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ONLINE RETAILING: THE RUMOURS OF ITS DEATH HAVE BEEN GREATLY EXAGGERATED

Posted on November 12, 2001

      There's an old saying in the fashion industry that goes: "All fashion ends in excess." Apply that philosophy to the dot-com arena, and you have a pretty good picture of the now-infamous rise and fall of online retailing (and just about any other Internet-based enterprise).

      It was a world of excess, indeed. The rise of the dot-com empire was meteoric and the introduction of new online ventures widespread. But the fall was equally spectacular - leaving pundits, retailers and venture capitalists alike sifting through the carnage to figure out just what went wrong. There are a lot of reasons why things didn't work out for the new wave of dot-coms. The investment well, which initially overflowed, ran dry. Gross miscalculations were made in terms of the cost of doing online business, profitability, rate of adoption, and one of the critical elements for any retail enterprise - good old-fashioned human behaviour. Return on investment proved to be a long, long way off, and few had the patience or resources to wait for it.

      Yet, after all this, and contrary to rumours of its demise, the online retailing story is not dead. It is, however, in the process of being resurrected in a very different form, without the glitz and the glamour. The key now, the experts say, is for retailers to take note of all the errors made during the early, uncharted days of Internet retailing and determine the next steps in developing a "saner" online strategy - one that makes sense for their business and, more important, is based on realistic expectations.

      "It's far too soon to give up on online retailing; [retailers] just have to change the way they look at the Internet," says Rick Broadhead of Rick Broadhead & Associates, a retail consultant and co-author of 30 Internet books. "The last couple of years was a learning curve for everybody. It's not as if there was a game plan or a map."

An old tale repeats itself

      Ironically, according to the experts, the shakeout for online retailing is a very familiar story that's been told time and time again.

      "Is what happened typical? Absolutely," says Ilya Bahar, leader of the Retail and Consumer Products Practice for PricewaterhouseCoopers in Toronto. "It's the same as any new business explosion. You have the gold rush first. Just look at the electrical, auto or railway industries when they began. The fact is, 95 per cent of new companies fail. History is no different this time.

      "The only thing that was different this time is that expectations were much higher," he adds. "People saw it as the new industrial revolution. Some went so far as to call it the new economy operating under new rules. That just wasn't the case."

The beginning of the end

      Luke Sklar, founder of Sklar Wilton & Associates in Toronto, says the early warnings of trouble for dot-coms became apparent in the early spring of 2000, when Barron's published an article by Jack Willoughby entitled "Burning Up: Warning: Internet Companies are Running out of Cash - Fast" that predicted the coming rout. Shortly thereafter the dominoes began to tumble one by one, with the front-line troops - the pure play dot-com retailers - taking the hardest hits.

      "When boo.com went down, the whole thing began to fall apart," says Sklar. "It was considered the 'poster child' of the dot-coms. It was so hyped, so cool, so fashionable - but it made absolutely no economic sense."

      Jim Dion of Dionco Inc. in Chicago says, "Boo.com had the arrogance to say that bricks and mortar was over and that we were entering a new economy. They burned through $67 million in capital in six months." And that was that - boo.com went out in a blaze of glory.

      It was just the beginning of the end for many online retailing ventures in the pure play arena. As it turned out, bricks-and-mortar retailers feeling threatened by the new wave of Internet shopping pure plays had little to be concerned about. The anticipated competition simply did not make the expected inroads into their domain.

      Instead, the dot-com casualty list grew exponentially as armies of Internet entrepreneurs with big ideas spent millions of dollars launching retailing ventures without showing a penny in returns. Then, the venture capitalists woke up and decided to stem the bloodletting by closing ranks.

      "The dot-coms spent way more than they were making," says Sklar. "And when they went back for more, no one was willing to cough up the cash," adds Broadhead.

      Meanwhile, the list of failed ventures kept expanding: petopia, eToys, garden.com, webvan, egghead.com, and so on. "One by one, dot-coms were booted off Nasdaq and sent into exile," says Broadhead. "Once they got kicked off, it was downhill from there."

Bricks, clicks and lessons learned

      While online retailing pure plays virtually got wiped out in the purge - with the exception of a few stalwarts such as amazon.com (who have yet to turn a profit) - the online retailing arms of many bricks-and-mortar retailers proved disappointing as well. The cost of entry for many was higher than expected, consumer adoption lower, and return on investment proved to be much further afield than originally predicted. And like any newly charted territory where the rules are made up along the way, some companies made very bad business decisions.

      "In-store retail bricks and mortar really suffered as they went to the new model," says Dion. "Most retailers bought into the panic to the detriment of their bricks-and-mortar operations and took their eye off the ball."

Identifying the mistakes

      Mistake number one was excessive optimism - which had no basis in reality. Initial expectations for online sales were astronomical, with some predicting they would reach as high as 20 to 30 per cent of overall retail sales. With those numbers in mind, some retailers decided to spin off their dot-com businesses as separate entities. "They thought they would spin off the online operations and do well," says Broadhead. "They didn't want the entrepreneurship of the dot-com to be burdened by bricks-and-mortar operations." Now, he says, just about all of those retailers have brought their online retailing operations back into the corporate fold.

      But as with everything else with the dot-com phenomenon, the online retailing bubble quickly burst and the anticipated percentages simply weren't there. They were, in fact, downright dismal. According to Broadhead, only 0.2 per cent of retail sales in Canada today are conducted on the Internet.

      Dion reports that a recent study done by Dionco and Nortel indicates that by 2004, with the most optimistic projections, bricks-and-mortar will still represent 87 per cent of all retail sales in North America. "It's evident that the Internet was not going to be the way everyone shopped."

Flawed Models

      Mistake number two was the adoption of bad business models. According to Broadhead, those that failed "didn't fail because the Internet doesn't work. It's because it was a flawed business model from the outset. Many retailers ran into problems above and beyond selling on the Internet. Some had great ideas, but the business plans were ridiculous - such as selling products below cost and generating revenues through advertising, or not having the tools to track orders properly or process returns."

Wrong numbers

      Mistake number three was underestimating the cost of online retailing. Broadhead points out: "They initially thought online retailing would be a low overhead extension of the business. The opposite is in fact true. There are costs associated with setting up the site, credit card expenses, fraud, shipping and handling, site design and updates, merchandising - there's a lot you need to consider. Returns, for example, can kill an online retailer."

Old habits die hard

      Then there was the final fatal error: underestimating human behaviour. People like to shop in person, but the Internet is not a social median. "Technology may move very quickly but people don't," says Dion. "People are still very social animals. It's not in their nature to lock themselves up in a semi-dark room to order on the Internet rather than go out for a beer and go shopping to try things on."

      Studies show, he adds, that although initial usage of the Internet is very high, "over time that surfing behaviour drops dramatically, and humans will revert to tried-and-true habits. Humans are creatures of habit after all."

      Ron Swift, Vice President of Customer Relationship Solutions at Teradata, a division of NCR Corp. in Dayton, Ohio, confirms that in its initial permutations, Internet shopping just didn't cut it with consumers. "The activity on the part of the consumer was relatively boring. There was little interaction. It wasn't exciting nor did it offer a unique customer experience. It's like going on a date where only one person does the talking ... it was boring. And boring means fewer orders."

Keeping heads above water

      For a lot of retailers who dipped their toes in the dot-com waters (or leapt in head first) e-tailing may not have been a rip-roaring success on the first go-round. But some did fare better than others. Retailers with a history in the catalogue business, for one, have done consistently well, because they have the back-end infrastructure in place. "They understood the supply chain, call centres and delivery requirements" says Sklar.

Product categories are also a factor

      "When it comes to products that don't depend on egos or are small volumes, such as CDs and books, the Internet has a higher value," says Bahar. "Other items, like apparel, where ego is a big issue, or for groceries where shipping costs are high, it's a harder sell. There has to be more motivation than just convenience." He cites travel and financial services and other research-intensive categories as areas that lend themselves to online success.

      Integration between operations is yet another critical factor. Retailers that have managed to integrate their store and online operations seamlessly are among those that will eventually reap the benefits of online retailing.

      "Retailers will continue to evolve to a multi-channel model," says Bahar. "They have the buying power pure plays don't have. Pure play e-tailers will probably be niche players and will only succeed where they can offer a new proposition to customers, such as auctioning on eBay."

E-tailing: The next generation

      Despite the perils and pitfalls there is considerable cause for optimism. According to Bahar, "Retailers have to look at [the Internet] like any other retail proposition. What is the value proposition for the consumer, and is it the same as the in-store experience? If you can offer range, price, delivery and/or convenience, you can be successful."

      Broadhead agrees that the Internet "is an important business channel and retailers have to be there. With 51 per cent of Canadian households now on the Internet, there's no question you should be there; it's only a matter of in what form, and how far you plan to go with it. Just be practical and sensible in how you use it, and don't end up with a bloated infrastructure. One of the first questions to answer is: Before I go on the Internet, can I turn a profit? Can I sell enough products? Are my margins enough?"

      "Is the Internet valuable as a dialogue with customers?" Sklar asks. "Absolutely. Research shows that if a consumer researches you on the Internet, they are far more likely to buy in-store. Consider it as part of the cost of competing. Just don't be stupid about it, and be cautious. Understand the needs, wants and demands of your customers. Start small and build - and don't blow your brains out."

      NCR's Swift agrees that the Internet will continue to be essential for retailers, but says right now there's much work to be done on the back end to achieve that elusive profitability that online entities are still seeking.

      "B2B is going to be where the focus is during this second round of online retailing. Increasing revenues will not necessarily make you profitable. B2B services in the way of exchanges, supply chain, parts ordering, etc. will help companies give the right product at the cheapest price."

      Retailers should remember that above all else, online retailing is still a brave, new world - less than five years old as a matter of fact. There's still much to be learned and experienced. While it isn't a category that's going to necessarily dominate the retail scene, it has a lot of time and life left in it. It's just a matter of finding the right balance - and keeping a level head.

E-Commerce Alerts are issued by Bennett Gold LLP, Chartered Professional Accountants as situations develop. Bookmark this site and check back often. Our e-mail address is: info@BennettGold.ca

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