E-commerce’s pesky little profitability problem

Online-only retailers have attracted huge amounts of investment capital during the past decade. Flash-sales sites such as Gilt and RueLaLa have collectively raised hundreds of millions of dollars. Rather small, but rapidly growing, specialty players like Bonobo’s, Warby Parker, One Kings Lane and Birchbox have all recently raised tens of millions of dollars and now have valuations approaching $1 billion or more. Net-a-porter, perhaps the strongest global fashion e-tailer, was purchased by luxury powerhouse Richemont for more than $500 million in 2010 and is reportedly being shopped for a multi-billion dollar price tag.

And on and on.

The pesky little problem–the seriously nagging and increasingly pressing issue, is that the vast majority of even the most established players don’t make any money and few have any prospect of doing so any time soon.

The bulls say that all trends point to the eventual dominance of e-commerce and that these brands must invest heavily in critical infra-structure, acquiring new customers and building their brands. Today’s heavy losses will yield category dominance and ungodly riches just a few years down the road. While I’m fairly certain that this will be true for a handful of today’s industry darlings, for most it’s likely to end badly.

Aside from consumer preference shifting toward online shopping, e-commerce seems to have important economic advantages, most notably avoidance of capital investment in physical real estate. In addition, by centralizing inventory in a few locations–or having a “buy it only when you sell it” model–the potential to streamline logistics costs and generate very high inventory productivity is significant. Digital-only marketing strategies also create the opportunity to serve customers more cost effectively than traditional sales and marketing tactics.

But here’s where reality starts to set in and why many e-commerce only models are profit-proof at any kind of reasonable scale.

While fixed costs are lower for pure-plays, marginal costs can be very high. Most hyper-growth companies find it initially fairly easy and cost-effective to acquire their “best fit”and most loyal customers. Consumers that are prone to gravitate to a disruptive business model often “get it” quickly and are great at spreading the word. They tend to return fewer items and aren’t as likely to need a deep discount to spur a purchase.

Unfortunately, growing beyond what I call the obsessive core, tends to be much more expensive and difficult. Acquisition costs rise dramatically. Big discounts are needed to drive conversion. Return rates are much higher. Assortments need to expand to create greater interest. Cost and complexity follows. Many of the new customers that contribute to higher sales, never have the potential to be profitable.

In fact, one of the reasons we are seeing many of these high growth brands now aggressively investing in physical stores is that they are finding it too difficult and expensive to acquire and serve new customers purely online.

So while it’s true that fixed costs are favorable in a pure-play model, it’s the dynamics of marginal profitability (and the associated variable costs) that ultimately determine the long-term viability of an e-commerce brand. And this will prove to be the Achilles Heel for many of today’s highly valued players.

It’s easy to extol the wonderful customer service delivered by Zappos, the incredible marketing and design from Bonobos or the overall awesomeness of Amazon. But lest we forget, it’s not that hard to be awesome if you aren’t required to make any money. It’s one thing to love these brands for the experience they deliver (which I do). It’s an entirely different thing to earn a return for the risk you are taking as an investor.

So far, the only winners from the advent and rapid growth of pure-play online shopping have been consumers and a small group of investors and entrepreneurs lucky enough to cash out at the right time.

Certainly Amazon could be profitable tomorrow if they wanted to (well, more accurately, if they could deal with a collapsing multiple). And a few e-commerce only companies ARE building strong brands and appeal to enough target consumers to eventually make real money. For this short list it is, in fact, just a matter of time.

But for the rest, don’t believe the hype. And proceed with caution.

 

 

 

 

 

Taking Pitches

In baseball we often see a batter “take a pitch.”  In other words, before the ball is thrown the batter decides he’s not going to swing regardless of how good the pitch is.  Sometimes this is a tactic to tire his competition–the pitcher–out.  Sometimes it’s an attempt to draw a walk because that’s the best the batter can hope for under the circumstances.  Sometimes it’s a strategy to wait things out, figuring a better opportunity will present itself later.

Lots of businesses take pitches.

When Sears allows discounters and category killers to erode their core customer base and chip away at their dominant market share, they are taking pitches.

When Blockbuster fails to mount a compelling response to NetFlix and Redbox, they are taking pitches.

When Neiman Marcus, Saks and Nordstrom allow flash-sales sites like Gilt and RueLaLa to build brands with significant market value, they are taking pitches.

When dozens of companies deny the future of social networking and location-based marketing, they are taking pitches.

Of course there are times when it makes sense to wait things out–to study and analyze before placing a big bet.    Customer-centric companies know who their most important customers and prospects are, and when the metrics on those customers deteriorate, they dig in to understand the drivers and take action.

You don’t always need to swing for the fences, but it’s hard to win without a few hits.

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Members only? Or “Members Only” jacket?

A powerful component of customer engagement is providing scarce, exclusive and relevant experiences that reinforce your brand positioning.

“Members Only” or “By Invitation Only” marketing programs can be compelling messages that tell your customer that you truly appreciate their business.   For years leading luxury retailers such as Bergdorf Goodman and Barney’s have feted their best customers with private lunches, exclusive parties or access to fashion designer “meet and greets.”  More accessible retailers like J. Crew and Nordstrom use their loyalty programs to reward members with unique privileges such as free alterations, early notice of new merchandise arrivals or special shopping hours.  In all cases, the customer is granted access based upon some meaningful qualification, typically spending level or loyalty.

But another kind of marketing seems to be gaining momentum, and it’s best illustrated by the flash-sales sites such as GiltGroupe, HauteLook and BeyondTheRack.  These businesses are growing dramatically–RueLaLa recently reported that their sales doubled year over year–and one of their hooks is that their low prices are for “members only.”   So what does one have to do to qualify to be a member?  Having a legitimate e-mail address is just about all it takes.

In the early 1980’s “Members Only” jackets quickly became all the rage.  If you wanted the world to know how cool you were, a “Members Only” jacket gave you quick access to an exclusive club.  But it wasn’t long before just about everybody had one and what propelled the brand soon eviscerated it.

There is ample evidence that, for a while, you can get away with hooking customers with faux exclusivity.  But just because you can, doesn’t mean you should.  Deep levels of engagement and loyalty are not built on smoke and mirrors; rather they are built on forging relationships rooted in respect and trust.

Authenticity matters.

Does your marketing look more Members Only or more “Members Only” Jacket?

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“Faux Clearance”: Do Outlet Store Customers Care?

One of the hottest retail segments right now is the outlet or off-price market.  Nordstrom, Saks and Neiman Marcus are opening more “clearance” stores than full-line stores.  Bloomingdale’s and Lord & Taylor have recently announced plans to open their own off-price formats.  Hundreds of manufacturers’ outlet stores from Ralph Lauren to Coach to Nike can be found throughout the country.

As I have learned in recent conversations with everyone from neighbors to business reporters to industry analysts, very few customers realize that the vast majority of product in most of these stores is NOT manufacturers’ overstocks or unsold merchandise from the full-price retail stores, but is in fact produced specifically for these stores.  I call this “faux clearance.”

Certainly these stores benefit from the impression that the reason you are getting such a great deal is that they had too much merchandise and had to mark it down to move it.   Their promotional material trumpets 30%, 40% (up to 70%!!!!)  off to reinforce that notion, when in fact in most cases that identical product has never been available anywhere at the “manufacturer’s suggested retail” or “compare at” price.  Deceptive? You decide.

With the retail outlet segment exploding–and the dramatic growth of “flash-sales” sites like Gilt and Rue La La–the reality is that the percentage of directly made for the channel product will only continue to rise.

So if you buy my premise that most customers of these store and sites do not understand the origin of the product in these channels–and btw if anyone has seen good data on this send it my way–would knowing actually change their behavior?

My guess is no, and here’s why.   The players that have been really successful in this market–one great example is Nordstrom Rack–understand that the core customer for these formats is a different customer than their full-line stores and have built the business model accordingly.  This is why Nordstrom can build a Rack store across the street or down the way from their full-line store and still thrive.  This is why we decided to accelerate the growth of our Last Call stores at Neiman Marcus and began work on a new concept.

The challenge going forward will be to consistently execute a compelling value proposition–and that means delivering an experience that complements the parent brand without diluting it and reliably offering great value in the product assortment.  This latter factor is not so easy, particularly as the demands of this channel increase dramatically.

But ultimately if these formats offer compelling price value in their assortments and a great customer experience, why should the customer care exactly why the product is being offered for sale?

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