E-Commerce's High-Tech Burden
August 28, 2001
However, it may turn out that selling on the Web generates no winners at all.
First, it is important to recognize that different Web sites have different goals. Sites maintained by individuals, cultural organizations and governments, for example, are not meant to make money, and they obligingly don't make money. Those sites have other goals, such as to provide information, to entertain, or to serve citizens or other constituencies.
Web sites that exist to promote a product or company, such as Cheerios or McDonald's probably also lose money on paper. However, they make up a bit of it by selling logo merchandise, or boosting sales, or encouraging investors to buy stock. But in any case, those Web site costs are coming out of marketing budgets that are supposed to be spent on promotions.
Then you have e-commerce: Web sites that exist to sell you something. This category has gone from being seen as the future of business two years ago, to being viewed as a useful addition to traditional brick-and-mortar sales. Yet, in my opinion, e-commerce should be thought of as a thorn in the side of traditional retail and a costly one at that.
Consider these frightening facts from an article about eToys in Fortune magazine, written about six months before the company went bankrupt. It stated that for every US$100 in sales, eToys spent $81 buying the toys, $29 on its Web site and technology, $33 on fulfillment ("picking and packing"), and $37 on advertising. That’s $180 total, for every $100 in sales. The article called the $37 on advertising the "killer cost," although it's better than the $460 that Pets.com spent in 1999, but looks bad compared to the $3 to $5 that a traditional store spends.
In my opinion, some of the other numbers are more worrisome. After all, advertising could slow down once the brand becomes more established, but what about the $29 on Web sites and the $33 on fulfillment? We'll call that $62 the "e-commerce burden" because it doesn't apply to a traditional store. Remember, that's $62 for every $100 in sales.
Let's compare those costs to the brick-and-mortar traditional stores run by Toys "R" Us. The Fortune article said that a typical traditional store spends about 7 percent of sales on physical property, and less than 15 percent on in-store personnel. Both of those items are expenses that an e-commerce site won't have. Throw in 4 percent for marketing costs and you have about $26 per $100 in sales. Assuming that the company makes 4 percent profit, that leaves it spending about $70 for buying the product, compared to $81 for eToys.
Now assume eToys had stuck around and grown large enough to get the economies of scale on toy purchases, so it also spent $70 for toys it could sell for $100, saving $11. But if you tack on the $62 e-commerce burden, then the company is still losing over $30 per $100 in sales.
More importantly, if you apply that same analysis to the hypothetical Toys "R" Us e-commerce initiative (before it partnered with Amazon.com to run its site), it appears that there is no way Toys "R" Us can make money on the Internet. It would be more profitable if it dropped e-commerce entirely and stuck to its traditional stores. Such a move would be less hip perhaps, but definitely more profitable.
What about outfits like Lands' End, catalog companies that already pay the "picking and packing" cost? You would think that putting up a Web site would just involve hardening its internal order system to make it usable by Joe and Jane Shopper. But $29 per $100 in sales sounds like a pretty stiff increase in technology expenditures.
What about the Web site cutting down on the need to send out catalogs? Well, Lands' End had revenue last year of about $1.5 billion and sent out 250 million catalogs at $1 each, according to an article published in The New Yorker. Based on those figures, the company is hypothetically only spending $16 per $100 in sales on catalogs. Thus, $29 for a Web site is a bad bargain and it still has to send out the catalogs to spike sales.
So e-commerce may not work for pure Web companies, and it may not work for traditional stores, and it may not work for catalog companies. For all of them, the e-commerce burden may be too much to overcome.
Unless, of course, there is some way to streamline Web site costs, learn to pick-and-ship efficiently, and meet the old economy standards of costs vs. revenues long held by traditional businesses.
Adam Barr worked at Microsoft for over 10 years before leaving in April 2000. His book about his time there, "Proudly Serving My Corporate Masters," was published in December 2000. He lives in Redmond, Washington and can be reached at firstname.lastname@example.org.