[📈 Investing] Part 1: Changing landscape for online merchants
Tl;dr: Retail is going online. This means that the current infrastructure is evolving and there’s a lot of innovative disruption in the space and this is providing a tailwind for new successful venture-backed start-ups.
Here is a database with start-ups within the e-commerce infrastructure space that I plan on building out as more and more start-ups build in the vertical.
If I missed a US-based start-up, please let me know through this form.
Overview of e-commerce
e-Commerce is when a transaction between a consumer and a merchant occurs through an online exchange of a physical product for monetary value
The end goal of the consumer is to purchase the product and the merchant is to be able to sell the product, however, both have slightly different user journeys. Let’s take a look at the consumer stack and merchant stack separately.
Consumer stack
In the last twenty years, we’ve seen a shift around how people buy: consumers are moving from shopping in brick and mortar stores to buying online. According to Benedict Evans, e-commerce represented ~20% of total retail in the US in 2020. If you were to translate this statistic to a real-world application, for every 5 purchases you make, you will buy 1 of them online. This was partially accelerated by COVID and the inability of consumers to go to a physical store to shop.
Source: Benedict Evans
In my opinion, this proportion is going to flip: we’ll live in a world where we’ll make 4 out of 5 purchases online. There is already a clear case of this happening in certain regions in the United States. A friend of mine lives in rural Colorado, and he can testify that 9 out of 10 of his purchases are online, which includes groceries as a single purchase.
Certain countries are also lightyears ahead of us. China has grown significantly in online shopping, with the digitization of shopping (Turner Novak wrote an extensive and comprehensive post on the rise of Pinduoduo). However, what’s unclear is how long it will take for this shift to happen for the rest of the US.
We’re driven to buy digitally because as consumers, we live on the interwebs: we consume content, we communicate with our friends and family, and we work online. As we see commerce going direct to consumers and brands reaching out to us through our digital connection, there are certain opportunities for new start-ups to thrive from the growing pains of moving towards shopping online.
Most likely, Millennials and Generation Z will have built a digital identity and will purchase directly from brands. We will see a slower adoption from the older generation but also a ripe opportunity for certain start-ups to make it as easy as possible for the generations who haven’t built digital literacy through their childhood.
For consumers, when they think about purchasing, they typically will be going through a customer journey of four steps:
Discover -> Compare -> Purchase -> Review
The online disruption is different at each phase of the consumer stack.
1. Discover: Consumers need a way to explore their needs online to better understand what they might even want to purchase to answer a need. For example, they might have a challenge around dirty dishes. As a product manager, I might write a user story like this: “as someone who eats at home, I need a way to clean my dirty dishes so that I can spend less of my time on chores” (not a great user story but bear with me). The consumer can solve this challenge in different ways, whether it be an automated way to wash the dishes (e.g. dishwasher, cleaning service, scrubber), something that will get the grease off (e.g. dish soap), or avoid the problem altogether (buy paper plates, eat food that can doesn’t need a plate, etc.).
At the Discover phase, there are different ways to answer a consumer’s need. It’s important to understand how to bundle different solutions and services that a consumer might need and allow a consumer to explore different solutions that fit one user story or pain point.
This is the first part of the consumer stack that is moving online. We no longer really look at catalogs or browse items in person, most of our browsing is done online. At this stage, the consumer has a low commitment to buying. They’re not in any rush to getting something and this is in a way a form of entertainment. The “Discover” phase for consumers is what we consider “marketing” for merchants.
2. Compare/Browse: Once a consumer has explored their needs and they know what kind of item they’re looking for, they will look and compare different brands. At this point, their exploration mode evolves into seriously considering what they want to purchase.
This step is still mainly in-person because a lot of people want to hold a product and get a real sense of it before they purchase it and there are certain steps that merchants are taking to get this online, including reviews and a better return policy.
3. Purchase: At this point, the consumer will purchase the item and pay for the item and bring the item home. Purchasing can be thought of as the transaction of an item for payment. We’ve already seen a handful of competitors within the payment space that handles most of the payments flow (e.g. Paypal, Stripe, Fast, Shop Pay).
In addition, there’s a move to create a vertical stack that will allow consumers to discover, compare, and purchase in one application (¾ consumer journey steps) . This is the move towards social commerce. The innovation here is not only a vertical use but the live video format that relies on influencers conveying the experience of trying out the product and giving a trusted review. Examples of competitors in this space include Pop Shop Live and Talk Shop Live.
4. Review: Once the consumer has started using the product, now is the moment of truth of whether the item has fulfilled their needs. You’ll see consumers writing reviews, considering whether to return the item, and finally considering whether they would buy this item again.
I previously mentioned a lot of companies built a strong return policy in order to overcome the hurdle of customers being able to try the product and decide whether they want it. However, this created a huge problem: we’ve seen large return rates, causing a fulfillment headache of how to return the product and sustainability issues where most products get thrown out. For example for Casper, 1 out of 8 mattresses was returned at the time of their IPO (NPR). Considering mattresses can’t be resold, they either end up in donation centers or in landfills.
Merchant stack
We’re going to look at the same experience of purchasing a physical good in exchange for monetary value from the merchant’s point of view.
In June 2020, Shopify announced they had onboarded 1 million merchants across 175 countries. More people are turning toward being entrepreneurs or founders, sometimes where they hire a small team. The barrier to entry for starting an online store is a lot lower: you don't need a lot of technical knowledge or money to spin up a Shopify store. In addition, the peer-to-peer ecosystem is growing with a good amount of resources in forums and Facebook groups.
Most people who are successful start solo and become successful due to marketing strategies. If we're talking about the truly smaller stores that are popping up and don't quit their day jobs until they really take off (which most never do). Once there is an initial success or if they are backed in some way (parent companies, influencer brands, etc), they hire a small team.
The merchant stack is Content -> Storefront -> Back-end -> Fulfillment -> Customer experience & returns.
This is a reflection of the same experience of the consumer journey, but from the merchant’s experience. Since consumers’ will have a different experience based on what tools merchants decide to use, I will be looking at the commerce infrastructure start-ups in this section.
Consumer stack ⇒ Merchant stack
Discover ⇒ Content
Compare ⇒ Storefront
Purchase ⇒ Back-end, Fulfillment
Review ⇒ Customer experience & returns
On the merchant side, they have a tech stack to support buyers in their purchasing experience. A merchant will have the following to support a buyer:
1. Content: For consumers to discover a brand, a merchant first needs to make the customer aware that the product exists. This space has large platforms such as Instagram, Facebook, and generally social media for consumer eyeballs.
The discovery part of the consumer has been the most expensive part of being a merchant. Merchants’ biggest costs have been acquiring customers and this cost has continued to rise. One of the recent disruptions has been how consumers discover new brands.
This is changing ultimately with the rise of the creator economy. With the rise of brand power, comes the ability to market on your own branding rather than finding a platform with a mass of consumers. Another way that merchants have tried to reduce costs is by managing customer acquisition through viral growth or by cross-marketing on other brands’ platforms. I believe we will see a lot of changes here over time because of how cost-prohibitive it is to promote brand discovery.
2. Storefront: This is the first step to get users into connecting the discovery experience to browsing and exploring specific items that will appeal to their needs. Merchants will add their catalog and display products that appeal to their customers with a unique voice.
3. Back-end: It’s becoming more common for the front-end and back-end to be separated with headless solutions so that your storefront is separate from the rest (e.g. shopping cart, check-out, fulfillment, etc.). We’re seeing this because each merchant might have slightly different needs.
In the past, the only solution was to build out your own full-stack to have a back-end that fit your needs as a merchant. Now, merchants have the ability to pick and choose between different integrations for their CRM, database, payments, etc., and are moving toward a plug and play model. They have the ability to choose between different third party integrations for different parts of the merchant stack. What I define as back-end will include:
Shopping cart: A shopping cart is a specific, important part of the buyer experience to get to purchase: it’s the conversion from non-commitment perusal to an actual purchase and is critical to increasing # of purchases. The customer has the intent to buy certain items
Check-out & payment: This is the final step for the user to commit to making a purchase and therefore has a high risk of abandonment.
Analytics: Data and personalization /taking certain actions are crucial for reducing costs, increase user revenue and effectiveness of a merchant’s marketing channels
Integrations: Putting together all the different pieces together to be able to automate workflows
4. Fulfillment: Most of what we have explored has all been the online presence for merchants, however since commerce relates to physical goods being purchased online, there’s an intersection between online intent and physical delivery of goods. Fulfillment will include focus areas such as shipping, inventory management, returns, forecasting demand, and supply chain.
5. Customer experience & returns: What happens after you’ve purchased an item? It’s extremely important to be able to have someone who can talk to you and help with any issues with the shipping and return if you decide you don’t want the item. Building out your own solution is expensive for small businesses that are getting started and don’t have the experience, especially because there’s an element of labor costs with merchants responding to customers’ requests and feedback.
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Now, I want to focus on fulfillment. When we think about how retail has seen an increase in online penetration with merchants sharing content, setting up a storefront, and allowing customers to purchase and pay for a product. What comes next is harder: How do you get this physical product to the customer after purchase?
For the follow-up analysis, here is Part 2: What is e-commerce fulfillment and how is it changing?
These are my personal thoughts and don’t represent my employer’s thoughts.