Case: Decor$-$R$-$Us$.$com

Setting the Scene:

In July $2018,$ the three freshly graduated business students with prior work experience in e$-$commerce, John, Kristin, and Eric, each had job offers with annual salaries of $$50,000$ in New England. Wishing instead to capitalize their acquired business skills, they decided to explore forming a new business to retail seasonal decoration merchandise on the internet. The business would specialize in selling high$-$quality decorations for the home as well as well$-$designed festive costumes and accessories for adults and children. The online offerings would change with the annual decoration cycle, starting with Christmas, winter carnival and Valentine$$s Day, continuing with Easter and Mother$$s Day, entering summer with July $4($Independence Day$),$ vacation decorations and not to forget the lucrative wedding d$$cor$,$ and closing the year after a back$-$ to$-$school phase with Halloween and Thanksgiving. The three graduates had already acquired the rights for $$Decor$-$R$-$Us$.$com$($DRU$),$ the tentative name for the new business.

To examine the potential market and costs of the business, John, who had prior experience in this industry, researched store retailers that were in the decoration merchandise business. The industry was fragmented with most of the businesses operating on a regional, rather than national scale. Thus far no specialized etailer existed in this industry. In New England, where the three lived, the largest retailer was FunDays, a public company that operated four stores throughout New England, all located in large malls. Exhibit $1$ shows FunDays$$ most recent income statement.

Projecting Profits:

Kristin, who had a financial background, volunteered to project profits for DRU. She decided that the data for FunDays provided a useful starting point. However, Kristin recognized that the cost structure of an etailer $($web$-$based retailer$)$ like DRU would differ somewhat from that of Fun Days. Based on conversations with professionals with similar business interests, market research on etailing, and her knowledge of the economics of e$-$commerce, Kristin made the following assumptions about DRU$$s performance for the first three years of operations:

$1.$ If the pricing was aggressive $($meaning an average selling price of only $$9$ per transaction, compared to $$18$ for FunDays$),$ DRU could expect to have $10,000$ sales transactions per month in its first year of operation. Typically, etailers priced more aggressively than retailers.

$2.$ Merchandise cost per transaction would be the same as for FunDays.

$3.$ In order to build customer loyalty, it would be critical for DRU to avoid stock$-$outs and deliver order efficiently. As a result, they decided to outsource warehousing, distribution, and customer service to Amazon. With Amazon$$s $$Fulfillment by Amazon$($FBA$)$ service, DRU can store their products in Amazon$$s fulfillment centers. Thereby, Amazon takes care of picking, packing, shipping, and providing customer service for DRU$$s products. The FBA contract would cost

$$30,000$ per year for up to $300,000$ transactions annually. In addition, DRU will have to compensate Amazon for the shipping cost to the customers. But DRU$$s customers will pay for the full cost of shipping merchandise: $$4$ per transaction.

$4.$ Kristin felt that selling, general, and administration $($SG&A$)$ expenses were a category with big advantages for etailers. Neither stores, nor sales staff were required. Hence, Kristin estimated total SG&A costs would be $$7,104$ per year and would not grow compared to sales.

$5.$ DRU would have to invest in computing capacity. The annual depreciation on this asset would amount to $$7,000.$ This investment would be adequate for the foreseeable future.

$6.$ Eric$$s research on the costs of building a web brand indicated that DRU would have to spend

$$60,000$ per year to have its name associated with home$-$and$-$family publications and activities. In addition, DRU would have to pay $$1$ for each new customer who purchased merchandise and had been led to the DRU website via a portal. Kristin estimated that an average of $1,200$ new customers per month would purchase goods online from DRU through this source in the next three years. Finally, during the next three years of image$-$building, DRU would pay $2\%$ of sales revenue to various arts$-$and$-$crafts internet sites, Google Ads, and Amazon postings to promote its products.

$7.$ Getting customers to linger at one location $($and spend more money there$)$ was more challenging for an etailer than a land$-$based store. The key was an appealing website. Kristin estimated that they would incur a one$-$time site development expenditure of $$100,000,$ depreciated over $10$ years. She had also read that on$-$going site maintenance had proved to be surprisingly expensive for etailers. Analysts$$ reports indicated that transaction volume was directly related to site maintenance expenditures. Kristin estimated that DRU would incur a site maintenance cost of $$0\mathrm{.}50$ per transaction.