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Are Online Retailers An Endangered Species?

With the cost and complexity of offering an acceptable online purchasing experience declining dramatically and with search making it possible for suppliers to directly reach consumers, online retailers are increasingly looking like potentially expendable middlemen.

In the physical world, retailers add value to both consumers and suppliers in several critical ways.  First, they have skilled buyers that search the world looking to locate appropriate products which both opens up new markets for suppliers and brings new goods to consumers.  Second, they have large networks of stores that offer consumers a consistent shopping experience and manufacturers an attractive distribution channel.    Third, they use marketing to generate strong brand awareness and consumer demand.  Fourth, they use merchandising skills to increase sales and improve the overall shopping experience.

Initially, most of the “value add” of physical retailing translated well to the online world.   Early on it was incredibly difficult from both a technical and operational standpoint to build and operate an online store with a decent shopping experience.   Not only did building a credible website take a lot of money, but building out the back-end fulfillment infrastructure necessary to actually ship products to consumers was also prohibitively expensive.  That made the few online retailers that got it “right” very valuable distribution channels to both suppliers and consumers.  Brand also played an important role given the relatively immaturity of the channel and significant consumer concerns regarding the security and reliability of online retailing.  This made online retailers with good websites and brands highly attractive to both consumers and suppliers.

Over the past ten years however, a number of new developments have eroded the value-add of online retailers to the point where these days they often add little more than excess costs to the process.    Some of most important developments include:

  1. Reduced technology costs:  In the 1990’s it cost a lot of money to build and operate a first class online retailing website.  Not only were hardware and bandwidth costs very high (as outlined in this excellent post), but the costs to hire and retain the few technical people who actually knew how to build and scale a decent website were extraordinarily high (that is if you could even find them).  Today, there are a number of excellent e-commerce software products that can be bought for a relative pittance and the pool of competent technical people that can build and run an online store is exponentially larger.  In fact, some start-ups are even offering “all you can eat” e-commerce services for seemingly insignificant sums compared to what major companies paid just a few years ago.  Take Venda for example.  They will design, build, host, and maintain a truly first class website for a flat fee of $10,000/month.  No up front costs at all. (And they even claim to be profitable.)  If you check out some of their sites such as this one or this one or this one, you realize that ten grand a month certainly goes a long way these days.
  2. Familiarity:  At first, only the intrepid few made online purchases.  These days online purchasing is increasingly a mundane mass-market activity.  As a result, consumers are becoming accustomed to the conventions of online purchasing such as the “shopping basket”, the “checkout process”, the confirmation e-mails, the package tracking, etc.  As the online shopping experience becomes routine, consistent, and predictable across websites, consumers are bound to become increasingly indifferent to which particular website they make their purchase on thus lowering the value of online retail brands.

  3. Outsourced logistics:  Over the past 10 years a large number of companies have entered the business of offering online retailers outsourced warehousing and logistics.  Competition between these companies has driven down prices and made the business fairly efficient.  Some companies, such as GSI Commerce, have even gone so far as to bundle outsourced logistics with hosted websites thereby dramatically reducing the start-up costs for an online retail presence.
  4. Search:  In the early 1990s search technology was relatively poor and largely limited to site level-directories.  Google changed all that by creating a much more comprehensive and relevant search experience.  This has now made it possible for detailed product-level searches that reveal not only comprehensive product information, but also a large number of potential purchasing channels. Search, in effect, devalues online retail brands by enabling consumers to think and act in terms of products rather than sites.  Yes, a brand can still stand for things like “great customer service”, but when retailers are selling the same product via a very similar web experience and in some cases even the same fulfillment and logistics back-end, trying to convince a consumer that they are should pay a higher price for choosing one site over another is a hard sell.   

Going Direct?
For suppliers, the Internet’s low costs and universal reach combined with search’s ability to readily generate high quality sales prospects presents a tempting opportunity to cut out the middleman.  In the past, suppliers have been loath to “go direct” to consumers for fear of alienating their powerful retail partners.  Even today many suppliers still just have “product information” websites and refer potential purchasers to retail partners or if they do sell their products on their website they sell them at full list price  (which is typically much higher than the “street” retail price) in order to prevent any “channel conflict”.

However as the internet becomes a universal mass-market channel, suppliers have to wonder whether or not it is really worth it to allow online retailers to mark up their goods by 30%, 50%, even 100%.  Why not cut their retail prices by 15-25% and go direct to consumers?  This would have been suicide when the Internet was such an immature channel, but now that the Internet is a mass market channel there’s a chance that any sales lost to the retail channel (both online and offline) will be more than offset by the additional margin generated by a “direct to consumer” Internet channel.

What’s A Online Retailer To Do?
For online retailers then, the writing is on the wall:  If they don’t figure out new ways to add value to consumers they are in deep trouble.  Indeed, even if their suppliers don’t go direct, the same trends that make such a move possible also make it incredibly easy for incremental retail competitors to enter the market.  So online retailers face two rather unappealing fates: they will either get undercut by their own suppliers on pricing or face increasing competition from a bunch of low-cost “me too” sites.  The odds-on bet is that they will ultimately face both. 

Fighting these trends will require some creative thinking.  At the highest level online retailers will have to focus on how they add value to consumers and suppliers outside of just distribution and brand.  For example, some online retailers may find may need to build out extensive lines of private label merchandise (a la Sharper Image), or they might find it necessary to build customer loyalty schemes (a la Amazon’s shipping subscription).  In any event, they will find it necessary to do something, because in the absence of doing something they will eventually end up in the middle of nothing

April 13, 2005 in Internet | Permalink


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The thoughts and opinions on this blog are mine and mine alone and not affiliated in any way with Inductive Capital LP, San Andreas Capital LLC, or any other company I am involved with. Nothing written in this blog should be considered investment, tax, legal,financial or any other kind of advice. These writings, misinformed as they may be, are just my personal opinions.