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internet business models

text and cases

OnLine RetailersTony Gauvin

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Online Retailers

• Only looking at Retailers of Physical Goods• Several Categories• How Online retailers create value• Economic models for Online Retailers• Payoff for GBF • Best Practices• Unique Challenges• Management and Strategic Issues

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What is an OnLine retailer?

• Use website to sell new physical products & goods to which they take title

• Rely on third party service providers to deliver goods

• Not• Auctions of non title goods (eBay)

• Service providers (real estate agents)

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Taxonomies

• Divided by – Merchandising emphasis

• Horizontal & vertical• Wal-Mart vs. Home Depot

– Pricing Format• Fixed• Adaptive pricing

– Auction– Group (demand aggregation)– Deep Discount (Loss leader)

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Creating value

• US Retail Market (1999) $1.6 trillion– Internet 1%– Catalogs 7-8%– Bricks and Mortar 90%

• Anticipated Distribution (200?)– Internet 15-20%– Catalogs 5%– Bricks and Mortar 75%

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Creating Value

• Online Market is very similar to catalog sales– Cannot directly inspect goods– Cannot access goods immediately after sales

• cognitive dissonance

• Online has greater value manifested by– Increase of household online

• doubled from 1998 to 2003– Increase in purchasing online (% of posiible customers)

• doubled from 1998 to 2003– Increase in spending per customer online

• doubled from 1998 to 2003

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What is a Good Online Product Category?

• Information Rich Products– Best fit for consumers

– Multiple consistent deliveries of sales pitch

• Large Selections

• Little need for hands-on Service or a product trial

• High value to Weight

• Easily Customizable Products

• Rapid Changes to Stock Availability

• Replenishment Driven

• Unpleasant Brick-and-Mortar Retailing Environments

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Barriers to Online Shopping

• Consumer concern about Credit and Privacy

• Consumer lack of familiarity with Brand– Virtual Presence versus physical presence

• Delivery concerns– People are often not home to accepted delivery

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Types of Shoppers

• E-Bivalent newbie's– Least likely to buy

• Time-sensitive materialists– Interested in saving

time

• Clicks and Mortar– Shop online– Buy offline

• Hooked, Online and Single– Young single males

with high incomes

• Hunter-Gatherers– Compares and analyzes

• Brand Loyalists– Go directly to site– Spend the most online

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Economic Advantage 1reduced cost

XYZ.com XYZ Superstore

Product Margin 28.0% 40.0%Freight In -2.0% -1.0%Credit Card Charges -2.5% -1.0%Shipping Revenue, Net 1.5% 0.0%Gross Margin 25.0% 38.0%Store Occupancy Costs 10.0%

Store Operating Expense 14.0%

Distribution and Customer Service 12.0%

R & D/Tech Costs 3.0%

Gross Advertising 7.0% 4.0%Co-op reimbursement/Ad Sales -3.0% -2.0%

G&A 1.0% 3.0%Total Operating Costs 20.0% 29.0%Operating Margin 5.0% 9.0%

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Factors affecting Operating margins

• Gross Margin• Distributions and Customer Service Expenses

– Pick and Pack operations– Call Centers

• Website Development– Should be fixed independent of scale

• Sales and Marketing– Pure play must spend lots for Branding

• General and Administrative (G&A)– Not a factor of sales but of size and complexity

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Less Working Capital

• This is the 2nd Economic advantage– More inventory turns

• 10 times for online vs. 2-5 for offline• Less stock in few warehouses than lots of stock at lots of stores• Not tied to a printed catalog

– Price changes– New items– Out of stock items

– Minimal receivables– 60 days net for suppliers

• Most online retailers have negative working Capital– Online retailer have positive cash flow!

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Less Fixed Capital

• No stores, minimal real estate

• Property, Plant and Equipment (PP&E)– 5% of sales for Amazon– 19% of sales for Borders

• Results– Greater return for Capital invested– Stock buyers frenzy STILL

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2001• 2001 online revenues were $51.3 billion (USD), up 21 percent over 2000¹. • Online revenues are estimated to grow 41 percent this year to $72.1 billion. • Online sales were 2.4 percent of total retail sales in 2001 and are projected to grow to 3.2

percent for 2002. • 56 percent of retailers reported profitable online operations in 2001, up from 43 percent

in 2000. • Overall operating margins have improved from a loss of 15 percent in 2000 to a loss of 6

percent in 2001. Operating margins are supposed to be zero or positive in 2002. • The average cost of customer acquisition has continued to improve, coming down to $14

in 2001 from $29 in 2000 and $38 in 1999. • Repeat buyers account for over half of sales, with 53 percent of revenue in 2001, up

from 40 percent in 2000 and 31 percent in 1999. • Conversion rate of visits into orders has improved from 2.2 percent in 2000 and 1.8

percent in 1999 to 3.1 percent in 2001. • Source The State of Retailing Online 5.0, a Shop.org annual study conducted by The

Boston Consulting Group with market-sizing data supplied by Forrester Research

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GBF??

• Preemptory strikes– Get market share now

– Easier for online than offline • Don’t have to build multiple stores

• Push to Web Site

• Examples– Amazon 1 billion in sales in 3 years

– Home Depot, Wal-Mart and Staples took 2 to 3 times as long

• 60, 229 and 174 stores

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GBF factors

• Online retailing: dubious gbf payoff• Network effects: basically, none!• Scale economies: some, but weak compared to other business models

– Purchasing economies with volume growth: buy direct from manufacturers and capture wholesaler’s margin (and coop funds)

– Modest scale economies in fulfillment and customer service operations– Big scale economies in website development and G&A– McKinsey: boosting sales from $100 million to $1 billion improves operating

margin from 6% to 8% for pure play online apparel retailer, and from –3% to 9% for pure play online computer retailer

• Intrinsic retention rates: weak– Familiarity with navigation– Customer service quality– Personalized recommendations (better with more history)– Investment in data entry (replenishment ordering)– Loyalty programs

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Tactics for Success

• High Quality Customer Service– Stock availability

– Site Design

– Reliable delivery

– Responsiveness to customer inquiries

• Build Community– Forums, Chats groups

• Personalization's– Increase Switching costs

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Issues Facing Offline Incumbents

• Advantages– Already Branded– Existing Supplier relationships– Already have Fulfillment and Customer Service– Cross-Channel Delivery (Buy online-Pick up at the

store)• Disadvantages

– Cannibalization– Channel Conflict

• Fulfillment• Pricing

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Other Issues

• Shopping Bots– Price compression– Does an online retailer cooperate??

• Disintermediation– Manufacture to consumer– Power plays by incumbents

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Hybrid Business Models

• Online retailing with content providing– Garden.com

• Online retailing with Internet Access providing– Bluelight.com

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EToys Example• Euphoria

– EToys launches late 1996– $30 million in revenue by F98; 5th most popular shopping site in December 1998 with 7%

reach• Overtrading

– May 1999 IPO; valuation exceeds Toys “R” Us’s by 35% and peaks at $10 billion in the Fall– In 1999, competitors emerge:

• Smarterkids.com;Toytime; Disney’s Toysmart; Viacom’s RedRocket; Amazon

• Toys “R” Us response – Gorilla (tied with Wal-Mart – each has 17% share of $22 billion toy business): huge offline

scale affords them a 7% gross margin advantage over eToys; knows how to predict fads– April 1999 enters JV with VC Benchmark– Disagreements over: 1) allocation of hot toys to dot com; 2) dot com ability to undercut store

prices; 3) governance – By August, Benchmark bails out and Toys “R” Us CEO that engineered the deal is booted for

online fiasco and poor earnings/stock price– Infrastructure not ready for Christmas 1999;

• 40% of site visitors turned away in November. • Site riddled with glitches. • 3% of orders not delivered on time.

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EToys Example

• Christmas 1999 debacle– EToys, having outsourced 50% of fulfillment to Fingerhut, fails to deliver 4% of

orders on time– Amazon writes off $39 million in inventory (50 week supply of Kermit phones)– Overall $220 million in advertising spent to sell $215 million worth of toys

• Revulsion– Toysmart, Toytime, and RedRocket pull the plug during the Summer of 2000;

KBKids.com pulls its IPO; eToys and SmarterKids.com stock prices decline 90%+• Toysrus.com response

– Secures $57 million from Softbank in February 2000 for 20% of company – Merger proposal to eToys in Spring 2000 rebuffed– Fixes website and fulfillment (spends $70 million on latter) – In August 2000, merges operations with Amazon, which will handle fulfillment and

customer service. Toys “R” Us to handle procurement and merchandising

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EToys Example• eToys response

– Pulls most fulfillment inhouse; accelerates construction of giant automated fulfillment facility. PP&E rises to $124 million in September 2000, up from $23 million year earlier

– Given fixed costs (including about $50 million/year to maintain sophisticated website), requires $750-900 million in revenue to breakeven

– Cuts marketing expenditures– Christmas 2000 revenue up only 30-40% over prior year, versus doubling originally projected.

Revenue for fiscal year ending March 2001 about $200 million– EToys missed window in late 1999 early 2000 for secondary stock offering. Later forced to

raise $100 million in private placement from bottom fishers. Subsequently tries to raise $100-150 million or sell company; no takers.

– Cumulative losses: about $350 million– Big layoffs, then pulls plug in early 2001 as cash runs out– K·B Toys, an 80-year-old toy retailer, purchased eToys' intellectual property and software on

May 17, 2001 and warehouse on August 9, 2001. eToys was re-launched on October 10, 2001.– More at

• http://www.etoys.com/help/aboutEtoysDirect.html• http://www.amazon.com/exec/obidos/tg/browse/-/227141//ref=halloween-stripe/002-0029230-1524853

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