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October 2000 |
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Heavy Weather
As market forces dash some e-retailers against the rocks, the rest lash themselves to the mast to ride out the rough seas
By Mary Wagner
When the NASDAQ goes down, sales of Evan Schwartz’s book go up. It could be the title, “Digital Darwinism”, which captures both the current mood on Wall Street and the corresponding unease among Internet retailers as an industry shakeout gathers steam.
“Stocks have been beaten to the ground and dot-coms are running out of money,” says Schwartz, a former Business Week editor and author of two top-rated books on e-commerce. “It’s getting brutal and there’s a struggle for survival.”
The scenario facing many e-retailers has by now acquired the reliability of a mathematical formula: sizzling cashburn rate + low customer numbers - needed financing round = dot-com start-up in trouble. Analysts forecast the failure rate for b2c e-retailers at 50-90% this year. A new study by turnaround specialists Getzler & Co offers yet another in a series of dismal snapshots from the e-retail landscape. Of 150 Internet companies tracked by the New York-based firm, 119 b2c companies have laid off staff or shut down altogether. Leading the industry-sector pack at 52 in number were e-retailers.
Being cautious has so far had all the panache of a Nehru jacket among retail’s pioneers in the go-for-it Internet economy. “The mantra has been, ‘First to market wins,’” says Andrew Bartels, vice president of Giga Information Group, Cambridge, Mass. “The feeling is if you’re not first, you lose. There’s been a whole lot less interest in being second—even if you’re better.”
The result has been crash-and-burns at speed that makes business development in the offline world look like life in the slow lane. But what’s apparent as the smoke clears is that being second can have unique benefits. There’s value for surviving e-retailers in failures that litter the landscape in the form of lessons learned, like the perils of overspending, and the risks of fuzzy value propositions—even the danger of sticking with entry-stage tactics as the market matures. Consider the well-publicized TV ad blitz during the Super Bowl, on which some newly hatched dot-coms spent millions. The mass media distribution reached multiple-millions of viewers who might never become customers, but companies wanted campaigns that got attention and created buzz. “That worked for one year,” says Schwartz. “Now there’s so much clutter you can’t stand above it.”
Bricks-and-mortar retailers just now moving online will not only get to leverage their existing physical world advantages but may also sidestep mistakes made by pure-plays who got there first. Shaken but still standing e-retailers have a chance to change course as newly acquired knowledge dictates. And as the market starts to reveal patterns in who’s making it and who isn’t, new rules for success are emerging in an industry that, more and more, is buttressing enthusiasm with experience.
Too many players
Given the frantic pace of dot-com retail launches, shakeout in the marketplace was built in. In fact, analysts have said forecasting it has been as easy as shooting fish in a barrel. Reason number one? The sheer number of b2c players on the field. “There just isn’t enough mind share and wallet share among consumers to spread out over the huge proliferation of sites,” says Rebecca Nidositko, Yankee Group analyst. “Venture capitalists who fund start-ups generally expect only 10-30% of their investments to succeed. From their perspective, it’s a given that the landscape would shake out. But some people forgot that rule. They thought that maybe everyone was going to be a winner.”
But in retail categories such as toys, pets and furniture, “a lot of category killers came out at the same time,” observes Heather Dougherty, digital commerce analyst at Jupiter Communications. Stronger players muscled out others where space was limited, pummeling a fair number of them into the ground or causing them to seek shelter in consolidation. Among the recently shuttered in the lifestyle and home furnishings sector are Foofoo.com, an online aggregator of luxury goods including home furnishings; furniture store Living.com and high-end home decor seller PuertaBella.com. Toysmart.com and Redrocket.com were toy sector casualties, while in the pet space, RIPs include Petstore.com, which was swallowed up by the larger Pets.com. And they won’t be the last to disappear. “The shakeout’s only a few months old at this point,” says Brian Mittman, vice president of Getzler & Company, New York. “A lot of companies have money to survive for a few more months. But we’ll see a lot more of them closing their doors in the next six months.”
Over-the-top spending fed into failures as start-up hopefuls tried to stand out in a cluttered landscape. The Super Bowl ads were just the tip of the iceberg. Internet companies including e-retailers spent $3.5 billion on advertising in 1999, about 16% of total sales, according to an Ernst & Young study. By contrast, Wal-Mart’s 1998 ad budget was less than 0.5% of sales, while Sears spent about 4%.
That kind of spending runs counter to most of the conventional wisdom in business development. But then, the Internet makes its own rules. “The Internet is a big-bang phenomenon,” says Bartels. “If you’re a brick-and-mortar store, you can launch in one market and replicate the model in the next market. Each time you do, you’re managing your marketing costs. But when you go on the web, you’re not confined to one city. You have customers everywhere.”
Or not, as some e-retailers who’ve invested big-time in advertising have found. “E-retailers have realized that they’re competing with click-and-mortar retailers and catalogers, whose customer acquisition costs were in the $10 to $20 range, while they were spending millions on broad TV ads, and their customer acquisition costs were $75 to $100. Right there you can see how much more value, transactions, and activity you need to get out of those customers,” says Barrett Ladd, an analyst with Cambridge, Mass.-based Gomez Advisors.
Some e-retailers are looking away from the short-term bump delivered by advertising to long-term promotional partnerships. “They’re going to become critical, and it’s critical that you have the right partner,” Ladd says. But it’s just as easy for companies to overspend for such deals. The recently closed Living.com, for example, had agreed to spend $145 million over five years to be Amazon’s exclusive furniture and home furnishings partner.
With much of the most visible online space concentrated at top sites like AOL and Yahoo, e-retailers have spent big on such opportunities, with no guarantee it will generate sales to justify the costs. Even so, it continues. A new study by PricewaterhouseCoopers says $1.95 billion was spent on web advertising in the first quarter of this year, a 182% jump over spending in Q1 99. Web-based companies buying ads in their own medium accounted for 12% of that spending.
Reports such as that just out by Media Metrix continue to tout online advertising as a traffic-builder. But whether traffic necessarily guarantees sales for e-retailers is another story, and some industry watchers believe it’s time to pull back. “Now is the time to say, am I better off giving $5 million to AOL or $1 million each to smaller sites and seeing what my benefit is from that,” says Mittman.
And it’s not just in the realm of advertising where e-retailers are paying—or overpaying—for partnerships. The struggling PlanetRx.com, an online drugstore, had an agreement with a pharmacy benefits management company that gave the company a 20% stake in PlanetRx as well as an annual payment of $14.6 million. In return, PlanetRx acquired the other company’s online prescription operation and got access to its customers. Was the partnership worth it?
“Giving almost $15 million to one partner when your annual revenues are only $36 million is excessive,” says one analyst. Beset by troubles, PlanetRx recently picked up $50 million in a financing round but remains far from stability by analysts’ reckoning.
Pinch those pennies
The bottom line in such tales is, well, the bottom line. A growing body of thought suggests e-retailers might do better resisting the temptation to win a big partnership if it means paying too much for it. A better bet? “Watching marketing costs very closely and measuring campaigns’ and partnerships’ true cost effectiveness,” says Mittman.
Technology developers have known for years that dislodging what’s established takes a product that’s a significant improvement over what’s available, not just a marginal one. Just look at what happened to 50 years of vinyl with the advent of smaller, more durable CDs. The same rule applies to online shopping, something many e-retailers either ignored or didn’t realize.
“A mistake online retailers made was to assume that all they had to do was mimic what happens in the offline world and apply it online—that added value wasn’t that important,” says Schwartz. “They thought that as long as you did a lot of mass media advertising and had nice prices and offered things like quick shipment, the convenience alone would enable you to survive.”
Pressed for more sales, a number of e-retailers have done what offline stores sometimes do: throw more SKUs at the problem. But the risk there is that already-wobbly web offerings could spread themselves too thin. More.com, for instance, an online drugstore, has added holistic products to a lineup of products that already weren’t racking up big sales, says Dougherty. “If you don’t already sell a certain number of SKUs well, adding more is not going to correct that problem,” she adds “Adding more selection is definitely not a good Band-Aid.”
What’s clear now is that to succeed, online merchants must deliver all the best parts of the offline experience to shoppers—and more. Analysts say one reason sales at Amazon ramped up so quickly is that the site dreamed up and offered unique features to web shoppers that they couldn’t get in a store, such as allowing them to write their own product reviews and recommending to shoppers other books they might like based on their personal profiles. “Catalogs have been around for decades,” points out Schwartz. “If all online shopping offers is the convenience of not having to go to a store, that’s not going to cut it.” Instead, to win, e-retailers must offer features that differentiate them from—and improve on by an order of magnitude—what other shopping environments offer.
A tale of two worlds
Short of scrutinizing partnerships to make sure they pay off and reining in spending, what can e-retailers to do to survive and thrive in the shakeout? Plenty, say the experts. (see “Online and in the Black”, p. 40.) Some companies are upping their chances of success by keeping their focus narrow. Take gift site RedEnvelope.com. “They don’t try to be a Wal-Mart and offer everything to everybody,” says Bartels. “Instead, they focus on finding the types of gifts people with good taste would like to give to their friends.”
Other companies are broadening focus to go after other opportunities. Ubid.com, for example, a consumer auction site, has announced plans to add a separate, dedicated site targeting the lucrative b2b market.
Many e-retailer also are spending on new technologies such as personalization tools to drive more sales from traffic already coming to their sites rather than pouring more money into increasing traffic. And when technology vendors are willing to accept payment per transaction, e-retailers’ upfront investment to add such features drops. Jeff DeCoux, president and CEO of personalization software company eCustomers, says even a small degree of personalization can go a long way toward serving shoppers better—and driving up sales. “Let’s say you walk into a general merchandiser in Minnesota in the middle of winter. It’s appropriate for you to see snow blowers. Walk into the same merchandiser in Texas, and it isn’t. Yet when you log onto their web store, you get a big blend of all the products they stock from point to point. Customers have a difficult time tracking down what they want. It’s a one size fits all approach, and we wonder why conversions aren’t more effective,” he says. The Austin, Texas-based company this spring rolled out software that transmits shopper preferences to participating web merchants as an anonymous score linked to corresponding demographic profiles that let the merchant instantly tailor web site content to the shopper’s interests. It also gives shoppers the ability to access and change their information to reflect what they want to see on different shopping occasions.
Perhaps the most important thing e-retailers can do is to recall and leverage what helped make the web so appealing in the first place. “What was so wonderful about the web had nothing to do with giving AOL millions of dollars or buying Super Bowl ads on TV,” says Schwartz. “It was these interactive features to build loyalty among customers that keeps them coming back. The great thing about the web is that it knows who you are.”
For that reason, e-retailers like Staples.com send periodic reminders with discount offers to regular customers, and LL Bean emails customers on sales coming up or when the new seasonal fashions are out. Such strategies to better leverage the existing customer base are winners, and merchants can make them work by getting to know customers in a way uniquely possible on the Internet.
While time will be the ultimate test of which e-retailers survive the shakeout (and how), industry watchers agree that the web is creating an entirely new business climate with new rules. Winners will adapt quickly, combining what’s best about the offline world with the best of what only the web can offer. “The dot-com’s have the advantage of moving fast,” says Schwartz, “but the traditional companies have the infrastructure, brands and distribution channels.” In the end, he says, it’s the hybrids that will win—and it won’t be the first time survival of the fittest has created an entirely new species. 
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