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.

 

 

 

 

 

Different, not dead: The future of brick & mortar retail

“Reports of my death have been greatly exaggerated.” 

Mark Twain*

Media reports highlight the dramatic shift of spending from traditional stores to e-commerce. Industry analysts and pundits predict the demise of brands with substantial investments in retail real estate. We live in an increasingly virtual world, they say, and those with deep roots in the physical realm are starting to look more and more like dinosaurs.

The transformation of shopping fueled by all things digital is profound with no signs of deceleration. The crazy little thing called the internet is changing virtually (pun intended) everything. But anyone who thinks that brick and mortar stores are going away has it wrong. Here’s why.

Brick and mortar retail can enhance the value proposition. Physical retail offers many important advantages–the ability to see and try on products, instant gratification, face-to-face customer service, social interaction and so on–that digital selling cannot readily replicate.

Purchase events matter. There is a reason that e-commerce penetration in many product categories remains low. Where the risk of buying online is perceived as high (apparel, many big ticket items), direct-to-consumer shares remain in the single digits. Brands like Zappo’s have innovated in customer service to overcome some of e-commerce’s limitations, but long-term growth potential is modest. In fact, e-commerce darlings like Bonobos, Nasty Gal and Warby Parker have begun to broaden their reach–and address flattening growth–by opening physical stores. Plenty of products–particularly perishables and low-priced items–also have underlying economic reasons why direct selling volume will remain constrained.

Consumer segments matter. Great customer intimate brands embrace the notion of treating different customers differently. When you do this, you understand the different needs, wants and behaviors of varied customer types. Depending on the product and the particular consumer, the purchase journey may begin and end at a physical store. For others, they will never set foot in a brick & mortar location. Others will research online and buy in store. You get the idea. Your mission is to understand the role your physical locations play in being intensely relevant and remarkable for the customers you need to attract, retain and grow. Then build out and customize the experience accordingly.

The blended channel is the only channel. Stop thinking channels and start thinking about a consistent, integrated customer experience for your brand. Other than products and experiences that can be delivered completely digitally, the majority of retail purchases are influenced by both the digital and physical realms. More and more data is emerging to confirm this. Your mileage will vary, but silo-ed thinking, organizations, incentives and metrics confuse, rather than illuminate.

Frictionless commerce is essential. Let’s be blunt: there’s more heat than light in the discussion of omni-channel capabilities. Strategically, the key is to hone in on how to be differentiated, relevant and remarkable for the customers you wish to serve. And then you must root out the sources of friction in your customer experience. With more consumers going back and forth between digital and physical channels in their decision journey, if you don’t make it easy to do business with you chances are there is a competitor who is ready to pounce.

Mobile adds value to physical retail. When e-commerce was either sitting at your home or office surfing the web, the distinction between digital and brick & mortar really meant something. Now with consumers untethered and having increasingly powerful devices with them 24/7, mobile becomes the great integrator–and makes the distinction between e-commerce and brick & mortar less relevant all the time.

Seismic changes ARE impacting retail. With the exception of companies in the early stages of maturity, most retailers need fewer stores and many of the stores they have will need to be smaller. But assuming that physical retail is going away any time soon is just plain wrong. The tendency to isolate e-commerce and brick & mortar performance is equally misguided.

Amazon and a handful of best-in-class e-commerce companies will continue to thrive. And new pure play digital models will undoubtedly emerge to captivate consumers and gobble up share.

But there is plenty of business to be done in physical stores. Less, but still plenty. And most of the growth in what is counted as e-commerce is not a shift to online-only brands, but rather to brands that have cohesive omni-channel strategies. Think Nordstrom and Macy’s so far. For them, stores are assets, not liabilities. But the way brick and mortar retail drives consumer engagement and loyalty is morphing quickly.

These emerging winners follow a simple but compelling formula:

More focused.

More differentiated.

More relevant.

More remarkable.

More personalized.

More integrated.

See you in the blur.

 

* This isn’t, apparently, the actual quotation, but one that has become part of his folklore.

A faster horse

“If I’d asked customers what they wanted, they would have said ‘a faster horse’.”

– Henry Ford

For me there are two lessons to take away from this famous quotation.

First, of course customers have a hard time articulating precisely what they want. Few customers are inventors.

But if you listen carefully you can hear the source of their dissatisfaction, the compromises they are forced to make. And you can attack those. You can glean that they want a hole, not a drill. Or a place to shop that doesn’t require them to drive twenty minutes, navigate a vast mall or store and settle for what one particular merchant happens to have in stock that day.

The second lesson is that a truly remarkable and powerful new business model rarely is an incremental iteration of a current one. Zappo’s doesn’t look much like your local shoe store.

So if you are hoping your consumer research is going to design the next great thing for you, you might want to change your expectations.

If you are working on a cheaper, smaller, faster, sturdier, lower calorie, better tasting, or whatever version of the particular horse you are riding, you might want to think again.

And if you think opening on Thanksgiving is the cure to what ails you, prepare to be disappointed.

Let’s get digital…digital

The first wave of digital retail was either about brands with a history in catalog merchandising putting up a basic e-commerce site (Williams-Sonoma, Lands’ End) or pure-plays picking off products categories that early adopters could readily embrace (Amazon). The market dealt harshly with models that could not execute a basic direct-to-consumer formula, targeted a product category that wasn’t ready for digital prime time (RIP pets.com) or a combination of both.

As consumers became more comfortable with buying on-line–and retailers got better at deploying new technologies–other categories made sense for pure-plays (Blue Nile, Zappos) and traditional retailers ramped up their multiple channel strategies. For most, this second wave was largely a silo-ed approach with the e-commerce and the bricks and mortar divisions pursuing related, but mainly independent, strategies.

In the most recent third wave, a few retailers (I’m looking at you Nordstrom) understood that most of their customers were interacting with their brand across multiple channels and touch-points. They accepted that brand trumps channel, that digital was transforming their business forever. They declared that silos belong on farms and began investing in a more integrated, customer-centric experience, leading with digital more often than not.

In the next wave, the blended channel is the only channel. The distinctions between devices, channels, touch-points and media begin to blur. Differences with little distinction. Or differences that lead to extinction if your core value proposition can be delivered better, cheaper, faster digitally.

Clearly not every product category is going completely digital. Groceries looks pretty safe. Cars too.

But failure to understand how digital transforms the customer discovery, engagement, purchasing, retention and advocacy process is a prescription for your brand’s demise.

So let’s get digital. Let me hear your actions talk.

Reset! Engaging Customers in the New Normal

If you missed the webinar that Jon Giegengack and I conducted earlier this week entitled Engaging Consumers and Growing Market Share in the “New Normal,” the recording of the session and presentation deck are now both available.

Webinar recording:

https://cmbinfoevents.webex.com/cmbinfoevents/lsr.php?AT=pb&SP=EC&rID=2764867&rKey=b264f15e93796eb1

Webinar deck:

http://www.cmbinfo.com/cmb-cms/wp-content/uploads/2010/10/The-New-Consumer-Report_2010.pdf

Expensive & Lousy Meets Free & Excellent

I just got back from Chicago where I spoke at the annual Shopper Insights in Action conference.  It was a great trip, but one of the things I will remember the most is a very disappointing experience I had at the host hotel.

At this hotel (which shall go nameless, but it rhymes with lariat), I was charged $14.95 for daily “high-speed” internet access.  Putting aside whether hotels should charge for web access–they shouldn’t–my primary complaint was that the service was far from high-speed.  In fact, it barely worked at all.

After a full day of trying to get my email account to even load properly, I finally relented and called the toll-free help line.   After half an hour on the phone with the support person listening to them spew indecipherable technical jargon and trying various things to increase my connection speed–most of which involved limiting service for other folks in the hotel–we concluded that this was a long-term problem at this location, likely caused by their not having upgraded their infra-structure.

Expensive & Lousy.

Ironically, the next day as part of my conference presentation, I shared the Zappos success story to reinforce the importance of using remarkable customer experiences to win in an intensely competitive market.  As you may know, part of Zappos growing reputation for legendary customer service is that delivery of their product is free–both for the original shipment and for any returns.  Moreover, Zappos will often upgrade the customer to overnight shipping at no charge.

Free & Excellent.

Of course, we cannot just randomly give away high value products and services.  But as brand stewards, minimally, we don’t have to call attention to the things that represent an obviously bad value, nor do we have to reinforce the notion that we are using every opportunity to nickel and dime our clients (I’m looking at you credit card and airline industries!).

Remarkable is a choice, and we get to decide which elements of our business model and brand promise create the wow, the buzz, the purple cow.  It’s not always easy or practical to deliver the Free & Excellent.  But you can certainly stop the Expensive & Lousy.