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Pure Plays Face Trouble in E-Commerce Shakeout
E-tailers who sell to their customers across multiple channels -- through
stores, catalogs, and online -- significantly increase their chances of
generating impressive returns and emerging victorious amid the
growing e-tail shakeout, according to a study by McKinsey &
Company and Salomon Smith Barney.
In their race to gain market share of customers, most major online
retailers lose money every time they sell anything, according to the
McKinsey/Salomon Smith Barney E-tail Economic Study. However,
online retailers can profit on every sale if they drive up their average
order size, hold the line on discounting and sell higher-margin products,
the study found.
"The notion of a 'pure-play' is turning out be the wrong play," said
Joanna Barsh, a director at McKinsey & Co. and a leader of the firm's
e-tail practice. "To be successful, online retailers need to exploit other
marketing channels simultaneously, such as in-store and catalog sales, as well as private labels.
A number of apparel e-tailers are already doing this successfully. Our study shows that
multi-channel players can increase their share of wallet, as many consumers are already
browsing on the Web before buying in the store."
The study found that first-quarter sales for orders taken by online retailers were below the cost
of acquiring and distributing goods sold to customers. Resulting per-order losses before
marketing, overhead, and Web site development costs ranged from $2 to as much as $12.
The study also pointed to the difficulties online retailers face in reaching a break-even point
while selling low-margin products over the Internet. For instance, even if an online pure play
retailer could generate an $11 per order contribution to gross income (which is extremely
ambitious given high fulfillment costs) it would need more than $1.0 billion in revenues
(approximately 5 percent of the total toy market) to support the $120 million to $140 million
it would have in fixed warehouse, Web site, marketing, and overhead costs.
Despite these findings, most online retailers and catalog merchants can generate significant
profits. The frequency and size of each order are much more important contributors to an
online retailer's profitability than large customer counts, the study found.
For example, while the average online grocery order generates only $9 in gross income, the
typical online customer will buy groceries on the Web up to 30 times a year. Thus, order
frequency drives the net present value of an online grocery customer to $909 over a four-year
time period, according to the study.
The McKinsey/Salomon Smith Barney E-tail Economic Study analyzed five industries,
focusing on specific sectors within those industries. Following groceries, online retail categories
showing the highest customer net present vales were: prescription drugs ($434 over a
seven-year period), specialty apparel ($384), department store apparel ($283), direct mail
apparel ($190), pure-play books ($50, off-price apparel ($39), pure-play toys ($9), and
pure-play apparel ($9).
"Shrewd e-tailers need to drive up their average order size to at least $50, hold the line on
discounting and move to products with margins over 35 percent," said Blair Crawford, a
principal at McKinsey & Co. "Together with maintaining high ticket sizes and decent gross
margins, driving order frequency is the way to bypass today's costly market-share wars."
Research by Bain & Company and Mainspring found that few segments of online customers
are profitable. For example, that research found that only 24 percent of consumers, those
buying based on brand or convenience, generated all the profits; in online groceries, the same
two segments (known as "Brand Buyers" and "Convenience Shoppers") accounted for only
31 percent of customers but 65 percent of profits. Other segments identified by the survey
("Casual Buyers," "Relationship Seekers," and "Bargain Hunters" are considerably less
profitable or money losing. The study found that customer segmentation is critical to a
retailer's economics, and companies can target profitable segments, for dramatic gains, both in
their choice of advertising channel and business model.
"Many online retailers are focused on trying to swell their revenues by attracting any and all
possible traffic to their sites," said Darrell Rigby, a director at Bain & Co. "Instead, online
retailers should take a more focused approach because all customers are not created equal. It's
more important to have a loyal group of the right customers than to have lots of the wrong
ones."
June 19, 2000 "
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