Failed Startup's Final Income Statements Reveal Grave Error

http://www.businessinsider.com/jody-sherman-ecomom-and-a-grave-financial-error-2013-4

by xadxad • 13 years ago

221 151 13 years ago

msandford• 13 years ago

If all that's true, it's simply breathtaking.

It boggles the mind that the investors, or even employees, let the margins get that ugly. When you're discounting your products/sales by $750K a month and accepting that loss, how is no one else missing that? Even if you don't see the actual income statement, you'd have to realize that you're selling all of your inventory at a discount. Not just some loss-leaders, but everything. How did no one call that out earlier?

The whole Ecomom story is tragic, and the lost life is the worst part of the whole story. Yet, I can't help but think that if someone else had been more forcefully stood up to Mr. Sherman's business model, the situation could have improved before it turned tragic.

VLM3• 13 years ago

I had to LOL at the line from the post mortem:

"No Balance Sheet or Statement of Cash flows had ever been prepared"

I've not been involved in the finance side of a startup, can you really raise millions without any documentation at all? I mean, yeah, we all heard about the dotcom boom but that's all in the past, right? Or is it?

at-fates-hands• 13 years ago

I had the same reaction.

I've been on both sides of the start-up game. I worked at some and I've also invested in some. The first thing, without exception, investors want to see is a fairly comprehensive business plan.

I'm still wondering how this guy received millions of dollars with such a flawed business plan. Either the BP was completely bogus and he managed to hoodwink a lot of people for a few years, or several people just completely missed the boat.

Either way, it's jaw dropping what happened.

rdouble4• 13 years ago

can you really raise millions without any documentation at all?

Yes, of course. Do you think Instagram had a "balance sheet" when they went to raise money? Replace Instagram with any other popular startup.

6cxs2hd6• 13 years ago

Very early on, someone experienced told me they always start with the Cash Flow statement. Of the statements, that's the least-bullshit one of the three. Look at Cash Flow, and look at the "Current" subtotals of the Balance Sheet. Look at these longer and more carefully than the P&L.

Technically you should understand how all three fit together; each alone could be misleading in its own way. But for many businesses the cash perspective is the closest to reality. If you only have time to understand one, deeply, that's the one.

I suspect most people look mostly at the P&L a.k.a. Income Statement. But that uses a lot of constructs (like "accruing" things over time) in a well-intentioned effort to tell a more-accurate story about the business. The problem is if you treat it as "hard numbers". Actually it's just one story about the business, a useful fiction with some truthiness value.

nostromo2• 13 years ago

These snafus compared to the dot com bubble are orders of magnitude smaller.

I remember when PayPal gave $10 to you just for signing up. (People of course signed up many times and got many bonuses. People howled about how they would never build a business if they had to buy customers.) I remember when Yahoo bought the domain Broadcast.com (and a few assets, but not really) for billions (with a b!) of dollars. I remember when Pets.com spent $10 million on advertising to get $500k in sales (not even net, sales). I remember when Amazon.com paid workers in a Seattle high rise to call mom-and-pop book stores in search of a $8 out of print book that had been ordered on the website. Etc., etc., etc.

I understand the urge to yell "bubble!" when reading these stories -- but comparisons to the dot com era is to make a mountain out of a molehill.

unreal373• 13 years ago

This is tough:

* Revenue $1.0MM

* Variable costs $1.5MM

* Fixed costs & admin $300K

* For a net loss of $800K

How can your variable costs exceed your revenue by so much? You might as well not be in business.

rdouble4• 13 years ago

This is what e-commerce balance sheets look like, though.

Someone must not have told him that anything related to online (or offline) retail loses money for at least 3 years, making any money at all after 5 years is considered amazing, and Amazon.com lost money for 12 years before it made any. The main personal attribute you need as an e-commerce executive is a strong stomach.

rollo_tommasi• 13 years ago

But surely most e-commerce websites can't have a net negative margin for three years?

socalnate1• 13 years ago

This is just plain not true. There are many e-commerce companies who are profitable and healthy immediately.

Start a store with Shopify or Miva Merchant for a low monthly cost, work of of your house and sell your goods for more than they cost you. Ton's of folks do this and are very quickly profitable on a small scale.

If you are trying to be Amazon or Walmart and sell non differentiated products for rock bottom prices, then you are correct. But there are plenty of companies content to run $2 Million - $20 Million dollar businesses without having to go through the pain of losing money for 3 years.

Guvante• 13 years ago

Was Amazon running at a loss at the gross margin level or the profit level?

Losing money at the profit level is fine, since that includes things like buying warehouses or developing technology.

Losing money at the gross margin level means you aren't even being paid for the goods you ship out, let alone the money you spend in infrastructure.

rexreed4• 13 years ago

It's called selling a product for less than it costs. A variable cost is one that is dependent on the the # of units sold. So, obviously, the more one sells, the more one loses money. Think of it this way: you could make a million dollars right now, really fast, by selling gasoline (in the US) for $1 a gallon. You'd sell a million gallons. And lose $2 million in the process. The more you sell, the more you lose because your costs (which are dependent on your total volume) increase with your revenues. This is why you can't confuse revenue with income.

Amazon had that model for many years of operation. But it went public before it ran out of money. Call it the "cost of acquiring the market". The problem was that Amazon had a much bigger market to work with.

ajross• 13 years ago

And Amazon is one of the very few success stories of its era. Remember that there were dozens of very well capitalized venture funded retailers working one part of the market or another. Remember pets.com?

This is a big part of the reason why the current startup environment "feels" the same as the dot com crash. Valuations and funding have gotten completely divorced from the business fundamentals. YC startups are being handed blank checks, and no one even remembers "ramen profitable".

At this point, IMHO, it's undeniably unsustainable. Whether it constitutes a "bubble" or not is something we won't know until it pops.

scott_meade3• 13 years ago

Their's was not the Amazon model. Amazon has always had a gross profit http://www.wikinvest.com/stock/Amazon.com_(AMZN)/Data/Gross_... and http://www.nasdaq.com/markets/ipos/filing.ashx?filingid=4268....

The more product Amazon sold, the more money they'd make (or more accurately, the less money they'd lose).

On the other hand, Ecomom never had a gross profit. The more product they sold, the more money they lost. This is the situation you describe in the gasoline scenario. I suspect the gasoline model was not their strategy by choice, but by accident. The controller's assertion is that it's the runaway discounts that did them in. 50% discounts intended to be for one-time-use-only were used on almost all orders.

Whether it was a long-term strategy or a fundamental mistake, whatever they did is not the Amazon model.

Compare.

  $000's

  Amazon - Quarter ended March, 1996

    Net sales:            $875
    Cost of sales:        $695
                          ----
    Gross profit:         $180
    Gross profit %:      20.6%


  Ecomom November, 2012

    Net sales[1]:          $52
    Cost of sales:        $548
                        ------
    Gross profit/loss:   -$496
    Gross profit %:       -45%





  [1]
  Sales:       $1,089
  Discounts:    $(751)
  Warehousing:  $(152)
  Freight:      $(134)
               -------
  Net sales:      $52

johnrob2• 13 years ago

Because, to investors, any revenue is better than no revenue. The latter implies the worst possible scenario: making something nobody wants.

rexreed4• 13 years ago

And this is why venture capital, as an asset class, performs so poorly and provides such a poor ROI.

pbreit2• 13 years ago

The referenced analysis is including a ton of marketing & advertising expenses into variable costs which is probably not appropriate. If you're like Khol's where 75-90% of items are on sale at any given time, then it makes sense. But something like Plum District is more of an acquisition, marketing cost, not part of COGS.

jeffasinger• 13 years ago

My understanding is that was exactly the major misunderstanding. Plum District and similar were being used on most sales, so pretty much everything was always 50% off.

It wasn't just first time customers who were getting those deals, so it's not really an acquisition cost.

scott_meade3• 13 years ago

Look again. I think he did include marketing and advertising as fixed costs, not variable. Top of page 4:

Fixed Costs ... Advertising

VLM3• 13 years ago

"How can your variable costs exceed your revenue by so much? You might as well not be in business."

I found it in the scribd doc,

"What value, then, was Ecomom providing to our customers? We became simply a middleman, and one that incurred double freight"

Basically they competed with amazon, whole foods, and walmart and lost miserably. either they discounted so heavily they could never dream of profiting, or when they abolished discounts, sales collapsed.

There's a strong cultural demand to not speak ill of the dead... but if the whole story were not tinted with the CEOs death, I think the tone would be astoundingly negative toward the CEO... What was he thinking...

jaggederest2• 13 years ago

> What was he thinking...

To be fair to the man, he was quite apparently mentally ill towards the end.

conanbatt• 13 years ago

How did the "outside accountant" miss this :S.

jarito• 13 years ago

He didn't. That's why he is refusing to talk through lawyers.

kevinpet2• 13 years ago

The accountant's job is to tell you how it is, not persuade you to fix it.

rdl3• 13 years ago

Where the fuck was the board?

It looks like he did a "party round" with tiny investments from a lot of sophisticated investors, combined with bigger investments from less sophisticated investors, and none of them were competent and interested enough to exercise any oversight.

http://www.crunchbase.com/company/ecomom

rocky1138• 13 years ago

Was there a board? From what I can tell it looks privately held with one majority shareholder.

rdl3• 13 years ago

Per the great state of Nevada:

Jody Sherman ("February Won, Inc") (this is ecomom)

Zem Joaquin ("February Won, Inc")

Alan R. Greene, M.D. FAAP (CareDox, Inc)

Robert Beck BS, MS (EcoMom, Inc.)

John Daniele Hamel (The Cue Ball Group, LLC)

The only one I'd consider credible is Dr. Greene, and in general doctors are exceptionally shitty businesspeople.

Cueball is a small/unknown VC in Boston.

unclebucknasty12• 13 years ago

I think it's an oversimplification to say that Mr. Sherman "did not understand margin". The concept is so fundamental that you can explain it to first-graders as soon as they're introduced to a number line.

Sure, he understood it. Did he respect it as the prime directive? It seems not. But, plenty of companies would take the same approach and write down the losses to the cost of customer acquisition--pure marketing--with the idea being to recoup later.

That drive, BTW, is a side effect of high-pressure SV culture. Rather than build more methodically with an emphasis on creating rabidly loyal fans who are willing to pay a higher price for service, customer experience, etc, the goal was to grow revenue and customer base as quickly as possible by any means. In this case, it meant deep discounting.

So, instead of a simple misunderstanding of margin, the problem here seems to be more that this pressure caused him to embark on a strategy ill-suited to his product. Once he'd trained his customers to expect discounts so deep that he couldn't possibly profit, there was no turning back. It seems, instead, that the Zappos model would have been more suited to his offering.

But the relentless pressure for growth combined with the belief that he had access to more capital seems most responsible for his approach. I think it's possible that many rational people would have been lulled into making the same mistake, even with a clear understanding of margin. To say that he didn't understand that you have to sell a product for more than it costs to profit is nearly insulting.

apalmer2• 13 years ago

No.

You are stating your opinion based on disregarding the facts at hand because they don't align with your worldview, this is exactly how an intelligent person can end up not understanding something basic.

The individual who actually went over the financials in detail, and who actually knew Sherman, and who actually spoke to Sherman about the financial situation at the time is putting his reputation on the statement that Sherman did not understand margin.

He might be right, or he may be wrong, but he has a lot more backing to his opinion than you do.

unclebucknasty12• 13 years ago

Yes, I am stating my opinion, as are you.

Odd that you charge me with speaking out of turn while yourself presuming to understand my "worldview" and the thought process that led me to my conclusions. You're in my head now?

>He has a lot more backing to his opinion than you do.

And, I know my own "worldview" better than you do. Or would you like to explain my worldview to me? As well, I know better than you how I arrived at my own conclusion. It's simple common sense. What adult doesn't understand that a company profits by earning more than it spends?

I could be right or I could be wrong, but I will go with the rational conclusion.

ScottWhigham• 13 years ago

Well said. And don't forget that, for many people, there's a difference between understanding a basic concept (margins) and understanding its effect on you/your baby/your life. We humans do this as a matter of routine (smoking, alcohol, obesity, etc).

fyi804• 13 years ago

Funny story: In 5th grade, on career day, the proprietor of an Army-Navy Surplus store explained margin to me:

I buy a shirt for $7, sell it for $10, and get $3 dollars profit and $7 to buy another shirt.

I was genuinely confused about the $10-3=$7 he was claiming he could use to buy more shirts, when it was already used to pay wholesale for the first shirt.

But maybe that was confusion about Return on Invested Capital, not confusion about margin.

unclebucknasty12• 13 years ago

Or maybe the guy went out of business the next week and is still trying to figure out what happened.

apalmer2• 13 years ago

I see your point, I guess its all in how you do your accounting. One way of looking at it is the initial $7 dollars is already sunk costs, and quite literally he probably was using the $7 dollars from Shirt A's sale to purchase Shirt B. I mean he didn't really literally take the $7 dollars from the sale of Shirt A to buy Shirt A so I can see why he thought that way. Does it make sense to run a business with that mindset i don't know...

photorized3• 13 years ago

I saw what looks like his AngelList profile:

https://angel.co/jodysherman

Accredited investor, previous exits, etc - I am, too, skeptical of that margin statement.

But then again - I didn't know the guy. I've met plenty of savvy business people who don't understand depreciation/amortization, for example.

phyalow• 13 years ago

I think you need to reevaluate your last sentence. Somebody who doesn't understand basic asset accounting is clearly not "Business Savvy"...

6d0debc071• 13 years ago

Of course a first grader can understand margins. They're not personally involved with the idea and they're probably not seriously depressed.

It doesn't seem unreasonable to me that he didn't understand margins. It's difficult to communicate how... decayed... your thinking can become under protracted stress that has gone beyond your ability to cope with.

You have a very limited budget of energy you can expend on doing anything in the day, and thinking, especially about things that are unpleasant to think about - like the reason you've lost - is incredibly costly. Basically all you want to do a lot of the time is lie in a dark room and sleep forever.

You know how, when you've been going at a program for a while, you can start to find it impossible to hold all the bits you know in your head? It's sort of like that, the number of things you can bring yourself to hold in your head at once nosedives, especially where they're unpleasant.

It's not implausible to me that he was mostly operating on cached habit and his thinking resources weren't large enough to stick the concepts together in any more. The poor guy went and offed himself subsequently, after all, he clearly wasn't reasoning with a healthy mind.

Whether he did or didn't understand it I don't know, but I can see how he might not have been in a position where he could.

auctiontheory• 13 years ago

Among other things, the "revenue" number seems totally bogus.

Reminds me of a tactic used by Skillshare. I sent them some feedback saying the class I'd just taken was terrible. They didn't offer me a refund (I hadn't asked for one), but they did give me a "scholarship" for the course amount - $20 back to PayPal, operationally identical to a refund. This way, they get to book "my" $20 as "revenue," and the "scholarship" as a "marketing expense."

davidandgoliath3• 13 years ago

Quite interesting! Hadn't ever seen that but it's rather wise from an accounting standpoint.

littlegiantcap• 13 years ago

Wise from the perspective of attracting investors? Maybe. Wise from the perspective of running a functional business? No. Fudging metrics to make yourself feel better is crazy. How are you expected to know the actual health of your business without having a clear view of metrics as simple as revenue, marketing, and returns.

richardjordan• 13 years ago

This is all a very sad state of affairs obviously. I think, though, cautionary tales do have some value - and hopefully allow a small silver lining to the accompanying cloud.

In this is, as the post outlines, an important lesson to founders from the sales/marketing side to not oversell yourself, not just to others but to yourself. This is part of the reason many VCs are reluctant to back companies founded by pure sales people, because such folks will oversell their own ideas to themselves and not look as critically. You MUST get to grips with fundamentals. You MUST understand the financial details of your business and not hand that responsibility off to someone else. I would also argue, though many disagree, that you MUST understand on some level of detail the engineering behind your product, even if you are not the level of coder your engineering team members hopefully are.

Pitching ability is necessary but not sufficient qualification for success as a startup founder. It's a very sad situation when someone pitches so far ahead of the curve they feel like they have no way out. Depression and despair is a frighteningly common situation to find yourself in as a founder. Help yourself by owning knowledge of all aspects of your business and THEN let the subject matter experts own the deep dive and the execution on those.

theflyingkiwi422• 13 years ago

Reading the Ecomom story it reminds me of Zappos. That company too was losing a lot of money. It only sold to Amazon after their investors refused to put more money in.

The Ecomom story is pretty mind boggling from a sound business perspective, but then so is Zappos. And look how celebrated Tony Hsieh is. And guess who was also an investor in Ecomom?

gokhan• 13 years ago

I think Zappos' and Ecomom's stories are way different. Are you referring to the info in the Zappos' book, delivering Happiness?

theflyingkiwi422• 13 years ago

Yes, I am. I am sure there are big differences (especially in the outcome) but both were losing money in the hope of building an audience, and to lower costs later.

As Hsieh wrote:

"Zappos sells shoes and apparel online, but what distinguished us from our competitors was that we'd put our company culture above all else. We'd bet that by being good to our employees -- for instance, by paying for 100 percent of health care premiums, spending heavily on personal development, and giving customer service reps more freedom than at a typical call center -- we would be able to offer better service than our competitors. Better service would translate into lots of repeat customers, which would mean low marketing expenses, long-term profits, and fast growth. Amazingly, it all seemed to be working. By 2005, gross merchandise sales were $370 million, and we made the Inc. 500. We weren't profitable yet, but we were close to breaking even, and our revenue was growing quickly."

http://www.inc.com/magazine/20100601/why-i-sold-zappos.html

Seems pretty similar to me. The only difference is that Zappos went after a much larger market.

dools• 13 years ago

It seems that at the core of their demise was the fact that their discounting strategy was very Groupon-esque, ie. Done using a 3rd party service and ultimately failing to capture loyalty of their customers.

The article states "when they stopped discounting, the sales stopped" but the way that reads to me is that the 3rd party discounting service was actually their only significant source of traffic.

It seems unlikely that if they were offering goods at a reasonable price that people needed with a trustworthy level of support, that their sales would completely evaporate in the absence of discounts otherwise.

Blockhead• 13 years ago

Wait, are you telling me I'll LOSE money if I sell things below cost? That's not a "grave financial error", it's an egregious violation of common sense.

He was basically running a Groupon for moms, and no one stopped to say "Hey, Groupon never turned a profit. What makes you think your company will?"

arbuge• 13 years ago

>> A large problem was Sherman did not understand some basic business principles. "I would bring the financial statements to Jody who would glance at them so cursorily and wave me away with 'no one can understand this without extensive analysis,' Prentiss writes. "Critically, he did not understand margin. At the end of December when things were getting truly desperate, he said to me, 'Phil, just bring me a forecast that shows how much we need to sell to break even.' He did not understand, after three years of negative margin, that increased sales resulted in increased losses. He had built his house by raising money and when times got tough he went with what he knew."

If the above it's true, it's really scary. You should not be in any business, let alone commerce, if you don't get this basic stuff. Building a business is about making money - coaxing it right out of the unit economics - not raising money.

prawn2• 13 years ago

I doubt he didn't get it, he just wasn't interested and thought he could make it work just by watching sales. He wanted a target that made sense to him. Obviously a flawed approach in the field he was in, ultimately.

eldude• 13 years ago

In other words, he didn't get it.

You cannot say someone truly gets that something is in their best interest if they think it's best to continue to do the opposite.

jwheeler792• 13 years ago

Can someone please help me understand what I'm missing? When I calculate the Net/Profit Loss on the first income statement I get ($521) and not ($548).

I don't see anything in the article that accounts for the missing $27K. What kind of accounting is that?

jacquesm2• 13 years ago

Two weeks ago I took a look at a company in distress. Three years of figures: 2010, profitable, 2011, still profitable but substantially lower, 2012, huge loss. Every year their turnover grew but their margins decreased (because they had to bid lower (more competitive) on contracts in order to grow their revenues). The CEO had no idea why they were in trouble, he'd attributed it to his co-director making off with money (which in fact he did, but only relatively small sums). They've filed for bankruptcy last week and to this day I'm not sure if I've been able to adequately explain to him that if you lose more money on every subsequent project that you contract that you can grow your revenues only until your cash reserves run out. Even with the figures laid out pretty clearly I think he still does not really get it. Puzzling.

I think they thought that as long as they were winning the contracts from their competitors that they were doing well but if you don't accurately track your purchasing you will never know whether you are making money or losing money on a contract.

robryan• 13 years ago

Yeah, in the optimistic financial planning they may be budgeting for a profit on every project? I always expect profits to be a fair bit lower than the back of the envelope estimates, so many little unaccounted for things come up.

jacquesm2• 13 years ago

Gross margins vs net margins was all it took to put close to a 100 people on the dole. In a cut-throat industry it takes pretty precise bookkeeping to know what you can bid on a contract, if you think you're making 10% when you're actually making -10% growing your business is the worst thing you could possibly do. First you'd need to fix your margins, and if that is not possible and some competitor still outbids you then you should simply let it go. Otherwise you'll end up winning all the battles but you will still lose the war.

eliajf2• 13 years ago

Great comment. I had a professor say often that "cash is king." Obviously these companies aren't paying attention to cash at all.

newbie12• 13 years ago

Actually, the opposite is true. They've got more cash coming in, and cash in the bank, which is masking the operating loss on each sale.

mynegation• 13 years ago

"We lose money on every deal, but we will make it up on volume"

akkartik• 13 years ago

Like Milo Minderbinder's egg syndicate. https://en.wikipedia.org/wiki/Milo_Minderbinder#The_Syndicat...

InclinedPlane• 13 years ago

The more examples I see the more I'm convinced that a big cause of failing businesses is just failure to do math. I've seen so many businesses struggle because they failed to do the simple thing: concentrate on profit margin and focus on maximizing it.

LancerSykera• 13 years ago

I work for a plumbing/heating/HVAC distributor and the absolute biggest number they look at is margin. Real simple shit, especially when you use a system that always shows the GP% on every screen.

netcan• 13 years ago

I wonder if the co-director making off with money or some other piece of the story was more important than you give it credit for.

A lot of the comments on this thread are "can't they count?!" which to me seems to beg another "why." Maybe having a scapegoat allows him to avoid seeing realities. It seems like a psychologist would be as relevant as an accountant.

unclebucknasty12• 13 years ago

Exactly. There are glaring holes here, money "lost", and people hiding behind lawyers.

And, aside from being completely gossipy and unprofessional, the controller's account doesn't add up (no pun intended).

It amazes me that the normally astute HN crowd isn't digging deeper.

incision• 13 years ago

Just replace the embezzling co-director with defecting technical leads and I've seen something nearly identical.

I think it's simple denial.

They've decided that they know what the problem is/was and being in a position of power surely have to shortage sycophants for reaffirmation.

I expect they'd see the situation quite clearly from the outside, abstracted from emotions and prepared rationalizations.

milkshakes• 13 years ago

"First and foremost,the VP of Sales was compensated according to sales before discounts, not according to margin or profit"

what could possibly go wrong?

mratzloff2• 13 years ago

Oh my god. What clown couldn't get personally rich with that setup?

feralchimp• 13 years ago

"Grave error" implies something that a non-fool might blunder into. Fools don't blunder, per se, they simply exist.

One of the first jokes I ever heard at a startup was "We'll give the product away and make it up on volume!" Changing the joke to "We'll pay people to take the product and make it up on volume!" doesn't make it less obviously ridiculous.

I'm amazed they were able to hire employees, let alone find investors. Doesn't make the guy's death any less tragic though.

specialist• 13 years ago

That's an oldie but a goodie.

Saturday Night Live Clip (First CityWide Change Bank 2) http://www.imdb.com/video/hulu/vi416284697/

fyi804• 13 years ago

Before startups or the Internet existed, the old joke was "Lose a little on every sale and make it up in volume".

fitandfunction• 13 years ago

It's not just small companies.

I worked briefly for a mid-sized tech company that took a >$70 mm round, but will likely be out-of-business before year end. Like Ecomom, it is helmed by a "visionary" / fanatical leader with a "grow at all cost mentality."

To me, a big red flag is when senior managers make plans without both revenues AND costs being openly discussed.

jwheeler792• 13 years ago

Here's the best part from the full post mortem

"First and foremost,the VP of Sales was compensated according to sales before discounts, not according to margin or profit. Our discount strategy resulted in enormous losses, but for the VP of sales the strategy optimized his bonus. "

It's called incentive based behavior, and it goes to show you that if you reward someone for the amount of shit they can sell without any consideration for margin, they'll give the damn shit away for free!

smartician• 13 years ago

| "For example the customer would pay Plum District $20 and receive a $40 coupon to be used on our site. We would ship $40 of retail value and receive nothing from the customer, but eventually receive $20 (less some service charge) from Plum District."

So it's basically Groupon for goods? For businesses with low variable costs (like restaurants and hotels) this might actually work, but for physical consumer goods with cut throat margins? Insane.

unreal373• 13 years ago

Seems like he was using a groupon like service to sell $40 coupons for $20, and then only getting part of that $20 back from the marketing company. Built in 66%+ loss on every sale.

Those coupons have hurt many a business. People buy only $39.99 and not a penny more since the coupon anchors the price and the expectation.

MattRogish2• 13 years ago

Holy mackerel, does this ring true!

Long ago, I had an internship at a company that focused primarily on daily revenue. An email would go out in the morning with yesterday's sales figures. It omitted (for reasons I don't know) the gross margins.

Someone high up figured out "Hey, we can goose the numbers by running sales!" and so the sales went up - almost daily - and yes, indeed, the daily revenue $ went up and up.

I'm not sure what happened to the business, but I'm sure if you want to maximize daily revenue you can but if you don't pay attention to margin, well - you're in trouble.

I thought this was an isolated case but clearly anyone can fall into that trap. Very weird, especially when the data is staring you in the face. Reality distortion field? Incompetence? Willful ignorance? Some of each?

jonnathanson• 13 years ago

In medium to large companies, this trap typically emerges in situations where someone responsible for top-line revenue is not responsible for bottom-line revenue (i.e., sometimes in organizations where Sales has little contact with, or accountability to, the other departments).

In startups and small companies, the problem has been exacerbated by a relatively recent obsession with growth uber alles. Growth, growth, growth, with little regard to whether growth is sustainable, or to how costs scale with revenue. Groupon is the ultimate lesson in the dangers of putting financial growth on a pedestal at the expense of all other considerations.

The problem is also made worse whenever founders run a company solely expecting to exit with a strategic buyout. If you're not really running the company as a going concern, you have less incentive to work toward long-term sustainable margins. We tend to glorify the big exit, and there's certainly a lot of hard work and skill that goes into achieving one -- but the highest peaks on the mountain of glory belong to whose who develop and run lasting businesses.

A professor in a business class in college used to put it this way, and I'll paraphrase: "If I want to start the world's fastest growing company, I can do that right now. It's not hard. I'll just start a business selling $100 bills for $90."

The metaphor was purposefully simplistic, but it's amazing how people seem to fall into similar business models without even considering that they have.

unclebucknasty12• 13 years ago

>In startups and small companies, the problem has been exacerbated by a relatively recent obsession with growth uber alles. Growth, growth, growth, with little regard to whether growth is sustainable, or to how costs scale with revenue.

This is absolutely true. I'm getting downvoted farther down on this thread for a similar observation, and for attributing this obsession to the SV culture, in particular.

This article is attempting to assert that Mr. Sherman was literally incapable of understanding basic math (i.e. the concept of margin). I think it's more likely that he was well-aware of the definition but was focused on growth at all costs.

It's funny, because you look at companies like Twitter and Pinterest which come up to scale with absolutely no revenue model, let alone revenue. That seems to be "normal". Nothing to see here. But, when a company with actual revenue deeply discounts products to scale up, it's somehow shockingly bad.

I'm not arguing that Ecomom had the right strategy here. I actually think they did not (partly for the reasons you mentioned). But, then in the same universe Pinterest could become the darling with millions of users and no revenue model?

It's funny how twisted things are without people seeming to notice the contradictions.

georgemcbay• 13 years ago

Unfortunately, whether Groupon is the "ultimate lesson in the dangers" of this type of growth-at-all-cost business or a validation that you can make a shit-ton of money being a founder or early investor of such a business (while leaving others to hold the bag) depends upon personal perspective, whether or not you've got a chair when the music stops and how willing you are to be ethically, morally and in some cases legally flexible in the pursuit of personal wealth.

MattRogish2• 13 years ago

Also I forgot: the aforementioned company also was a physical goods company. Warehouses full of stuff, etc. There was an intense pressure to get rid of the inventory as quickly as possible (inventory turns) because most of the items were subject to "spoilage" or obsolescence.

Yes, negative margins are bad, but they're a whole lot better than not selling the item at all (recovery). Inventory isn't as liquid as cash, and you can't use the excess inventory to pay salaries. There can be a real view of needing to liquidate just to get some cash to buy more inventory.

If you're not careful, however, you can easily get into the mindset "we'll take a loss on this batch, but we'll make it up next time" - and next time is no different.

Although folks are claiming the CEO didn't understand basic math I wonder if the problem was much more complex and nuanced. Haven't we all pulled an all-nighter to get a project "done" even though we knew that it would be buggy, and it would've been better to get good rest and merely admit to missing a deadline? I'm not excusing his alleged behavior, just suggesting that folks here might empathize a bit more.

unreal373• 13 years ago

Also, keep in mind that he killed himself as his company imploded. It's a sad cautionary tale.

Those who knew him spoke very highly of how nice he was. A genuinely nice guy. Hopefully most aren't judging him too harshly in light of that.

photorized3• 13 years ago

Re: "Our discounts are meant to be one time only, but we can't limit them by customer so every order ends up sold 50% off"

Sounds like a technology problem.

yekko2• 13 years ago

No it isn't. It's a business plan problem. Stop blaming the developers for everything :)

photorized3• 13 years ago

As a former dev myself, I've seen that problem quite often. :)

yannisp• 13 years ago

I hope no one forgets we often value companies (in an overly simplified way) by a multiple of their revenue. Of course other things are taken into consideration but had they kept their discount as a marketing expense they could have gotten away with it in going on to next steps like a potential IPO. What the article highlights is that the wrong variables were taken into account when calculating margin, and this could happen very easily/could be debated both ways.

The thing I'm curious about is their balance sheet. If someone buys from a site like plum district a gift certificate for $40 that they paid $20 for, California residents are entitled to at least $20 of goods for an unlimited time... What a nightmare!

yekko2• 13 years ago

School should teach critical thinking skills and I guess the concept of profit/loss...

jsumrall• 13 years ago

I don't get it. The guy was an idiot, and the people who funded Ecomom were blind. A high school student could have pointed out the flaws here.

dennisgorelik• 13 years ago

Investors must invest responsibly and don't give money to clueless entrepreneurs.

These misguided investments pushed that clueless & reckless entrepreneur toward suicide.

Irresponsible investing is similar to irresponsible lending during the housing bubble (pre-2008).

atechnerd• 13 years ago

I recommend reading the full letter from Prentiss as opposed to the summarized version on B-insider. The full-version presents a very clear cautionary tale about business strategy and management. Prentiss articulates himself well and gives you an inside look at what it's like to watch a start up fail.

trotsky3• 13 years ago

I'm getting tired of seeing the never ending spin from one or another person that given that justice would be considering changes if it wasn't for the fact that jody swote the final chapter.

I don't know phillip, and I'm sure he's a nice guy, but nobody that took an accounting class at community college has a lack of financial knowledge so great that they couldn't see two trains inexorably colliding, a process that began well before 4Q12 and in fact stretched back to prior to the last round of funding closing (late summer).

A mere glance at the numbers showing 90% of the days orders a) via 50% pre-sale b) had significant coupon (often 30%) stacked on top of that that applied to the total not just their share, c) 99% got free shipping that they valued at $6 but likely ran twice that much of the time. When you add it all up you are losing money on every sale even if your product is free, you have no marketing costs, no fullfillment, no chargeback, no backoffice, no ceo's that need to bust it at yet another conference.

It was so bad that you could easily within seconds spot the real transactions - people paying ~70%-~%80 of list and shipping. because you;d only see one once a day if you were lucky.

There's a phrase accountants use when they really wan to to say a certain word but it gets you sued if you do. So here we go. There was an obvious material weakness present in absolutely everyone conducting the business of the board and the c level posts. As much as nerds want to believe that crap about how dumb the population is, people aren't that dumb.

Make no mistake, there was something completely unmistakable for incompetence at the very best at work here. Sure they wasted a bunch buying customers, but thats not how you go from $5+1secured in a few months.

This money walked out the door. Where'd it go? Well it turns out that post crisis the lead investor and secondary spot of the board poured over books day in day out withe the brand new "fall guy" president, elected by the board two days after jodys death. They amounted to the entirety of the forensic accounting done and found that no money was missing though employees never saw the books.

Then, 28 days after his death they transferred all shares and assets without prior announcement to in effect liquidate without the oversight of the court. The key part there is oversight - a court appointed trustee would have the obligation to claw back money, especially from insiders. The Instead in this case the insiders paid a significant amount of their cash on hand (six figures) as they wrapped up to provide sherwood partners a hefty cash guarantee on their liquidation expenses, and likely covered some of their secured debt as well to buy the ascent of the major secured creditor. While that happened in secret they continued to ensure contractors that'd be paid and enough was there. Now that's 0 for the benefit of bankers. For no more than 100-200 gained off of misclassified 1099s.

That substantial fraud occurred goes essentially unquestioned in those circles. That the active member of the board from cue ball was at least guilty of gross negligence seems difficult to argue against.

And yet nobody in the whole process is willing to stand up, investors, employees, the many parties only speaking through lawyers, about it because of the code of silence in vc-istan. Which is absolutely real and will absolutely fuck you.

If you're doing venture backed lottery schemes for a living you should make sure find some of the contrarian stories and listen - when things don't work out the windowns are far from having free snacks.

trotsky3• 13 years ago

In the end, the idea that Jody lacked a basic understanding of margins after years of being a retailer clearly doesn't make sense. Nobody sells goods for lower than their cost of acquisition without being aware.

It's too bad tech journalism is a farce now, 15 years ago the sj mercury news would have actually put someone on it that had a basic understanding of extracting truth from lies. There are plenty of people who might talk, if they had any belief it'd actually result in a researched and unbiased piece.

olalonde• 13 years ago

I assume "Magneto" is in fact "Magento".

james1071• 13 years ago

The reality is that small online retailers have no chance against amazon unless they sell at a loss. The delusion is to think that the losses are an investment.

ErikAugust• 13 years ago

Multiply by a negative number - and guess what? You get a bigger negative number.

lhnz• 13 years ago

    Prentiss also says Sherman drew up a will one week before he died and gave it to his secretary.

And they didn't consider this a massive red flag?

lectrick• 13 years ago

So the "grave error" is a lack of simple understanding of what a margin is? Seriously?

Failed Startup's Final Income Statements Reveal Grave Error

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