The “E-Commerce Code” – how to steer your online shop to success

The “E-Commerce Code” – how to steer your online shop to success

The E-commerce Code is a strategy and work program for e-commerce businesses. This program can set in motion a flywheel for more growth and success in e-commerce. However, the E-commerce Code is also an indicator-based management tool for e-commerce companies. In this first part of a series of articles, the “E-commerce Code” is developed as a success formula that is very helpful for the selection of and control with key figures. At its core is the achievement of contribution margins.

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E-commerce Code

The E-commerce Code – more success with key figures

E-commerce is a complex form of marketing goods and services based on technology, but it also offers many opportunities in addition to its complexity. One of the most important advantages in e-commerce is the data available for all levels of transactions. These data can be used to generate key performance indicators (KPIs) that reduce complexity and help to find the right focus for managing the company and the activities of its employees.

KPI systems are often perceived as daunting – because they are extensive and difficult to understand. However, in order to be able to develop an effective management tool, widespread acceptance is an important success factor. Therefore, the e-commerce code as an ideal control system for e-commerce companies must be both accurate and comprehensible as well as flexible. What could such an e-commerce code look like?

Let’s start with the goals. E-commerce is a sales channel, so it’s less about controlling the company as a whole and more about controlling the sales channel. Let’s assume that the e-commerce channel should make a concrete contribution to covering the overhead costs of a company. In the case of a pure player, i.e. a company that uses e-commerce as its only sales channel, the contribution margins from e-commerce must then cover 100% of the overhead costs; in the case of multi-channel companies with several sales channels, only a proportion.

The starting point is therefore the contribution margin, which must exceed a certain value. The contribution margin is generally defined as follows:

(1) Contribution margin = turnover – direct costs.

Now, not only experienced controllers know that there are different levels of contribution margins, which differ in the extent of the costs taken into account. Since in e-commerce online marketing costs can be allocated to individual products, it makes sense to consider contribution margin II, i.e. including direct marketing costs, as a target figure:

(2) Contribution margin II (DB II) = turnover – acquisition costs – direct marketing costs.

This DB II must therefore cover all or part of the overhead costs, that is the goal. In order for us to achieve the goal, it must be operationalised, i.e. made manageable. We can achieve this by bringing our online marketing activities into play. Online marketing is the key activity in e-commerce.

We know that turnover depends on conversions -that is, orders placed in the online shop- and on the average revenue per conversion, which in turn is determined by the sales price:

(3) Turnover = Conversions (C) x Sales price (VK),

so that our contribution margin formula can be represented as follows:

(4) DB II = C x VK – direct marketing costs (MK) – acquisition costs (AK).

Conversions, in turn, are a product of page visits and the conversion rate, which is a good indicator of the attractiveness of the product range and the usability of the shop:

(5) C = page visits x conversion rate (CR).

The page visits in turn are a product of the impressions – i.e. the display of our advertising messages, e.g. in the search engine – and the click-through rates, which in turn are a good indicator of the quality of our online marketing:

(6) Page visits = Impressions (I) x Click-Through-Rate (CTR),

so that

(7) Turnover = I x CTR x CR x VK

is. Putting this into our DB II formula, we get:

(8) DB II = I x CTR x CR x VK- MK – AK.

Now this expression does not really look like reduced complexity. However, this can be achieved if we take into account that direct marketing costs such as sales and conversions depend on page visits. The direct marketing costs (MK) are in fact nothing else than

(9) MK = I x CTR x click price (CPC),

where the click price stands for the cost per page view. This can be determined very quickly for a campaign in search engine marketing, but only indirectly for a page view from the organic search results. So let’s put the direct marketing costs into our DB II formula:

(10) DB II = I x CTR x CR x VK – I x CTR x CPC – AK

then the simplification is immediately obvious:

(11) DB II = I x CTR (CR x VK – CPC) – AK

Now we know that the acquisition costs are a product of the retailer’s purchase price and the quantity sold. The quantity, in turn, results from the marketing parameters I x CTR x CR. From this follows:

(12) DB II = I x CTR (CR x VK – CPC) – (I x CTR x CR x EK).

Now we know that DB II must cover the overhead costs. The minimum condition for profitability is therefore

(12) DB II = Overhead (GK)

We can therefore formulate

(13) GK = I x CTR (CR x VK – CPC) – (I x CTR x CR x EK)

A little summary gives the following expression:

(15) GK = I x CTR [(CR x VK – CPC) – (CR x EK)]

and further

(16) GK = I x CTR [CR (VK – EK) – CPC]

and voilà: that is the e-commerce code.

What are the advantages of this objective function? It includes all essential control levels in an e-commerce company. The following list provides an overview before this article concludes with an example:

Impressions I stand for the demand or the potential of possible customers that can be reached online.
The click-through rate CTR stands for the quality of the online marketing measures.
The conversion rate CR is an indicator of the quality of the online shop.
The sales price VK stands for the target group’s willingness to pay and for the quality or value of the product.
The click price CPC is a suitable measure of competition in an online market.
The purchase price EK in relation to the sales price is an indicator of both the added value in the company and the purchasing power.

A numerical example of the e-commerce code shows how e-commerce companies can be controlled with this target function:

DB II = 200,000 (I) x 5% (CTR) x [3% (CR) x (75€ (VK) – 30€ (EK)) – 0.20€ (CPC)]

DB II = 10.000 x (3% x 45€ – 0,20€) = 10.000 €

GK = 10.000€ = DB II = 11.500€

This means that the e-commerce activities are profitable in the period under consideration – e.g. one month – and measures and starting points must be defined accordingly to ensure sufficient contribution margins to achieve profitability.

The second part of the series “The E-commerce Code” shows you how the concrete control can be operationalised with the help of the E-commerce Code.

Author: Prof. Dr. Dominik Große Holtforth

Translated with (free version)

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