My 2 bits about the Bitcoin phenomenon

There is a lot of discussion about the BitCoin, the digital currency which is to be issued in finite quantity (21 MM Bitcoins in the next few years). The BitCoin has seen a sudden rise (and then a significant reversal) in its value over the past 2 months.

People who try to justify the value of the BitCoin point to its advantages:
1) Frictionless medium of commerce, devoid of banking interchange fees
2) Ability to conduct commerce across borders and circumvent local governmental/regulatory money restrictions

This logic holds good if the BitCoin holds its value over time or has a mildly increasing value over time (as was the case from its inception till early April 2013). Merchants who held the currency had the added advantage of BitCoin appreciation in addition to the 2 points above.

But the last few days (the decline from $266 to $120 per BitCoin) shows the risk of this 'asset' for merchants. Imagine a merchant that sold a widget worth $266 for a Bitcoin at the peak of its value. If the merchant held on to the BitCoin and exchanged it for dollars today, he would have to take a loss of more than 50%!

Clearly the lack of stability is a bigger negative than the 2 points noted above (unless you are a merchant in a country where you are willing to take the risk of getting an X% lower payment in an international currency than your local currency).

Thus I feel the usage of the BitCoin for international commerce will diminish.

Some of the latecomers to the party don't seem to fully comprehend the economics of this 'asset'. They think that the finite liquidity of the BitCoin, along with the divisibility of the BitCoin (upto 0.00000001 Bitcoins) make this a viable 'asset' class and medium of exchange (along with points 1 and 2 noted above).

I think the whole BitCoin phenomenon is similar to the Dutch Black Tulip bubble in the 17th century.

Companies that solve complex problems are issued BitCoins (similar to lucky or meticulous Dutch farmers who produced a single deviant tulip). This process is called 'mining'. These 'miners' are the only group of people on the planet who are given economic benefits by a herd of cheering 'investors', for doing an activity that adds no economic value to humankind (solving meaningless math problems).

I think this is going to end badly unless the Central bankers/ Governments caution investors against the perils of this digital tulip.

Sign-up discounts: Bad strategy for eCommerce firms

A lot of eCommerce players in the Indian eCommerce industry offer  up to 25% discount coupons on sign-up which give discounts up to Rs. 2000 (~$35). These include Jabong, Myntra, and fashionara, among others.

The logic that these players might be using for this strategy may be:
1) The discount coupons allow them to acquire new customers, that may remain loyal after the initial discounts are over.
2) They operate mainly in the apparel category where regular gross margins are 30-40% to begin with. So a 25% discount would not lead to a negative gross margin on each sale.

I think this is not a good long-term strategy because:
1) Based on chatting with a few young friends, I feel that most have figured out that they can use multiple email addresses to get multiple coupons. They don't use the same email address to purchase after the discount coupons are exhausted. This also leads to a problem of customer duplicates in the database of the eCommerce retailer.

2) A 25% discount on an item which had an initial gross margin of 35% may not sound like unprofitable business. However that calculation ignores the free shipping given to the customer and the cost-per-action commissions (up to 10% of the sale!) given by the website. This implies that the items purchased by these 'acquired customers' are often being sold at a negative margin. The terms of the discount coupons (e.g., 'Cannot be combined with other offers') mean that most signups occur for fully-priced merchandise during the regular season. This is clearly a double whammy.

3) Most of these online apparel retailers are getting into accessory businesses. The discount coupons are often valid on accessories. This converts what should be a regular, high-margin, attachment business into a money loser.

4) I imagine there would be a significant sales backlash when the sign-up discounts are eventually withdrawn.

My advice: The industry needs to move from rewarding customer sign-up to rewarding long-term customer loyalty.

Retail discounts and the illusion of success

I came across a blog post for a retail software product (which I will not name here), which said the following: "We have achieved great success with our product implementation at a European online auto parts retailer. Our product was able to deliver a 15% sales lift with an effective discounting of only 2.17%..."

I thought that sounded very good.

But then I indulged myself in a thought experiment: 'What sales lift does a retailer need to breakeven on an initiative which discounts the price by 2.17% below the regular price?'. Stop for a moment and answer that question within 5 seconds without pen and paper....

Now let's look at the math behind a 'successful' promotion

If you are an online retailer with gross margins of 20%, average CPA commission of 1% and net shipping costs (shipping costs less shipping charges to customers) of 6% of revenue, then your 'effective' margin is 13% of revenue.

To breakeven on a 2.17% discount, you would require a sales lift of 20% (!!!).

Here is a What-if scenario table which calculates breakeven sales lift for various levels of effective margin and discount:

Said in another way, to breakeven on a 2.17% discount with a sales lift of 15%, the European retailer would need an 'effective' margin of 16.7%. With 1% average CPA commissions and 6% net shipping costs, they would need a gross margin higher than 23.7%.

I doubt whether the European retailer broke even on the discount, because my thought experiment doesn't even include the cost of the software (which claimed 'great success').

The thought experiment is an eye-opener for eCommerce and retail companies who are willing to spend a lot on discount programs. Remember that even a harmless looking 5% discount requires a sales lift of 63% if your 'effective' margin is 13% (refer to the table above).

So that set off another thought in my mind: "What long-term strategic reasons would merit making an apparent loss on a discount program?"

Here's what I think are potentially valid strategic reasons for any retailer:

1) It is a short life-cycle/ shelf-life product (clothes, shoes, books, mobile phones, cameras, laptops, perishables) which is approaching the end of its season/life-cycle/ shelf life. As a retailer you are taking a strategic call that the cost and the risk of carrying inventory beyond the end of the season/life-cycle/ shelf life would be too high. However it is critical to distinguish long life-cycle products in short-life cycle categories (e.g., plain blue jeans, basic dress shoes, text books, reference books, etc) and ensure that you are not discounting those as much as the short-life cycle products.


2) Competition is discounting the same product heavily and you assess that you will not be able to sell the product at a 'regular price' later. This reason may often play along with reason 1. However it makes sense to use price comparison frequently (at least daily) to ensure that you are not pricing well below competition.

3) By discounting the product and taking a short-term loss, you estimate that you will be able to acquire new customers who will be loyal beyond the short-term. Many eCommerce companies seem to be thinking this way. My good wishes for pulling this strategy off :-)

Would love to hear your thoughts. If you need a copy of the spreadsheet behind the breakeven table (which has a more detailed working based on gross margin, CPA commissions, and shipping costs), please email me at raj AT knowledgefoundry.net

JC Penney's pricing experiments (continued)

I had written about JC Penney's failed experiments with reducing discount sales a few weeks ago (click here). I had made 4 points:
1) Everyday Low Price needs to be tested before being implemented
2) Need to continue store-in-store concept
3) Need good exclusive designers
4) Website needs major overhaul

I heard that they are getting discount sales back in the store (click here). They are also showing price comparisons for comparable products and maximum suggested retail price for each product.

While I think this is a good move, it will take significant effort to turn-around JC Penney. They will have to convince shoppers who have struck JC Penney off their shopping list to visit the store again...and that's not an easy task.