Is Pure-Play eRetailing Viable?

The answer to this question probably depends upon your perspective. If you are an investor in a failed dotcom eRetailer, then your answer is most likely a resounding YES. A more impartial observer may come to an alternative conclusion however.

A key component of the pure-play eRetail business model is the supposition that it is more profitable to deliver products directly to the consumer than it is to build retail stores, staff them and fill them with inventory. The “dotcom” theory suggested that eRetail can save money by having lower inventory overheads and no investments in expensive stores that it could be much more profitable than traditional retailing. It was not too many months ago that we heard analysts pronounce the imminent demise of traditional retailing at the hands of the new, more efficient dotcoms. In hindsight, we can see how unrealistic this supposition turned out to be. Could we have predicted the demise of so many dotcoms?

Firstly, if the economies of direct distribution were so much better than traditional retailing, catalog retailers would have dominated the retail sector many years ago. They did not for good reasons. For example, people still like to touch products before they buy them; the unit cost of distributing merchandise directly to the consumer is much higher than through stores; the returns rate for direct to consumer shipments is much higher than it is for merchandise sold through stores (because the consumer has not had the opportunity to see and touch the merchandise).

Successful catalog retailers have carved out a niche for themselves by becoming extremely efficient at what they do, utilizing some of the most sophisticated consumer analysis tools yet devised to predict consumer behavior and spending patterns. The science of laying out a catalog is extremely sophisticated these days. It is not a matter of throwing a few products together on a page. Every page is analyzed for its effectiveness in persuading a consumer to buy; every product is considered with respect to other products on the page, the size and position of a product’s image has a significant impact on purchase behavior; what page a product appears on has an impact on its sales. These factors, and more, are all analyzed on order to produce catalogs that have the best chance of enticing consumers to buy.

Despite mountains of consumer data and years of experience, catalog retailers have not displaced traditional retailers except for their ability to supply niche markets that cannot be effectively serviced through traditional stores. Why should we suppose a pure eRetail business model would be more successful than these experienced catalog retailers? Is it because of the economies of scale?

Another argument in favor of the “dotcom strategy” has been that the “economies of scale” resulting from massive consumer sales via an unlimited Internet marketplace would generate higher margins. What most companies have found is that the much touted volume market is not readily accessible. There are many possible reason for this, including:

• Too many companies chasing too few consumers

• Lack of brand loyalty

• Slower than expected take up of the Internet as a shopping medium

The result has been that companies have not been able to attract enough consumers to their sites to achieve the economies of scale suggested by their business plans. Dotcoms have continued to sell merchandise at prices below cost in order to build traffic. In addition, in an attempt to attract and retain new customers in this highly competitive marketplace, dotcom companies resorted to spending millions of dollars on advertising, much of which failed to yield the required return on investment. Building a brand on the Internet is much more expensive than anyone anticipated. Unfortunately, dotcom retailers did not have the luxury of growing brands over a number of years. Working in “Internet time” became the “key to success”, which translated into spending money faster than we would have thought possible just a couple of years earlier.

Many catalog companies have taken years to build a loyal customer base. This path to profitability would not be possible for many new, VC-backed dotcom companies. Investors wanted to see a return on their significant investments in “Internet time.” However, catalog and traditional retailers alike were able to take advantage of their brand equity when they eventually arrived on the Internet en-mass at the end of 1999. That was when eRetailNews predicted the market was about to change in favor of the traditional retailer to the detriment of the dotcom pure-play (see Over Dot Com’d?).

Had the amount of venture capital invested in the Internet retailing market been invested in the traditional retail market instead, I believe we would now be witnessing the biggest decline in traditional retailing in history. Following simple supply and demand economics, if the market is over stimulated on the supply side of the equation there must be fallout somewhere down the road in terms of a future contraction. Would such over-stimulation of the retailing sector, had it taken place, have implied the demise of retailing? ….Hardly. Many companies would have perished, but the strong would survive.

Will the over-stimulation of the dotcom retail sector signal the end of Internet retailing or the pure-play dotcom? I don’t think so. What the Internet offers is a distribution channel that has its own nuances that must be mastered before a company can achieve profitability. This channel should be chosen for the right reasons, based upon servicing a market niche that cannot be served more efficiently through traditional retail stores or catalogs, or to supplement these existing channels. Clearly, eRetailing will continue to flourish as part of traditional and catalog retailers as they learn to more tightly integrate this new channel into their business models.

The Internet is effectively just another component of the four P’s of marketing mix (product, price, place {distribution} and promotion). Success stems from the effective use of all four components of the mix, and not just one component (i.e. place).

The pure-play dotcoms most likely to reach profitability will do so through a niche-play strategy. The key will be in segmenting the market so as to identify niches that are not efficiently serviced through catalog and traditional store channels, and being able to service such a niche with a unique product assortment that is hard to replicate (e.g. own-label merchandise).

In conclusion, although eRetailing will be most successful as part of an integrated multi-channel strategy, there will be continual opportunities for successful pure-play eRetailers to become established as the channel becomes more widely accepted as buying medium. However, the low barriers to entry on the Internet will require successful companies to be able to defend their position through the use of proprietary merchandise assortments and services that cannot be readily replicated.

May 22nd 2001