Ultimate Guide to testing and validating an eCommerce business idea
So you want to start an eCommerce business? Fantastic. We are incredibly bullish on the long-term of eCommerce generally. Step one is to come up with an idea. But not all eCommerce business ideas are created equal. How do you find out if your idea is any good? Read our guide on vetting eCommerce company ideas.
What makes a good eCommerce business?
First, let's cover the fundamentals of the qualities of an attractive eCommerce business. No company is perfect and will have all of these characteristics, but if your idea doesn’t have at least a couple of these characteristics, it might be worth it to pivot. Some of the qualities will be conflicting (e.g., higher AOVs typically mean lower repurchase rates - think of Away luggage the AOV for Away is likely $100+ but how many suitcases do you need? The AOV will be high (great!), but the reorder rate will be low (not so great)). All of these factors will help ensure that the holy grail metric in DTC: CAC / LTV will pencil. What is CAC / LTV? Basically it compares your customer acquisition cost to your customer lifetime value. Many venture backed DTC companies failed because this metric was out of whack. Companies spent too much in paid advertising (high CAC) and weren’t able to generate enough value from the customers they acquired (low LTV).
Qualities of a great eCommerce business:
High margin: Typically successful eCommerce businesses have at least a 66% gross margin. So if your cost to produce / procure a product is $10, you will need to be able to sell the product for 3x the cost ($30). Many categories of products are inherently higher margin (e.g., beauty & cosmetics, supplements etc.)
High AOV: High AOVs (average order values) will let you spend more in paid acquisition while still remaining first order profitable. High average order values can be achieved with single SKUs being sold at high price points or offering multiple lower priced SKUs but bundling them together. This is why so much emphasis is placed on bundles and upsells when optimizing a site's conversion rate. All of these efforts will increase AOV.
High repurchase rate / subscription: Consumable products will lend themselves to higher repurchase rates. A mattress will last for 10 years whereas a deodorant will last for a couple of months. Higher repurchase rates will help to increase your customer’s LTV
Easy to ship (or high value to weight ratio): Beverage is a notoriously tough DTC category because you are essentially shipping mostly water to a customer’s doorstep. Beverage has a low value to weight ratio. This is why successful DTC beverage companies (Liquid IV, LMNT etc.) have changed the form factor and shipped electrolyte packets (stripping out the water) and increasing the value to weight ratio. This doesn’t mean you can’t sell a heavy product, but if you do, it must also have a high AOV
Large category (big TAM): WIth iOS tracking changes it is increasingly difficult to target niche products to target customers. This is why we prefer categories that are broadly appealing. Think of True Classic Tees. Nearly everyone owns a basic t-shirt. The large category allows you to use broad targeting on Facebook and other paid channels effectively.
Few DTC competitors: When Native launched their natural deodorant, there were very few direct-to-consumer competitors. Today, there are hundreds if not thousands. So it might have been a good idea back then to launch a natural deodorant, today it will be much more difficult. You will be competing against these products for paid acquisition. It will be much harder to grow your business if there are already a lot of direct-to-consumer competitors.
Few SKUs: How many products (SKUs) will you need to launch your business? For certain categories like footwear or clothing you will need to launch with many different sizes. This will increase the upfront investment and make it more challenging to scale your business. We think the ideal DTC business can launch with only one or a handful of SKUs.
Key value prop: How is your product different? You should be able to sum up in a single sentence what makes your product different from the competition. Bonus points for products that can visually demonstrate their key value prop as this will make paid ads even more effective. We see too many direct-to-consumer companies hoping that brand will differentiate their product (e.g., the Supreme of category X). We think these entrepreneurs underestimate the difficulty of building a truly strong brand. We think it is much easier to launch with a strong value prop that resonates with consumers and build the brand over time with profits from ongoing sales.
No business will have all of these characteristics, but it will be tough sledding if the company doesn’t at least check a couple of these. Can a business work that meets none of these criteria? Sure. But why make things harder for yourself? Ecommerce is already a difficult industry and if you don’t have the bones of a solid business, it will be even harder.
How do you know what the margins or AOV will be? This will take some research.
How to research potential business ideas?
This is an important step. Time spent researching and validating your idea will save you tons of wasted time down the road working on a bad idea.
Here are a couple of tools to aid your research:
Companies house - This is a UK government website that you can access here where companies of a certain size are required to publish their financial data. It is a gold mine for doing research on your company idea. Thinking of launching a high end paper goods company? Check out Papier’s filings. They had £22M in sales and a 58% gross margin in 2022. It will require some creativity to find a UK brand that is large enough to file public financials with companies house, but it’s worth the time to research.
Public companies data - Unlike 10 years ago, there are now lots of DTC companies that have IPO’d and are now public. Brilliant Earth, Yeti, Warby Parker, and Allbirds are all public companies. Look up their investor presentations and filings (10-Ks & Qs) for a wealth of publicly available information. Don’t have a public DTC company that’s in your category? Don't worry. There are public companies in all categories that you can use for research. Thinking of launching a skincare company? Read L’Oreals public filings. Thinking of launching a jewelry business? Read Tiffany's filings from before they were acquired by LVMH.
Particl - this is a paid product, but we have tested their data against Shopify stores where we know their sales figures and the results are pretty accurate. This will give you an order of magnitude sense of a businesses sales and a directional sense of their best selling products.
Competitive deep dive - Competitive analysis is crucial when testing a new brand, product, or ideal. Go deep on what your competition is doing. No DTC idea is so unique that you wont have direct competition. Consumers today are likely to do a ton of research before making any purchase. Here is what you should be looking for when doing a competitive deep dive:
Understand the competitor's offering: Apart from the physical product, determine the unique selling proposition or angle they use to market it. For example, for a product like a supplement it could be marketing the benefits of increased focus, clearer skin, or less bloating. Or maybe it's focused on the organic certified ingredients.
Identify common customer questions and concerns: Utilize social media platforms like Twitter, Instagram, TikTok, and Facebook to find customer queries, complaints, and concerns. Additionally, observing comments on retargeting ads can provide insights into what potential customers are thinking.
Analyze what resonates with the target audience: Examine the engagement on the competitor's organic social media posts to identify the content that performs best. On the paid side, study their Facebook Ads library, looking for high-performing creatives with different copy variants.
So your idea has some of the characteristics of a good eCommerce business, you’ve done your competitive deep dive, and you think your idea might have legs. What's the next step? Validate your idea.
How to validate an ecommerce business idea?
1) Napkin math: No need to build a full blown financial model. Frankly, that will be a waste of time at this point. But you should put together some napkin math to validate your idea. You should have an estimate for AOV, gross margin, and customer acquisition cost (CAC) for your business. These will be validated later on but having estimates on paper will help you get a rough sense for the basic economics of the business.
2) Feedback from your target market: Pitch a couple of people in your target market your idea. How do they react? If you can’t find anyone in your target market to pitch, that might be a sign that it will be difficult to reach this market. They like the idea but don’t like your proposed price? Great feedback. Maybe you need to revisit pricing. They don’t understand the idea? Great feedback. Maybe you need to refine the pitch.
3) Test launch: The beauty of an eCommerce business is that you can test launch a concept and get feedback from your actual customers. Asking friends and family about your idea is great, but getting feedback from paid marketing is invaluable. Read this breakdown of how Justin Mares validated his idea for Kettle & Fire bone broth. To do this you will need to set up a simple website or landing page and spend $500-1,000 in paid ads. The feedback you get from this will help you refine your napkin math. What was your customer acquisition cost? What was your average order value? Yes, these will change over time, but this test will give you a starting point.
4) Soft launch or pivot: Once you have gone through these steps, you have arrived at a crucial moment - pivot or persevere? Was the feedback from friends and family positive and the data from the test launch amazing? Great! Order a small batch of product and launch for real. Maybe the data wasn’t great, but you can take the learnings and test another idea. Now you will have the data from your first launch to compare to your next test launch.
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