How ecommerce startups can win against Amazon

In 2016, U.S. consumers spent $360 billion at online retailers, with Amazon accounting for a whopping $150 billion of that. In other words, almost 50 cents of every ecommerce dollar goes to Amazon.

Amazon is hard to beat on price, selection, and convenience. So what ecommerce opportunities are left for startups? This is a question my fund looks at very carefully, since we’ve been focused on high-potential ecommerce plays. Here are a few takeaways from our playbook:

Where Amazon wins — and where it doesn’t

Amazon wins when you already know the specific SKU you want to buy. But half the shopping experience happens when you don’t know exactly what you want. In those times, you’re shopping for entertainment, discovery, self-expression, artisanal, and custom goods.

A search for “red shoes” or “standing desk” on Amazon produces hundreds of pages of results to sift through. In those situations, many people prefer a more curated experience with just a few precise, new, or different offerings that are tailored for them. Many of the most appealing direct-to-consumer brands aren’t even sold on Amazon.

The future of commerce is going to be a really interesting hybrid of different models. It won’t be purely online or offline. These mixed models might incorporate some in-person retail demos, workshops, or events. It could be showrooming, it could be a personalized fitting, or even an assessment and onboarding meeting with a personal buyer or concierge. There are even more post-consumption models such as rental, share, or try before you buy. Startups are creating a personalized and community-based approach to shopping that Amazon doesn’t offer, and this is where startups can innovate.

The playbook

It’s difficult for startup companies to compete with Amazon and other large ecommerce retailers like Alibaba by only selling third-party products. You’re in a price war, which usually results in low margins. This results in low-quality revenue that doesn’t lead to a healthy business.

We’re seeing newer startups design original first-party products that they own, design, maintain, and source. Instead of just selling third-party products that consumers could also find on Amazon, these startups sell a mix of curated third-party products and original flagship products.

These first-party products can differentiate a startup’s offerings from Amazon, while the third party products capture more of the wallet and increase average order value. A 50/50 blend between first- and third-party goods tends to lead to healthy revenue, with the first-party products having higher margins. If you only have third-party products like Amazon, your margins won’t be healthy enough to compete and keep growing viably long-term; but if you only have a limited selection of first-party products, you may be capturing a tiny portion of the consumer’s spend in that category.

I look for these three Cs in next-generation commerce companies:

Curation. The company offers excellent curation, including content around product selection and what the hot new products are.

Community. There is a company-run forum where customers and users to discuss the products. Users can show off how they use the product or share their personal stories in addition to sharing their wishlists and reviews.

Commerce. The marketplace should offer convenient and unique ways to buy the products, not just big discounts or free shipping and returns.

The first generation of commerce companies focused on one of these three Cs. But today, we’re seeing more companies combine two or even all three of these.

Online fashion marketplace Poshmark, which my fund chose to invest in, is an example of a company that got this right. Poshmark worked hard to really empower the sellers on its platform, building a community that’s there for far more than the transactions. Customers see that and get excited, which leads to commerce.

Other startups like Houzz, GOAT, Watchgang, and Reverb.com have also combined these three C’s in some compelling ways, and I believe any passion product vertical is well suited for a similar strategy.

Additionally, there are four new, emerging Cs that we’re seeing ecommerce head towards with new mechanics.

Crowdsourcing. Companies let enthusiastic customers act as the merchandiser, the buyer, and even the designer of the products they want to buy. Not only are top customers avid fans and high frequency purchasers (or even collectors), but they often know more about the products than the manufacturers and marketers themselves. They’re providing direct feedback on how to tweak or launch new products that they’ll readily buy and even sign up to purchase in advance.

Crowdfunding. When a new product is about to drop, companies will get customers to pre-fund or pre-order the incoming product. This is a great way to show and aggregate demand ahead of launching — and ahead of investing in new product developments.

C2C marketplaces. An example is passionate customers that want to buy, sell, or trade their own items with each other.

Cryptocurrency. This particular trend is still very nascent, but blockchain and cryptocurrencies could revolutionize the back-end of commerce, including supply chain, logistics, and working capital. There’s also potentially the opportunity to have virtual currencies on the front-end, tying into next-generation loyalty programs and the ability to earn and spend tokens.

Metrics that matter now

Many entrepreneurs ask me about the metrics that make a next-gen commerce company compelling. Here’s a breakdown of some of the key metrics that my fund looks for when evaluating new ecommerce startups:

Quality of revenue. In prior years, many startups would focus their pitches solely on fast-growing and large GMV top-line revenue from gross sales. Now, it’s the quality of the revenue that matters. We base that revenue quality on the gross profit rates and the contribution margins at play.

Effective payback period versus cost of acquisition (CAC). The threshold we’re looking for is CAC payback on a contribution-margin basis within six months or less.

Time to double the CAC investment. In other words, how long does it take to make back 2x on your CAC on a contribution margin basis? Top performers usually take 12 months.

Recurring revenue models. Companies with these models have customers who order on a recurring basis, including subscriptions. This leads to more predictability and generates a nice accretive effect.

Source of traffic. Is there a healthy proportion of organic traffic, meaning companies are doing 50 percent or more of their traffic organically via word of mouth or referrals instead of relying on paid acquisition?

Diversified paid acquisition. We like to see the acquisition coming through multiple platforms. We’re really impressed when companies can find non-Facebook paid acquisition channels: e.g. influencer marketing, channels like Reddit, and user-generated content. We’ve seen many commerce startups get to a $50 million — even a $100 million — gross merchandise volume, but then, as they try to break through to that half billion or billion dollar revenue threshold, the model starts to fall apart as reliance on Facebook or Google starts to get costlier and costlier with diminishing returns.

Customer engagement mechanics. This could be personal buyers, concierges, or communicating with customers directly via messaging platforms, text message, or chat, not just email blasts of coupons and promotional material.

Hopefully, this explains our excitement and why we’re making more bets in these areas with founders that get these three Cs, with the additional four Cs. We’re looking at new models that can stay well ahead and differentiated from the Amazons and Alibabas of the world.