Got this cool email from a longtime client and friend about valuing your ecommerce business and he said I could blog it!
I have another client who is actively buying ongoing ecommerce concerns with cashflows of anywhere from $100K a year to $2MM. If y'all are looking to cash out, drop me an email.
Finally got around to pre-ordering my copy of your book today--trying not to hold my breath until it arrives. I wrote the info below on e-commerce business valuation and thought you might find it interesting. I think this is a subject of great importance to many of your customers. --- Chris, CyberAuto.com
The valuation of e-commerce businesses has been the subject of extensive research and discussion. My opinion, presented here, is that the valuation of an Internet-based business, once ridiculously high, is now unreasonably low. While the peculiarities of Internet trade need to be taken into consideration, an e-commerce business can be valuated much as any other type of business.
A website is so much more than a group of files hosted on a server. Were it just that, its valuation would simply be the cost, in terms of labor and software, to replicate the site with a slightly different domain name.
No, as a minimum, an individual website’s value can be measured in terms of the traffic it is capable of capturing at any given moment. While a website may be duplicated, at the point of it’s duplication it is of absolutely no value. Until that website is able to attract customers and generate revenue, it is worthless in terms of valuation.
The newly duplicated site can be worth some amount of value with pay-per-click advertising. At this point, however, its value as a revenue generating device is reduced by the cost of paying to bring the customers to the site. The unfortunate truth of pay-per-click advertising is there only has to be a single advertiser willing to pay more than the sale of a product is worth to make competing sites of no value.
Because of the simplicity of e-commerce shopping, one vendor who simultaneously increases their bid on pay-per-click advertising and reduces the cost of their product will effectively eliminate all competition—differences in brand, quality, and customer service notwithstanding.
Therefore, the only way that a website can have any value is to rank well in the results that search engines provide at no cost to the vendor. This is the true measure of the worth of a website. This includes websites that have no e-commerce, as they have at least as much value as competitive websites are paying to attract customers to their products.
Indeed, this is the foundation of content websites, which offer nothing for sale but succeed financially by attracting customers and then directing them to e-commerce websites who pay for this service.
True, if a website is built from scratch and effective in its design, it will eventually be able to obtain placement in search engine results. But at what cost in terms of time? Currently, many large search engines’ algorithms do not even choose to rank a website for as much as 6 months after it is found, since the longevity of a site is a measurable part of the relevance algorithm.
Even then, since the algorithm includes scores for links to the site from other sites, it can take years to see a significant improvement in a site’s placement. Search engines are very perceptive at attempts to falsify the relevance rating (called “spamming”), and punish the offending site quite harshly.
And yet, while I have asserted that a website has at least the value that other e-commerce sites are willing to pay to attract the same customers, this is not an easy thing to calculate. No tool exists to identify the keyword phrases that visitors have used to find the site on every search engine and provide the cost being bid for pay-per-click advertising on each of those keyword phrases.
It can be easily calculated manually for a handful of keyword phrases, but to do this exhaustively would be impossible. The search engine rankings and pay-per-click bids change frequently enough that any data that was obtained would be obsolete by the time it was completed.
While another method would be desirable, we find ourselves gravitating back to revenue generation and profit as a baseline for website valuation. However, if the logic that lead us to this point has held—that websites cannot simply be duplicated, and that the true value of a website is in the traffic that it generates for keywords that bring buyers—then this is a fair method of valuation.
For some reason, we have allowed ourselves to be convinced that while a brick-and-mortar business can be valuated based on revenue and profit, an e-commerce business cannot. This is in due in part, no doubt, to the outrageous valuations placed on e-commerce businesses during the initial boom period of Internet.commerce After so many of these businesses tanked, taking with them unprecedented amounts of investor funds, public sentiment swung dramatically in the opposite direction, placing valuations where they are today.
In truth, these businesses failed for the same reason that many businesses fail—because of a broken business plan. The failure was simply magnified by the outrageous amounts of cash thrown at the business, cash that allowed the seed of a miserable business plan to germinate into the weed of a miserable business, and then to live far longer than was possible of a brick-and-mortar business because it was tagged as an “Internet Business”.
E-commerce businesses today succeed or fail based on the business principles upon which they are founded and the way they are led. Just as there is nothing magic about conducting business on the Internet to justify the obscene valuations of the late 90’s, there is nothing boding doom to justify the poor valuations today.
In conclusion, an e-commerce business should be valuated based on the exact same fundamentals as any other business. Proper consideration should be given to both the strengths and weaknesses particular to e-commerce business, but these won’t normally dramatically affect the final valuation. - CM
Thanks, Chris! -- Rob
Rob,
I love this post on valuation. I could nerd out on different valuation techniques for days.
I'd like to add that one common sense element a traffic-centric valuation method misses is the value of existing customers.
"They" say it is 8-10 more expensive to acquire a new customer than to sell to an existing one. So, aside from the fact that an existing site (if it's smart enough to listen to you) has gained top rankings, it also has an incredible asset in its existing customers. With all the hoopla over search and it's efficacy, that basic premise seems to be lost. It may be why some people feel compelled to focus only on your ability to get people to your site as the basis of valuing your business.
To get people past that way of thinking, focus on growing & retaining your existing customers. You can then make a compelling argument for more traditional valuation methods.
Customers are what matters, not traffic, per se.
Ron
Posted by: Ron Pereira | Saturday, April 08, 2006 at 05:03 PM