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.
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
