Malls and department stores are shutting down. Commercial property research firm Green Street Advisors found that at least 50% of all department stores that rely on malls for traffic will close by the end of 2021.
Most mall-based traditional retailers will go down with them, unless they learn to fill the gap these venues used to occupy in consumers’ minds as a place to hang out with friends and family, or a venue to browse new products.
The way retailers can take up the space department stores leave is to become the malls themselves. Digital marketplaces are simply retailer-owned digital malls, with the retailer’s own brand, products, and offerings as the centrepiece. They allow retailers to serve as the landlord for their customer’s attention, instead of as a renter in a mall’s physical location.
Thankfully, retailers are no longer locked in to serving a single geographical community. With their own piece of digital real estate they can serve a global customer base. They have full ownership over the customer experience, from acquisition to retention. In fact, they can collaborate and “lease out” their endless aisle space to hand-picked brands with whom they want to work.
This article walks retail leaders who are interested in the concept of launching a digital mall through the pros and cons of launching a vertically integrated ecommerce marketplace. We quantify the hidden costs and benefits of launching and scaling a marketplace -- financials which most retail companies don’t discuss publicly. Finally, we go into detail on when a retailer can expect a return on their marketplace investment (and how much that could be).
Retailer business model assumptions
Throughout this article we’ll use a composite organization’s metrics to model the cost benefit analysis of a retail marketplace, beginning with the revenue performa below.
In our revenue calculation, we assume:
- An average revenue per vendor. We assumed $50,000 for our composite retailer, however readers can substitute this value with the data they have.
- A 10% discount rate. This rate allows us to put a present cash value on the future benefits we project a marketplace will have. The reader should determine the rate that is most appropriate for their industry.
- A blended average margin. We used 35% as a conservative margin for our composite retailer. Readers can deduct 10% - 15% from their keystone or wholesale margins and use that for their blended margin calculations.
Revenue & inventory savings: Quantifying the benefits of a retail marketplace
Retailers can use these variations of the 3 assumptions above to test out different business models for their digital marketplace.
For example, if a retailer would like to run an online outlet marketplace to liquidate inventory, then they might have more vendors at a lower blended margin, but still retain a higher revenue per vendor than their main retail site.
Understanding the business model that works for the marketplace initiative is important because how the retailer chooses to operate the marketplace dictates the financial metrics it needs to achieve to justify the cost of a launch.
For a traditional retail marketplace where the vendors set the price, revenue comes from the commission the retailer makes from the sale. Therefore, revenue does not come from the projected gross market value (GMV) but from the sales margin.
On the other hand, for a dropship retail marketplace, the retailer sets the price of the SKU and profits directly from the sale. Thus, a dropship marketplace retailer’s revenue comes from GMV, not the margin.
These caveats and assumptions aside, vendor count is the primary driver of marketplace revenue projections. Multiplying the marketplace vendor count by the average revenue per vendor yields the projected revenue for the marketplace. Retailers that work to increase the vendor count year over year directly drive ever-increasing revenue for the marketplace.
Marketplaces also scale exponentially. Our composite retailer launches its marketplace with 35 vendors with the full intention of scaling that up to double or triple the number of vendors each year. Starting with a small, manageable vendor cohort allows them to meet their implementation timelines and build vendor enablement systems they can use to scale dramatically later on.
The unquantified benefits of a marketplace
In addition to the revenue projections above, digital retail leaders should take into consideration a number of hidden, specific benefits that a marketplace strategy could produce for their organization.
Research from Forrester shows that retailers looking to add a digital marketplace as a distribution channel can expect increases in customer lifetime value (LTV). Having an accessible piece of digital real estate allows retailers to serve their customers wherever they are, 24/7.
The research firm also found that digital marketplaces increased a retailer’s average order value (AOV) by 15% on average. An online marketplace also frees retailers from the constraints of floor space. They can have as many products from as many vendors available for sale as they want, priced exactly the way the retailer wants. This increases the chance a customer adds more complementary or related items to their cart.
Retailers also saw an uptick in foot traffic and sales in their physical stores after launching their online marketplace. This was due to customers visiting stores to return or pick up their orders. Customer sales data from the digital site that also serves to inform in-store merchandising decisions and maximize the additional foot traffic the digital site generates.
Finally, retailers can reasonably expect to capture additional revenue that was previously lost due to stockouts. This is especially true if the retailer is pursuing a dropship order fulfillment strategy in conjunction with a marketplace launch. Retailers reap the benefits of just-in-time ordering and the additional savings they can incur by not purchasing inventory.
For example, in the benefit calculation below, the retailer takes the projected revenue we derived from the revenue calculation, multiplied by an arbitrary cash value that represents the non-inventoried SKUs. This gives them an implicit value they save with or without owning inventory based on the value of all the SKUs on their site.
Software & staffing: Quantifying the costs of a retail marketplace
Whether the retailer chooses to build or buy, the top two costs of launching a retail marketplace is the software used to power the marketplace and the staffing required to run the marketplace.
Most marketplace software companies either charge a fixed cost, take a percentage of the marketplace GMV, or a blend of both, also known as a cost-plus model. Some companies also offer professional services to implement the strategy. These services could be baked into the initial fee or are an optional, add-on service.
For example, one of the biggest SaaS companies on the market, charges at least $350,000 for the use of its software, plus a 1.5% fee off of GMV.
Research found that most organizations who pursue a marketplace strategy tend to hire over a dozen people over the course of the 3 years as the marketplace chases profitability. Getting the marketplace up and running alone takes a dedicated team about 6 months. Retailers who use older technology might take even longer.
Because the success of a marketplace hinges on vendor sourcing and onboarding, merchandising teams need to staff up to keep up with the work required to price products, onboard vendors, and merchandise SKUs. More employees are required to fulfill orders, process returns, and update inventory to keep up with the increased demand of a new distribution channel.
This said, if a retailer pursues an automated dropship supply chain strategy along with a marketplace distribution channel, then staffing -- the biggest cost of a marketplace initiative -- could be significantly diminished. In this model, the retailer sends orders directly to vendors for them to fulfill. Although this might result in lower margins, this also removes the requirement of hiring a bigger team. A retailer should take these two approaches into account when doing their marketplace cost-benefit analysis to see which one works best for them.
“What is the ROI of a retail marketplace?”
This is a tough question to answer. According to Forrester, the risk-adjusted ROI of retail marketplaces is at 162% with a 3-month payback period. At the same time, industry average enterprise software implementations do not experience any positive ROI until Year 3.
From our experience launching marketplaces, when done right, marketplace losses in Years 1-2 result in category leadership in Years 3-5 for the patient retailer who takes the long view.
Similar to the brick-and-mortar wholesale model, a marketplace needs to achieve scale in terms of SKUs and demand first, in order to negotiate terms with vendors. Particularly with low-priced products, the initial unit economics of marketplaces do not work until the retailer has that leverage to eke out profit margins.
ROI takes time also because marketplace retailers need to test and learn how to onboard 3rd party vendors and their SKUs on their marketplace platform. Demand is built when retailers layer complementary SKUs to increase average order value (AOV). More vendors lead to more SKUs, which lead to a wider assortment that attracts more customers.
Each incremental brand, vendor, or partner that a retailer onboards to their marketplace brings a portion of their pre-existing customer base with them. Because of this, it’s imperative to take the first 2 years to thoughtfully onboard and build warm relationships with as many sellers as possible. This kickstarts a seller flywheel effect by generating seller word of mouth amongst their network and marketplace demand through the seller’s existing customer base, and leads to positive ROI by Year 3.
Marketplaces help retail businesses build resilience & flexibility
In addition to capturing tangible upside, we believe launching a digital marketplace initiative gives retailers valuable data they can use to predict the future of their industry. If a retailer can avoid unsold inventory or understand the supply and demand equilibrium of a given product or vendor, then that gives their business a higher chance of survival.
As traditional malls and department stores lose relevance, a gold rush-like opportunity in retail appears on the horizon. Classic retailers with existing brand recognition have the unique opportunity to establish themselves as the next generation of malls where consumers can spend their leisure time and dollars. But because of the 3-year ramp up period required to achieve marketplace category leadership, retailers who want to be at the forefront of this retail land grab need to get executive buy in and kickstart their marketplace initiative now.
As an integration software that facilitates relationships between a retailer’s ecommerce systems and its vendors’, Convictional helps brick-and-mortar retailers launch digital marketplace initiatives without replatforming. We help retailers launch marketplaces to grow their revenue, product assortment, and vendor partnerships without needing to hire more people. Subscribe to our email newsletter below to get more in-depth articles like this.