Not every retailer needs e-commerce to score global success

The U.S. Department of Commerce reports that 2005 U.S. e-commerce sales rose to $86.3 billion — 25 percent over 2004 sales. Yet e-commerce represents only around 2 percent of U.S. retail sales. Why are some successful companies, even some large ones (think IKEA or Bath and Body Works), not embracing fully the proven sales driver that is the Web? A new research study of cost-to-serve dynamics for Internet retailing answers this question. The simple fact is, Internet sales are just not a good fit for every product, according to the researchers.

The Internet is such an effective tool to enable or enhance business that it's surprising to learn that there are companies — and not only small ones — that have yet to mine the riches of cyberspace. According to a recent article in The Wall Street Journal, the U.S. Department of Commerce reported that 2005 U.S. e-commerce sales rose 25 percent over 2004 sales, to $86.3 billion.

The piece said comScore Networks found that during the 2005 fall holiday shopping period, 25 percent of people who researched products online proceeded to buy items, but some 63 percent of those purchases were completed offline, at a store. Yet e-commerce represents only around 2 percent of U.S. retail sales. Well-known retailers like IKEA, Limited Brands Inc. (the umbrella company including Bath and Body Works, The Limited, Express), and Aeropostale, offer either very limited inventory online or none at all.

Why are successful companies not embracing fully the proven sales driver that is the Web? W. P. Carey School of Business assistant professor of supply chain management Elliot Rabinovich says one of the reasons is that Internet sales are just not a natural match for every product.

His ongoing research on cost-to-serve for Internet retailing, with Tim Laseter of the Darden Graduate School of Business at the University of Virginia and Angela Huang of the business and technology consulting firm Booz Allen Hamilton, is showing that some products lend themselves more naturally to cyberspace success.

On the other hand, other products require more elaborate business operations. In their article for the Spring 2006 issue of strategy+business magazine, the trio explain that understanding operating cost drivers is critical to online success. They make an example of eBags.com, which though profitable, is learning that shipping luggage — its initial and highly successful offering on the Web — is less complicated than shipping shoes, which it started trying to sell on the Internet in 2004.

No stroll in the park

Luggage tends to come in one size and few colors, shoes in many of both. The differences in inventory, and the way manufacturers ship each type of product, as well as those products' different periods of obsolescence and rates of return, means eBags had to change its business model for shoes. Some companies don't or can't adjust. The authors mention Webvan (grocery), Value America and eToys as notable shutdowns due to mismanagement of key operating activities such as inventory management, delivery and handling.

"Over the second decade of online retailing," the authors write, "the companies that truly grasp the drivers of cost-to-serve at the level of individual items and individual customers will unlock the full value-creating potential of online retailing as an alternative to — and complement of — traditional retailing."

Amazon is one of the companies that has truly grasped the intricacies of cost-to-serve, and continues to tweak operations. Its free shipping offering turns on a $25 minimum purchase, and Amazon sells many items that cost less than that, and on their music pages, for example, openly suggest pairing the sought-after CD with another of the artist's productions.

"Amazon has developed certain types of knowledge others are trying to acquire," Rabinovich says. "They understand that the free shipping is good so long as you can get customers to buy multiple items."

The key, says Rabinovich, is that if more items can be shipped per delivery, the cost-to-serve per item is lower. But bundling is not a cure-all, Rabinovich says. For instance, if a company doesn't own its inventory and can't do the actual packaging of the bundle itself, or if items bought together have to be shipped separately, the cost-to-serve rises.

In the Amazon fulfillment centers, labor coordination is important, he says. Orders from customers who have chosen two-day shipping get priority — "They can't get that wrong," says Rabinovich — and when those are taken care of, the free-shipping orders are picked and packed. "It keeps work flow uniform and efficient," Rabinovich says of the peak-valley nature of consumer demand driving the picking and packing system at Amazon's fulfillment centers.

"They manage the inventory themselves, and in doing so they are able to serve customers at the lowest cost possible."

Amazon boosts partners

Contrary to popular belief, says Rabinovich, Amazon is not the be-all and end-all of online retailing. It hasn't even spelled doom for similar multipurpose entities like Buy.com and Overstock.com.

Yes, you can find almost anything on Amazon.com, but while one of the keys to its success is that it manages its inventory, it doesn't work alone. Also contrary to a popular perception — that Amazon is harmful to smaller retailers — Rabinovich says its partnerships with niche businesses (it has one with eBags) help both. Browse Amazon.com for just a bit and these relationships stand out — small book stores, used-product specialists.

Amazon maintains and deepens its offerings, thus attracting customers and, in turn, vendors and advertising, while the partner gets its goods on one of the world's best-known retail sites and has its inventory managed by Amazon. "They can't do everything themselves," Rabinovich says of Amazon. "They don't want to re-invent the wheel." Rabinovich mentions drugstore giant Walgreen's as a smart user of the Internet as well. Customers can order prescriptions and refills online, and most pick up the order at a store.

Walgreen's likes this for several reasons, says Rabinovich: cost-to-serve is lowered, pickups can be scheduled (and thus order-filling prioritized and labor organized), foot traffic is encouraged, paperwork is streamlined, and in-store queues are reduced. The authors suggest that most retailers can successfully sell online, given the right plan.

"For each combination of customer and merchandise there is an optimal cost-to-serve option among the different delivery services — store inventory, store delivery, in-store pickup, and direct delivery," they write. "Future growth in e-commerce will likely come from continued modification of existing supply chains rather than wholesale replacement."

• Some products lend themselves more naturally to cyberspace success; others require more elaborate business operations.
• A company's understanding of operating cost drivers is critical to online success.
• Most retailers can successfully sell online, given the right plan.
• Future growth in e-commerce will likely come from continued modification of existing supply chains rather than wholesale replacement.