It’s Not All About Price

I recently had a discussion with another redditor about pricing.  Specifically, someone asked what kind of margins other e-commerce owners had and what their markup should be. Instead of answering, the redditor posted that they should stop focusing on price as a number and the only way to compete and as a reflection of their brand.

I don’t disagree with that – it’s actually a decent way of looking at it.  However, it’s also worthwhile understanding that when you develop your business model, it’s not just about deciding on where you want to position yourself (and thus the price) but also the underlying business industry you are working in.

It’s even more important to understand this and your business resources when developing your business.

Let’s give an example – you sell Widget A. If you and your competitors are all selling Widget A, then you cannot afford to price yourself too far off from your online competitors. If they sell it for $10, it’s really, really difficult for you to sell it for $50 or $30. You might be able to pull off $20. Part of how much you can afford to price yourself away from them is based off how knowledgeable / fractured your market is. For example, if a significant portion of your market reads 2 magazines, and your competitors all advertise there, you can’t be too far off. If, however, your market is extremely fractured, then you can afford to price yourself at a higher rate.

Developing a brand will allow you to price at the $20 range and get customers – the number of customers really depends on the demand curve.  How brand (in)sensitive are your customers? How brand loyal?  If you sell sugar – the answer is almost negligible.   If you sell high end clothing, the answer is extremely high.

In addition, you need to take into account the various services and your resources – a high price generally requires a high level of service.  That level of service generally dictates a higher cost in time and money.  If you are a one man show with very little money, you might not be able to handle a lot of business – so your markup better be really, really good.  Again, at the higher ends it’s viable at the few hundred dollars and more range. If your product is only selling at $30 but that’s a 300% markup, things might get tricky.

In addition, there’s also the question on time.  Getting a $50 customer will likely take longer than getting the $10 customer.  In e-commerce terms, it might be the difference between a 1% conversion rate and a 0.01% conversion rate.   When traffic is hard to get, that 0.01% conversion rate might be a killer.

Business Valuation

For a number of reasons I’ve had to discuss / review business values.   Based on that, I thought I’d discuss business valuation in more detail.  Let’s start with the most common valuation method which is the earnings valuation method.

The Basic Calculation

The basic calculation was calculated as follows – net assets multiplied by the earnings multiplier. Or written out:

(Assets – Liabilities) + (Profit  x Earnings Multiplier) = Business Value

Things however get complicated for a number of reasons.

Assets

Assets for most e-commerce businesses include the stock, furniture, website and the accounts receivable amounts.

Note, however that things can get complicated if the company has decided to purchase assets like furniture outright or has already applied depreciation.  In addition, you’ve got t o assess the value of a website which can be tricky.

Goodwill theoretically should be there. but Goodwill is often disregarded in cases like this.

Liabilities

Liabilities are generally easier to do.  You have Loans and Accounts Payable to worry about, but not much else..  Shareholder loans can be tricky as you need to assess what the loan requirements are – many companies have a substantial shareholder loan but no documentation attached to it.

Profits

Profits at first seem pretty simple – just take the Net Profit right? However, it’s more complicated than that.  When selling, you want to include things like the Owner’s draw and discretionary expenses (Add Backs) that might have been taken out of the Net Profit that are not necessary to the running of the business.

Often, especially with smaller companies; a number of discretionary expenses are added to lower the tax burden.  These costs shouldn’t be part of the actual profit and thus, the sale price.

Profit Multiplier

How about the profit multiplier? Well, this is tricky.  The multiplier can be as low as 1 and as high as 10 depending on the industry and the growth (expected or historical) of the company.  This is a harder number to find though business brokers or business sites like BizBuySell, etc can be a good place to start.  Generally, multipliers of 2 to 3 are quite common for profitable businesses.

Other Factors

Are there other factors to take into account? Yes, a ton.

  • Growth potential of the company can drive up the profit multiplier
  • A history of profitable earnings can increase you general profit, not to mention your profit multiplier (if it’s shown to continually increase as well)
  • Documentation and processes – a well documented business with policies & procedures that make it turnkey can significantly increase the value of a company
  • Seller financing (i.e. you being willing to be paid out from the profits) can increase the value of the company
  • Market share / ease of entrance into marketplace.  If you are in an industry that is hard to enter and/or have a substantial market share (i.e. market leader); you can often command a higher premium for the company

Other Valuation Methods

Lastly, let’s talk other valuation methods:

  • Book value (what’s it worth on paper?)
  • Liquidation value (great if the company is liquidated and/or not an on-going concern)
  • Debt-paying ability / Free cash flow (how much free cash does the company provide, thus allowing the business to be bought for that value)
  • Capitilzation of earnings (basically, figuring out the return the buyer can expect)
  • Revenue multiple (for high growth companies, this could be viable if they are not making any profits).

At the end of the day, there are a ton of methods of valuing a company.  It’s worth noting why a company is being sold too – if you approach a company ‘blind’; unless the owner was intending to sell the company; you are likely to pay a premium compared to one that is actively looking for a buyer.

Crowdfunding, Shareholders and Oculus Rift

So, this is going to be a somewhat meandering post about branding and managing expectations, especially dealing with things like Kickstarter and ownership.

Oculus Rift

Let’s summarise this quickly – Oculus Rift is a tech company that is building a VR interface which from all reports is really good.  Oculus Rift went to Kickstarter to get further funding and they received a ton of cash – nearly a million I believe compared to their $100k ask.

This means they had a lot of stakeholders (i.e. people who have an interest in the company) but not a lot of shareholders (i.e. people who own a part of their company). They recently sold the company to Facebook for a cool billion.  Yeah, b not m.  The shareholders made a lot of money this way, but the stakeholders didn’t.

Since then, a lot of people have grown angry with them – going as far as threats on the owner and his family.

Shareholders & Stakeholders

Shareholders have a tangible stake in your company.  They physically own a part of your company.

Stakeholders on the other hand just have an interest in your company – emotional or contractual (e.g. suppliers); they have an interest in your company but don’t have a say in how it’s run (technically).  You can ignore your stakeholders, but as per Oculus Rift, there will be lashback.

Branding & Public Relations

Your job as the marketer in the company (and you could be CEO too for all I care, you are still doing marketing); your job is to manage perceptions.  Much of the anger that has been directed at Oculus Rift is because they  never attempted to manage perceptions beforehand – the news was rather startling and made many of the stakeholders feel betrayed.

In addition, you should understand that crowd-funding systems like Kickstarter are still new in execution.  Few people who take part in the system have an understanding of what is required in terms of communication and branding.  The closest relation that I can think of is the way non-profits manage donations from their supporters.  They don’t control the non-profit, but without the donations the non-profits are nothing.

Manage expectations, manage the idea of what say people have and can have, where you might be going (the vision / the brand!) and you can avoid or at least decrease the issues you might have in terms of the backlash.  Don’t and well… you have another Oculus Rift.