September 23, 2020

The Profitability Death Spiral for Ecommerce, Explained

By John LeBaron / Grow Your Sales, Price Erosion

Revenue at all costs. It’s what many ecommerce brand leaders eat, sleep, and breathe when they’re attempting to grow their business. Historically, it was the strategy by which brands gauged their success. In today’s world of omnichannel ecommerce, however, “revenue at all cost” is what will eventually stop your brand’s growth dead in its tracks.

A revenue-first approach can be great for short-term revenue gains. What it’s not so good for is your long-term profitability. In fact, focusing on revenue first is the biggest mistake that sales leaders make when they’re trying to grow their ecommerce business. A revenue-first approach can lead to unauthorized sellers seizing control of your brand and left unchecked, it can send your brand careening headfirst into the Profitability Death Spiral.

The Profitability Death Spiral for Ecommerce | Pattern

The Profitability Death Spiral

The Profitability Death Spiral, as its name suggests, is where online brand growth and revenue go to die. Okay, so maybe it isn’t so dramatic, but when your business gets caught in it, this spiral can eat up your profits and set your fledgling ecommerce brand back just as you’re ready to spring forward. That’s why it’s important to be aware of what will put you there.

There are three steps that lead your brand straight into the Profitability Death Spiral: 1. Wide distribution 2. Price erosion from online retailers 3. Profit erosion across all channels

Wide distribution

You might think that wide distribution is a good thing for your brand, and historically, that may have been the case. Brands used to be heavily incentivized to have as many points of distribution as they could to maximize their revenue, and wide distribution gave them healthy margins, strong brick-and-mortar sales, and fast growing ecommerce sales.

Not anymore.

With the rise in popularity of mobile shopping, the retail landscape has changed dramatically, and while wide distribution in the past meant more revenue, wide distribution today means more competition and less control over your brand.

When your product is being carried by too many distributors, online sellers will break the rules to be able to compete and it becomes much easier for unauthorized third-party sellers to distribute your product on sites like Amazon undetected. Once you’ve distributed your product widely, you’ve opened the door widely for bad players. Then comes the next step of the death spiral: price erosion by online retailers.

Price erosion by online retailers

Selling online is similar to driving on a freeway: when other sellers follow the rules, everything flows smoothly. When someone breaks the rules to get ahead, it can cause a chain reaction that negatively impacts every lane of your business. The tricky thing is that Amazon offers plenty of incentives for rule-breaking, and when you have too many distributors, rule-breaking is easy.

Because sellers on Amazon are encouraged to list products at the lowest prices possible and rewarded for doing so with special placement on the site (which drives even more sales), rogue, arbitrage sellers will drop their prices to make the sale. Other distributors are then forced to price-match to compete.

Once the price drop domino has been toppled, it can lead to a price war with sellers dropping their prices back and forth until they have zero margin left and the price of your product has been eroded. That leads your brand right into step three of the death spiral.

Price erosion across all channels

What happens online doesn’t stay online in the world of ecommerce. Price erosion negatively affects your brick-and-mortar partners, too. Because customers are constantly looking for the best deal, they’ll forgo shopping in a store for a product if they can find it cheaper on Amazon. Brick-and-mortar stores are then forced to price match as well and erode their own margins.

Erosion is especially bad news when it happens to brick-and-mortar stores because 85% of retail sales are going through brick-and-mortar in the U.S. Sellers forced to price match will bill you for the differences in the form of reduced wholesale costs, accruals, and other concessions to compensate for their losses. This not only hurts your profits, but your business relationships, which ultimately harms long-term profitability.

Once all of your other distribution partners have lowered their prices to compete, Amazon will inevitably lower their prices. This cycle will repeat itself over and over again until eventually Amazon stops sending you POs because your products Can’t Realize a Profit (or CRaP out).

This is the Profitability Death Spiral, and if you don’t do what you can to escape it, you’ll see your revenue and profits continue to plummet until it’s game over.

How to stop your profits from spiraling

The good news about the death spiral is there is a strategic solution to prevent it. We like to call it the Profitability Flywheel. In our work with nearly 100 different consumer brands across myriad marketplaces, countries, and selling categories, we’ve found that focusing on three things is key to creating a Profitability Flywheel that gets you out of a Profitability Death Spiral.

1. Selective distribution 2. Stabilize pricing 3. Seller expertise

Download our eBook here to learn more about the profitability flywheel.

Here at Pattern, we have the data and expertise to help companies regain control of their brand online. Our unique approach to ecommerce with the aid of our specialized Predict software helps brands assess where their weak spots are, create a strategy for success, and focus on profitable growth, not just revenue, so they can find sustainable expansion across ecommerce channels.

For a free, comprehensive analysis of your brand across ecommerce that can help your profitability grow, reach out at hello@pattern.com, visit pattern.com, or call us at 888-881-7576.

More Resources
The Great Debate: Is Revenue More Important Than Profit?