The Impact of E-retailing

The Impact of E-retailing

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For retailers, suppliers and their creditors, the Internet creates a dramatically different set of planning dimensions, skills and success criteria. Understanding these differences and mastering the new skills they demand will be the key to retailing success in the next millennium. This shift in skills and business environment will have a significant impact on the shape and nature of retail bankruptcy in the not-so-distant future.


Over the course of the next five years, e-retailing will grow dramatically. Total sales are projected to exceed $200 billion by 2005, up from $20 billion in 1999. Despite the rapid growth, e-retailing will still own but a small share of total retailing. Much like catalogs, e-retailing is but another channel of product distribution and communication to the consumer. While some product categories, such as books, software and consumer electronics, will experience high market penetration, others, such as food and apparel, will be much lower.

The Persistence of Deflation

Cross-competition, the Internet and the over-investment in capacity have created a general oversupply of just about everything. That, in turn, is producing a deflationary retail environment that will persist. From apparel to consumer electronics, home furnishings to many food products, deflation is the order of the day.

Depending on their product mix, deflation is a benefit for some retailers. Where consumers are very price-sensitive, as is the case in jewelry, consumer electronics and many sporting goods categories, falling prices actually increase the size of the market. However, for many products, like apparel and food, falling prices do not expand the size of the market. In these cases, deflation simply produces reduced revenues.

Deflation changes the economic model for retailers as it reduces the value of inventory and real estate while increasing the burden of debt. It rewards cash and makes productivity improvement and increasing market share the only paths to profitability.

Deflation is also squeezing retailer net worth, increasing the likelihood and the number of future retail bankruptcies. This squeeze on retail net worth will also likely result in more unexpected bankruptcies. Deflation also reduces the value of assets in liquidation, which may impact creditor recoveries.

Human vs. Financial Capital

The number-one resource problem facing retailers today is the scarcity of workers at all levels. E-retailing makes this problem even more critical. E-retailers, with their promise of stock option wealth, are draining traditional retailers of their best talent. Retailers in the future will be only as good as the workers they are able to recruit, train and retain today. In the past decade, retailers have fallen behind the rest of the economy in terms of employment growth. Unless the industry can reposition itself with workers as a quality work environment that provides opportunities for professional growth and enrichment, retailing will fall even farther behind in attracting good workers.

Virtually all e-retail companies today are valued not on their tangible assets, but on the value of the idea and the people behind that idea.

While human capital will grow scarce, financial capital is growing more abundant. Price deflation and expanding government budget surpluses continue to create an abundance of capital, despite modest increases in interest rates. Good ideas will find themselves besieged with financing. Access to capital is no longer a competitive advantage. The abundance of capital also means that more bad ideas will get financing, increasing the number of bankruptcies in the future.

Employment contracts to keep key individuals will become more important in bankruptcy as talented executives will have other alternatives to staying with a sinking ship. Obtaining post-bankruptcy financing will be less of a problem. Terms will be better from the debtor's perspective, making the likelihood for longer stays in bankruptcy for both traditional and e-retailers.

Information Becomes a Critical Asset

Information is the most important asset that both traditional and e-retailers have on or off their balance sheets. It is also the most valuable product that retailers have to sell. When consumers pay a premium for a brand, they are essentially paying for information. Information goods are essentially experience goods that have high fixed and low variable costs. They are more difficult to market because the buyer needs to be assured of what he or she is buying.

While tangible assets are deflating in value, intangible ones like customer information are increasing in value. The bankruptcy process will have to learn to adapt and deal with assets that traditionally have been overlooked in the process. Information systems will play a much bigger role in determining the ability of a bankrupt retailer to emerge from bankruptcy.

Internet Success: Brands, Execution and Pricing

Success on the Internet flows from three factors: (1) having a well-known brand, (2) being able to execute and (3) pricing products for profitability. The Internet is a very brand-friendly environment. As a vast forest of competing offers, consumers have shown that they are more willing to do business with a familiar brand. Growing fears over the loss of privacy will only add to consumers' brand focus. The brand-friendly nature of the Internet gives traditional retailers a leg up in competing with Internet-only start-ups and more than overcompensates for any first-mover advantages that the start-ups may have enjoyed.

Successful execution of an Internet business requires a very different set of skills than a traditional retailer. These differences have led many traditional retailers to operate their brick-and-mortar operations separately from their Internet businesses. Successful Internet execution requires a shift from pallets to packages. Internet fulfillment also has to be viewed as a 360-degree process. Not only does the product have to be shipped out to the consumer, processes have to be in place to get it back from the consumer with equal ease.

Pricing in traditional retailing is done to control inventories. For e-retailers, pricing is a strategic weapon that is used to manage customers. Every customer can and must be viewed differently. Strategies have to be developed to deliver a higher level of service to better customers and to extract a higher price point from them. Treating everyone the same is a sure path to losing the best customers and incurring too much cost for the marginal ones.

The Growing Importance of Place

Location, location, location has always been the watchword of the successful retailer. The Internet is going to change the meaning and value of place. Because of the Internet, workers no longer have to travel to work if work can be moved digitally to the worker. The boundary between workplace and home is blurring, with commuting often being a short walk from the kitchen to the study. If workers can now choose their place of work, place will matter now more than ever. The combination of demographics, economics and technology is shifting the venue of winning locations from the suburbs to the inner city and to smaller, high quality-of-life towns.

Suburban sprawl is becoming an important political issue. Local efforts are being made to stop or alter the character of retail development through stricter zoning laws and the purchase of open space. Neighborhood stores are growing in popularity as the desire for a pedestrian-based lifestyle grows at the expense of an auto-based world. Add the effects of the Internet, and real estate strategies will undergo more change in the next few years than they have at any time in the last 50 years.

The shift in real estate values means that the value of much of the real estate that existing retailers have is going to fall. The shift to inner city and neighborhood retailing will increase the likelihood of bankruptcy among suburban-based retailers.

Expanding Penetration

Initially this has just involved giving click-through access to the portal or Internet Service Providers (ISPs), like America Online, Mindspring and Yahoo, in return for a percentage of the sales that this activity generated. The demands for growth will force the ISPs to add online retailers and traditional, land-based retailers to their acquisition list. In time, the ISPs will operate a portfolio of customer-centric retail businesses that will be vertically integrated. These businesses will be organized around lifestyles and customer issues like transportation, health care, home maintenance and adornment. The objective of each of these businesses will be to be within an arm's reach of customer desire, wherever that customer may be.

Given their lofty stock market valuations, the ISPs should also have enough cash flow and debt leverage left over to buy hot retail businesses as they bubble up from the churning masses. In five years or so, if all this "vertical integration" works out and the Internet really does follow us around wherever we go, AOL/Time Warner may have enough of a market valuation to close the loop by acquiring, say, Wal-Mart, in another "merger of equals."

The emergence of the ISPs as the traffic cops of e-retailing will drive retailing consolidation. It may also give creditors a deep pocket to pursue in some future e-retailing bankruptcy proceeding.

A Consumer-centric World

Retailers and suppliers alike are well practiced in muttering the mantras of consumer importance. And yet, their marketing, merchandising, advertising and logistical practices all belie their chants of homage to the consumer. Today, the value chain is still a product-focused set of logistical relationships aimed at moving goods from their raw materials into the waiting hands of the consumer. The consumer only gets an opportunity at the very last step of the process to give a "thumbs up" or "thumbs down" to the workings of the supply chain.

E-retailing will turn this product-focused logistical process on its head. The value channel of the future will be consumer-centric and consumer-driven with marketing, merchandising and logistics all directed by the knowledge of the consumer. The shift to consumer-centric retailers will increase the likelihood of bankruptcy among product-centric retailers. Bringing product-centric retailers out of bankruptcy will be much more difficult, as it will require a change in their marketing, merchandising, advertising and logistical practices for them to be successful in a consumer-centric world.

Teaching Old Dogs New Tricks

Many traditional retailers have entered e-retailing not because they think it represents a good opportunity, but in response to pressure from Wall Street. Some of these forays will end in tears. The losses incurred in these Internet misadventures will add to the number of traditional retailers who find themselves in bankruptcy.

In addition, some traditional retailers who find themselves in bankruptcy may be tempted to take on the risk of an Internet strategy that they were not willing to pursue when they were risking their own money. In almost all cases, these attempts to take on an Internet strategy in bankruptcy are destined to fail. Retailers in bankruptcy are often there due to the weakness of their consumer franchise. Without a strong consumer franchise, going on the Internet will only accelerate the losses of an already failing business.


Virtually all e-retail companies today are valued not on their tangible assets, but on the value of the idea and the people behind that idea. This "people and idea" valuation means than when things go wrong, there is not going to be much of value left to pay off creditors. The physical assets like computers and customer lists will be of limited value. Creditors will be left with little in the way of recoverable value.

The only way to balance the risk of any one e-retailer going bankrupt will be to have a broad equity exposure to many e-retailers. By having a portfolio of e-retailing equity, a few successes will more than offset the failures.

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Saturday, April 1, 2000