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This $47M "E-Commerce Tax" Goes Unnoticed by Retailers

Nevin Shetty

Nevin Shetty

September 16
  •  
7 minute read
The $47M Hidden E-Commerce Tax That Goes Unnoticed by Retailers

As the CFO of one of the most disruptive and fastest-growing companies in e-commerce, I often have the privilege of meeting with enterprise-level business executives to discuss a particularly vexing issue: the total cost of ownership (TCO) of implementing, maintaining, and scaling e-commerce solutions with software. 

More specifically, our conversations tend to focus on the financial impact of operating rigid e-commerce platforms like Salesforce Commerce Cloud, Oracle ATG, and Shopify Plus, and how the indirect costs of running their software can dramatically exceed the cost of the actual software itself.

When this collective sum is expressed as a percentage of gross merchandise volume (GMV), we call it the hidden “e-commerce tax” for merchants. 

ecommerce-tax-formula

Ryan Bartley, our co-founder at fabric, recently sounded the alarm on the rise of the e-commerce tax. He estimates that total costs could range from 8% to as high as 15% for companies, depending on their GMV. For example, with a business that generates $500 million in GMV, we estimate an e-commerce total cost of ownership of around 9.4% or $47 million (calculations below).

That’s a shocking figure for anyone to digest, let alone a global e-commerce business that generates billions in GMV. With worldwide retail e-commerce sales projected to approach $5 trillion this year and reach $6.4 trillion by 2024, it’s imperative that enterprise businesses complete a TCO analysis to reduce their software-related operating costs before they spiral out of control.

In this post, we’ll examine this problem in-depth and explore strategies for identifying and eliminating e-commerce expenses.

 

The Surging Cost of Doing Business Online

Launching and operating an online business is expensive. Due to increasing competition, rising marketing costs, high shipping fees, and the growing volume of returned items, many businesses have found it “really difficult” to make a profit selling online.

In fact, some prominent retailers have shunned the e-commerce model altogether. Trader Joe’s, for example, has outright refused to sell its products online and, according to Matt Sloan, their VP of marketing, the reason is simple:

Creating an online shopping system for curbside pickup or the infrastructure for delivery, it’s a massive undertaking. It’s something that takes months or years to plan, build, and implement, and it requires tremendous resources.


A quick look at the
profit margins for grocery retailers shows just how difficult it is for companies to compete online today:

grocery-retailers-profit-margins

Generally, the earnings before interest and tax (EBIT) margins for a traditional in-store-only grocery business ranges from 2-4%. By adding only a little bit of e-commerce capability, EBIT margins sink to -15% for home delivery and -5% for click-and-collect models. That’s a significant technological undertaking for little return.

An online grocer must invest heavily in infrastructure, logistics, and fulfillment before profit margins begin to expand and the ability to capture market share increases. However, only mature retailers with automated micro-fulfillment models can turn a profit, and, even then, they need to charge delivery and click-and-collect fees for the economics to make sense.

Making matters more challenging for grocers and other retailers is COVID-19. Since March 2020, the global pandemic has accelerated digital sales growth, forcing many businesses to invest heavily in e-commerce operations just to survive. As a result, technology budgets have ballooned, digital transformation has become a buzzword, hidden costs have surged, and profit margins have deteriorated.

Companies are now scrambling to find solutions as they face intense and mounting competition online. But, unless they change the accounting treatment of technology expenses and vastly improve the efficiency of their e-commerce operations, businesses can expect even more pressure on their profitability moving forward. 

 

Aggregation: The Reason for Hidden E-Commerce Expenses

Back in the day, companies ignored the total costs of owning and running technologies because their financial impacts were negligible. Even though there were many parameters that affected the cost of ownership, items with similar characteristics were aggregated together for the sake of simplifying the presentation and disclosure of these expenses.

A 2010 whitepaper by Dell was one of the first to provide initial insights into the disaggregated costs of data center systems, one of the main costs of running on-prem e-commerce software from IBM, Oracle, and SAP at the time. Even then, the study only focused on capital expenditures (CAPEX) and ignored operating expenses (OPEX).

Today, aggregated accounting systems have become painfully obsolete. Not only do they fail to capture the fully landed costs of running today’s e-commerce software, but they also aggregate expenditures neatly into “cost buckets” that don’t provide any details on the ancillary products, services, and people that are critical to an e-commerce operation. 

For example, software development expenses often omit personnel charges for engineers, architects, and other roles. Without this degree of transparency, it becomes abundantly clear why companies are now getting blindsided by the rise of the e-commerce tax. In fact, a 2019 survey by Blackline found that only 38% of finance professionals trust the accuracy of their financial data, and 70% think they’ve made a significant business decision based on incorrect financial data.

Businesses suffer as IASB drags their feet

Accounting professionals agree: the aggregating of expenses into “cost buckets” won’t fly anymore. It obscures relevant information and reduces the understandability of the information disclosed. This is why the disaggregation and presentation of different types of expense items have become such a hot topic in accounting circles. It’s also why the International Accounting Standards Board (IASB) recently proposed changes to the way these items should be reported. 

Once the new International Financial Reporting Standards (IFRS) changes are finalized, a single dissimilar characteristic will be enough to disaggregate expenses if that information is considered material. For example, a product information manager (PIM) will not be grouped with an order management system (OMS) as one expense under the e-commerce software category.

But there’s a problem: as of this writing, none of these changes have been approved yet. There has been no set date for the launch of the new standard, and even when it gets finalized, entities would be given at least 18-24 months to prepare for the transition. In the meantime, many e-commerce companies that are drowning in expenses have been left on their own. Only a few are using this time as an opportunity to analyze costs and direct inefficiencies with a modern software architecture for e-commerce.

 

Reducing the E-Commerce Tax with Modern Architecture

Moving from monoliths to modules

Traditional monolithic e-commerce platforms like Salesforce Commerce Cloud (SFCC) and Shopify Plus are built as single, indivisible units, which aggregate features and their associated costs. On the other hand, modular e-commerce platforms like fabric divide backend components into individual e-commerce modules that let companies disaggregate expenses effortlessly. 

Monolithic e-commerce solutions also require many extra services and people, some of which include web servers, payment processors, system integrators, consultants, and software developers. Many of these fees and expenses are difficult to estimate, and there are additional costs you won’t find on standard income statements or balance sheets.

To illustrate this point, below is a hypothetical TCO comparison between two businesses that generate $500 million of GMV. On the left, you have a typical enterprise company that uses SFCC with Manhattan OMS. On the right, you have an enterprise company that uses fabric:

tco-comparison

As you can see, running legacy monolithic platforms carries high costs. Comparatively, a modern e-commerce platform reduces expenses across the board, from the software itself to the reduction of headcount due to platform productivity. By segregating out just a few of the key line items, we estimate that a company transacting approximately $500M in GMV will save 60% or $28M in operating expenses.

Using modules while decreasing vendor management

With monolithic e-commerce platforms, cost attribution complexity arises from aggregated features, as well as from multiple vendors. Often, these vendors are introduced in the form of add-ons from places like the Shopify App Store and Salesforce AppExchange.

Legitimate add-ons cost money, which is fine, but defeat the “all-in-one” benefit of the monolithic platform. Furthermore, they lead to “patchy” e-commerce systems, result in technical debt, and become aggregated into platform costs.

Using distinct commerce modules and associated APIs from third-party vendors solves these issues but not the vendor management piece. And this is where fabric comes in. Instead of using a different vendor for PIM, OMS, pricing, checkout, loyalty, and other commerce functionality, fabric provides it all. It also connects with other software—search, recommendations, reviews—without relying on questionable apps.

 

The Time to Cut Costs is Now

Most executives are unaware that the cost of managing e-commerce operations ultimately results in both a financial and operational tax on their organizations. And with much-needed IFRS accounting changes still over two years away, we expect hidden costs to continue to decimate the profitability of many online merchants unless action is taken today. 

Take action with these steps

To start, choose one of the aggregated features/costs in your existing platform that you believe is overpriced, underused, or inefficient. Then, find a module to replace the feature. For instance, if an outdated PIM or OMS feature is targeted, you’ll need to find a PIM module or OMS module. Speak with the provider of the module and perform a cost/feature analysis.

After this, consult with your engineering team about sunsetting this feature with the strangler fig pattern while using a service mesh to keep existing operations steady. We show you how to do that with SFCC here.

Consider partnering with fabric 

With trillions of dollars in commerce shifting online, fabric is helping mid-size and enterprise B2B, B2C, and D2C brands deliver exceptional e-commerce experiences at scale with the first comprehensive collection of cloud-native commerce modules and APIs for reducing TCO, vendor management, and technical debt.

If you want to learn more about how fabric can help your business lower its e-commerce tax and increase its profitability, all while giving you the tools you need to scale your business, we’d love to speak with you.


Nevin Shetty

Nevin Shetty

CFO @ fabric. Previously @ Coltrane Asset Management, L.P., and CEO @ Blueprint Registry, Inc.

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