Post for Ebusiness Blog - Saurabh Jain (12DM-180)

Dear Sir,

Please find my entry to the E-business Blog:

HOW MUCH SHOULD YOU SPEND ON E-COMMERCE?

Just what is a REASONABLE price to pay?

The answer to this question really depends an awful lot on your own unique circumstances. The thing to remember when choosing the proper e-commerce solution is this...

COST IS NOT THE ISSUE - THE RETURN ON INVESTMENT IS

Think about it this way: What if I told you that an enterprise-level e-commerce package was going to cost you $500,000. Your initial reaction might be "Wow, $500,000 eh? That's a whole lot of money!" But what if that $500,000 investment could generate $2,000,000 in additional gross margin each year and save you another $1,000,000 in operating costs, then would the $500,000 investment still be A LOT? The answer of course is no.

Positive Cash Flow: $2,000,000 + $1,000,000 - $500,000 = $2,500,000

The point is simple: you've got to figure out how much money an e-commerce solution will make you before you draw a conclusion of whether the cost is too much. So how do you do that?

Here is a simple process for determining the Return on Investment (or ROI) of an e-commerce storefront. First, you've got to know how much profit you make on each sale. For instance, if you buy whatever it is you sell for $50 and you sell it for $80, your gross margin is $30. That's easy enough. Now take that calculation up a level and do the same thing for all of your products together. Hint: start with the Income Statement. One of your bean counters on staff can definitely help you get accurate enough numbers 

CALCULATING ROI: An Example

Here's a simple example to illustrate. Let's say ABC Company sold 200,000 widgets last year for $100 each. The cost for each one of these widgets was $40. Therefore, you would take 200,000 widgets x ($100 - $40) and get a total gross margin for ABC Company of $12,000,000 for all of last year.

Step Two is to figure out how much you can save by streamlining the order taking process and eliminating any wasted effort. To determine your cost savings, you have to figure out how much each one of these order entry resources costs the company. To do this, take their combined salaries, add in things like vacation pay, payroll taxes, benefits, etc, or simply multiply their gross salaries by about 150% to account for that other good stuff.

Let's say, for instance, that you have five branch offices, and in each office you have four people whose job it is to take customer orders and/or apply payments. You pay these resources, on average, about $30,000 per year. To get the total cost of order taking, you need to multiple $30,000 x 150% for overhead x 5 offices x 4 people per office. In this example, the calculation amounts to $900,000.

Step 3 is to plug all these great numbers into the table below to figure out your profit from e-commerce.

Here are the three steps again:

1. Figure out your gross margin from sales
2. Calculate the total personnel costs from your order taking process
3. Work out the breakeven amount that you can spend on an e-commerce solution.

Increased Profits from Revenue
Total Revenue last year	$20,000,000
Subtract: Cost of Goods Sold	$8,000,000
Gross Profit	$12,000,000
Multiply by Expected Increase In Revenue From E-Commerce (keep it conservative, Cowboy!)	5%
Expected Increase In Profits From Revenue (1)		$600,000
Increased Profits from Cost Savings
Total Order Processing Costs	$900,000
Multiply by the percentage of customers who will convert to a self-service environment (rule of thumb is 30% in first two years	30%
Expected Increase In Profits From Cost Savings (2)		$270,000
Total Increase In Profits from E-Commerce
Add: (1) + (2)		$870,000

There. That's your breakeven figure! In this case, ABC Company could spend up to $870,000 on an e-commerce solution and still break even the first year. Then, in Year 2, 3, 4…100, this amount becomes pure profit. Imagine that!

Once you have this information, you can figure out what you will make over the next five years, like this:

Increase in sales ($000)	Yr 1	Yr 2	Yr 3	Yr 4	Yr 5	5 Yr Total
% Increase in Sales	5%	7%	9%	11%	13%
Increased Profits from Sales	$600	$840	$1,080	$1,320	$1,560	$5,400
Increased Profits from Savings	$270	$270	$270	$270	$270	$1,350
Initial Cost of Solution	($250)	-	-	-	-	($250)
Annual Software Maintenance	($30)	($30)	($30)	($30)	($30)	($150)
Net Profit	$590	$1,080	$1,320	$1,560	$1,800	$6,350

Now, did you get that? That's over $6,000,000 in pure positive cash flow over the next five years for an investment that paid for itself in Year 1.

Regards,

Saurabh Jain

12DM-180