Finding Sustainable Profitability in Electronic Commerce

1. Finding Sustainable Profitability in Electronic Commerce Management Analysis Summer 2001

2. Why Study E-Commerce Strategy? • E-Commerce companies are extremely difficult to value in terms of profits or assets • Phenomenal stock price appreciation plus a great deal of volatility • Many investors prefer to own small and unprofitable e-commerce companies vs. large, profitable traditional retailers • Billions of dollars and thousands of the brightest business minds are riding on e-commerce wave

3. What Can We Learn? • Discriminate between types of e-commerce that will be attractive and profitable vs. those that will end up as commodities • Understand the role of product quality, information transmission, reputation and risk in the context of market structure and company capabilities AND

4. What Can We Learn? • Market segmentation analysis sheds light on the industry and product characteristics that drive profitability • Develop segment specific strategies to reach above average profitability

5. All Goods Are Not Equal • We must examine the extent to which goods differ in the ability of consumers to ascertain the quality of products in cyberspace Quality is easy to judge on the web Quality is hard to judge on the web • Commodity Products • Oil, Paper clips • Quasi-Commodity Products • Books, CDs, Videos • “Look and Feel” Goods • Suits, Homes • “Look and Feel” Goods with Variable Quality • Produce, Art E-Commerce Product Continuum

6. Commodity Products • Quality can be clearly and contractually articulated and conveyed and determined easily by product description • Actual maker of the product is unimportant, except in extremely high-performance construction situations • Title and specifications convey complete information about quality and other characteristics • Consumers care about correct characterization of the products, price and terms of delivery

7. Quasi-Commodity Products • Considered differentiated products, not commodities • However, once the specific product is chosen by a consumer, it is identical across vendors • No difference in quality, content, or condition if shipped properly • Consumers make choices in two-step process • Find the specific product • Select lowest priced vendor

8. “Look and Feel” Goods • Consumers need to actually touch, feel, try on, or see these products in person before they buy • Quality is very difficult to assess from afar • Competing products differ in quality, look, feel and reliability • Unbranded products have difficulty competing with branded products on the web – consumers may be reluctant to buy a product of unknown or less than fully known quality

9. Look and Feel Goods with Variable Quality • Even if the buyer has completed the search, knows the product, and recognizes the brand, she/he will need to see, feel, and touch the individual product • Each and every individual product is different and needs to be examined before purchase

10. Refinements to Framework • As you move from left to right on product continuum • Intensity of consumer experience increases • Other aspects of buying process change • How much more information the seller has about the product than the buyer • Need of the consumer to search for optimal goods • Degree to which seller reputation is important • The purpose of the product and the need to engage in searching might determine the segment to which the product belongs

11. Selecting Markets and Competitive Advantage • Sources of competitive advantage differ across product segments • The market the company chooses to serve should determine the preferred strategy

12. Commodity Market Strategy • Industry structure inherently unattractive • Companies are “price takers” • Held in check by customers who shop around for the lowest price • Market power is very hard to obtain • Only viable strategy is to drive down costs • Take advantage of economies of scale • Utilize low-cost production technology • Achieve efficient distribution and low overhead

13. Quasi-Commodity Market Strategy • Entry into market is easy • Strategic challenge is to differentiate in the search process and insulate from price competition in the purchase stage

14. Quasi-Commodity Market Strategy • First Stage - Differentiate via • Info technology • Search engines that match consumer preferences • Data base management tools • Make web site sticky – encourage shoppers to stay on site • Offer one-stop shopping • Seek first mover advantage • Establish e-commerce branding

15. Quasi-Commodity Market Strategy • Second Stage – Low Cost and Differentiation • Take advantage of economies of scale • Seek preferential treatment with wholesale suppliers • Ensure that delivery of product is reliable and timely • Offer additional customer services such as chat rooms, affinity programs, and other Web-site stickiness technologies • Offer site-specific customer loyalty programs • Strong e-commerce brands can signal quality in reliability of delivery, security of personal info, dependability of return policy, general customer service

16. Look and Feel Market Strategy • How can e-commerce retailers provide consumers with look and feel over the Web? • Vertically Integrated Firms – Full Differentiation Strategy • Establish equivalent of store brands • Incorporate latest technologies to convey look and feel to consumers • Excel at online customer service with both interactive and phone customer support • Offer industry-leading warranties and return policies

17. Look and Feel Market Strategy • Hybrid Firms Require Additional Differentiation • Use creative pricing strategies – time based preferences • Provide showrooms to display merchandise • Develop bifurcated back-end logistics and delivery systems to ensure on-time delivery in showrooms and to homes

18. Look and Feel with Variable Quality Market Strategy • Customization Strategy • Keep abreast of and use advances in Web-cam technology • Combine Web-search technologies with delivery logistics to deliver precise items viewed on the Web • Develop build-to-order technical capabilities

19. Look and Feel with Variable Quality Market Strategy • Additional Issues • Offer inexpensive products that lend themselves to repeat purchasing • Build reputation for quality and reliability One time purchase from same seller Multiple purchases from same seller Used Car Collectible Art Expensive Used Records Produce Inexpensive

20. Incumbents vs. New Entrants • Which has the advantage? • Traditional incumbents have substantial advantage in products that tend toward the look and feel end of the continuum • Traditional incumbents tend to have difficulty in commodity end of the continuum – their brands and brick-and-mortar stores provide little advantage • Exceptions are firms with first-mover advantages and strong histories in information technology and serving customers at a distance

21. Sustaining Competitive Advantage • Barriers to entry grow higher as we move from commodity to look and feel with variable quality ends of the product continuum • As barriers to entry grow, so does the profit potential (and risk of failure) • Companies should shoot for above average profitability • Branding strategies are important at all points in the continuum

22. Amazon Your Industry Management Analysis April 10, 2001

23. How To “Amazon” An Industry • Fundamentally transform the entire industry value chain • Analyze the economics of each player in the industry – what drives profits for each player? • Identify the linchpin of the supply chain • Replace physical retail shelf space with virtual shelf space • Eliminate need to forecast consumer interests – allow true demand to drive the supply network • Reduce product return-rate

24. How To Amazon An Industry • Develop more efficient methods of distributing the product • Consolidate the industry to gain greater efficiency and economies of scale • Use technological innovations to transform the supply web by eliminating steps in the model • Develop reputation for high on-time delivery in order to establish first-mover advantages – market share and economies of scale • Deliver goods in a cost-effective and timely way • Invest wisely in information systems that monitor customer demand and product flow

25. How To Amazon An Industry • Hire and retain distribution expertise • Develop strong national and regional distribution centers to optimize supply economics • Excel at getting products from distribution centers to ultimate customers • Potential to provide delivery services for other retailers, offer installation services • Gather and use customer information effectively – track and analyze ordering patterns – develop deep insights into customers • Use customer information and insights to guide product development

26. deFigueiredo’s Model • Discriminate between types of e-commerce using the product continuum • Where do Amazon.com’s products fit on the continuum? • Understand role of product quality, information transmission, reputation and risk in context of market structure and company capabilities • Segment market into industry and product characteristics that drive profitability • Develop segment specific strategies to reach above average profitability

27. Amazon’s Place on the Product Continuum • Quasi-Commodity Products • Considered differentiated, not commodities • Once specific product is selected by consumer, it is identical across vendors • Consumers make choices in two-step process • Find the specific product • Select lowest priced vendor

28. Appropriate Market Strategy? • Differentiate in the search process • Information technology • Search engines that match consumer preferences • Data base management tools • Make web site sticky – keep shoppers on the site • Offer one-stop shopping • Seek first mover advantages • Establish e-commerce branding

29. Appropriate Market Strategy? • Insulate from price competition in the purchase stage • Take advantage of economies of scale • Seek preferential treatment from wholesale suppliers • Ensure that delivery of product is reliable and timely • Offer additional customer services such as chat rooms, affinity programs, and other web-site stickiness technologies • Offer site-specific customer loyalty programs • Develop strong e-commerce brand to signal quality in reliability of delivery, security of personal information, dependability of return policy, general customer service

30. Incumbents VS. New Entrants? • Who has the advantage? • Traditional retailers (incumbents) have advantage in look and feel products • At the commodity end of the continuum, traditional retailers’ brands and brick-and-mortar stores provide little advantage • Theoretically, Amazon might have an advantage, but they have not been profitable yet • Amazon has an advantage over new e-commerce entrants – brand name recognition and reputation

31. Amazon’s Challenges? • Win the search process • Continue to use customer information to guide product development • Improve ability of search engines to match customer preferences • Continue providing high quality product information • Develop proprietary product comparison database to replace Productopia • Find new ways to make web site sticky – selling space to advertisers might generate revenue, but will it keep customers on the Amazon site? • Continue efforts to develop the e-commerce brand

32. Amazon’s Challenges? • Insulate from price competition • Continue to reduce costs • Increase efficiency • Develop preferential relationships with suppliers – quit buying products through retail channels and reselling them • Continue to improve delivery reliability • Develop site-specific customer loyalty program

33. Amazon’s Challenges? • Mobilization and Motivation of People • Improve relationship with customer service reps and warehouse workers • Do a better job of listening to employees • Increase compensation • Reduce amount of overtime • Create better incentives • Design the Appropriate Organizational Structure

34. Recommendations • Continue to add quasi-commodity products to virtual portfolio • Make sure the market strategies are aligned with the type of product, market structure, and company capabilities • Continue to increase efficiency • Find new ways to streamline the supply chain – eliminate unnecessary costs • Continue to invest in state of the art information systems and inventory management and distribution systems • Treat your employees better – greatest resource