at, nor that they are paying too much for the luxury item.
The Birth Of The Business Idea
Once I was convinced there was money to be made in this niche, I knew I wanted to establish some sort of a business around it. I don’t exactly remember today how I thought about the Sam’s Club concept, but maybe because our family had shopped there for years it had come to mind among the mix of various other business models.
If you are not familiar with the Sam’s Club concept, it goes like this: you pay the club (merchant) an annual fee, and in return the merchant provides you with wholesale shopping experience. Because the merchant’s profit margins are low on the items sold, and on some products they merely break even, they charge an annual membership fee to the club to make their profits.
What a concept I thought for the designer fragrance industry. I mean why not? Every mall I went to had a kiosk of designer fragrances. Every flea market, outdoor seasonal market and downtowns have mom and pop shops that carry designer fragrances. I knew there was a need.
I spent some time talking to a few of these shops, mainly kiosks at malls and realized that their number one concern or difficulty in doing business is that they were often ignored by big perfume distributors. And rightfully so, who would cater to a small $3,000 order when there are customers that buy in the hundreds of thousands of dollars?
I thought to myself, why not take my concept online and create a platform where all the moms and pops from across the country can order from? Because no one was doing this online, and I had heard of ways to streamline doing business online, I figured this valuable proposition would hit with both the supplier and the small business customer.
The internet was growing in leaps and bounds (it still is) and more transactions were being conducted online year after year, contributing toward the multi-billion dollar e-commerce industry we have today. As online transaction infrastructure grew, and as people became more comfortable doing business online (i.e. buying cars and planes like they are today), I was convinced that this was the way to go in the future.
The Search For A Distributor
At this point I knew I was on to something, but the biggest piece of the puzzle was missing, the actual product! I needed a supplier that was willing to drop ship the product. My business concept was one based on volume (sales), and not product margin (profit per item sold).
Therefore drop shipping from the source was critical, unless I was willing to fork out a million bucks to buy the inventory beforehand. There was no way I was going to do that in an industry I was brand new to.
I searched online directories, bulletin boards, ThomasNet and other similar websites and must have contacted every grey marketer or distributor I could find in the USA, only to get rejected call after call.
There were a few players interested who I personally visited, but for one reason or another nothing panned out. I was on the verge of giving up and posting my idea in a public forum for someone to take and run away with it.
Then during a family event, I was reminded of a relative who had migrated to the USA years before I did and who had entered the designer fragrance industry. I wasn’t in touch with them but like anyone in need, I made an effort to reach out.
I flew out to the West Coast to meet him, pitched my idea and left with a verbal agreement to work together. It cost me 50% (strategic decision making remained with me) of my business, but at this point I was willing to do that.
I made another trip to walk through his gigantic warehouse, and learn a bit about product mix, pricing and supply chain. He already had a discount shipping platform through UPS, which we decided to leverage for the online business by simply changing the name on the “Sent From” field to reflect our business’ name.
I flew back home, drafted a working agreement using Socrates, incorporated the business, established the employee identification number (EIN) or tax ID, established a separate bank account and sent my new partner copies of the agreement for execution and record keeping.
We signed the agreement a few days later, funded the bank account with some initial start-up capital (we needed this to meet the minimum business account balance requirements with Bank of America), and I started my search for a programmer who could create my vision.
The Creation And Growth Of The Website
I did not know anyone personally who could design a website for us, so I posted the task on Craigslist, Guru and Elance. After exchanging countless emails back and forth with several applicants, and spending time talking to many over Skype, I decided to go with a programmer based on the West Coast. My intention was for either me or my partner to meet with him face-to-face at some point, which never happened.
The development of the website took just about 30 days, with another 30 days for testing, tweaks, edits and content upload. The content upload process was extremely time-consuming. My partner and I had worked seven straight days on uploading over one thousand individual fragrances, each with its own image, set of title, keywords and description. It was brutal.
The first five days of development were spent designing and approving our brand or logo, and the remainder on the actual website and underlying product databases. The website was built on OS Commerce, with open source shopping cart ZenCart in the back-end, which made it easier for us non-tech literate folks to manage simple functions of the website. We also had Google Analytics scripts installed for visitor and conversion tracking.
I had registered the domain with Go Daddy for about $7 (I believe). I also bought a shared hosting service package with them ($14 per month I believe), as well as a secure sockets layer (SSL) certificate (under $100 annually) to ensure customer information was protected.
We used Authorize.net as our merchant processor, and later incorporated both Google Checkout and PayPal as additional payment options. Although these programs kill you with transaction fees, it is foolish to ignore them because of their popular and wide-spread usage. In addition, Google gave us Pay Per Click (PPC) credit for racking up Google Checkout transaction fees, so at least we were getting something back in return for the excessive fees we were forking out.
We tried to leverage our small operation as much as we could. The entire website, including the logo creation cost us just under $3,000.
Subsequently, we also implemented an email newsletter series to build relationships and directly communicate and market to our recurring customer base so we could cut back on marketing and advertising.
Marketing was our highest tab, or largest business expense because we had no idea what search engine optimization (SEO) was (this was before all the scammers started sending out SEO service solicitation emails).
So even when the site was up, other than word of mouth traffic, visitors weren’t flocking in like I had fantasized in my dreams. Lesson number one learned. Online business is NOT like a brick and mortar shop. If you simply build, they will not come! You have to go out and get them.
So just like an inexperienced and overanxious novice, and thanks to Google for poisoning my mind, I pursued PPC advertising. This is how we got the bulk of our customers, and lucky for us word started spreading on the street. Our traffic was up, visitor count was up, subscribership was up and the customer database was growing.
Because the business itself was keeping our hands tied up, I couldn’t learn about SEO as much as I wanted to. The website was horrible from an SEO perspective. It didn’t even contain the basic fundamentals of SEO such as the meta data.
We had to keep spending money on PPC advertising to drive traffic to the website. When we stopped spending, the traffic stopped coming. Key lesson number two. Focus on fundamental SEO to improve your chances of growth through free, organic search traffic.
Heck the site wasn’t even submitted to search engines. To make matters worse, our programmer had incorporated several “black hat” SEO strategies unconsciously such as keyword stuffing the footer of the website with every single designer’s brand name. I say “unconsciously” because he himself had no idea what SEO was. And because I didn’t either, I wasn’t able to identify these black hat strategies on our website.
He also managed to do this near the header in fine print, and because the header had to be changed to a different color later on, the previous text that was there blended in and couldn’t be seen by the human eye.
Now that I know about SEO, I know that this was a BIG MISTAKE in retrospect. Though shall not deceive Mother Google. Little did I know back then though.
For all we knew, our website could have very well been indexed by Google at one point and later kicked out because of such bad behavior like search engine trickery and deception. We were very, very bad.
Taking A Break
I had initially planned on making this a full case study from start to finish, but for everyone’s sanity (mainly mine), I need to stop here and continue on with the sequel in the coming week. So far I have discussed everything from the beginning up until the point of operation. The fun was just beginning at this point.
In the sequel, I will discuss the real fun revelations (i.e. the problems encountered and more lessons learned). I will also discuss the exit strategy, which was the $250,000 sale to the second largest Power Seller on Ebay at the time. Finally, I will spend some time discussing my thoughts on the overall experience.