1 internet business models text and cases On

2 Online Retailers • • Only looking at Retailers of Physical Goods Several Categories How Online retailers create value Economic models for Online Retailers Payoff for GBF Best Practices Unique Challenges Management and Strategic Issues © 2003 UMFK.

3 What is an On. Line retailer? • Use website to sell new physical products & goods to which they take title • Rely on third party service providers to deliver goods • Not • Auctions of non title goods (e. Bay) • Service providers (real estate agents) © 2003 UMFK.

4 Taxonomies • Divided by – Merchandising emphasis • Horizontal & vertical • Wal-Mart vs. Home Depot – Pricing Format • Fixed • Adaptive pricing – Auction – Group (demand aggregation) – Deep Discount (Loss leader) © 2003 UMFK.

5 Creating value • US Retail Market (1999) $1. 6 trillion – Internet 1% – Catalogs 7 -8% – Bricks and Mortar 90% • Anticipated Distribution (200? ) – Internet 15 -20% – Catalogs 5% – Bricks and Mortar 75% © 2003 UMFK.

6 Creating Value • Online Market is very similar to catalog sales – Cannot directly inspect goods – Cannot access goods immediately after sales • cognitive dissonance • Online has greater value manifested by – Increase of household online • doubled from 1998 to 2003 – Increase in purchasing online (% of posiible customers) • doubled from 1998 to 2003 – Increase in spending per customer online • doubled from 1998 to 2003 © 2003 UMFK.

7 What is a Good Online Product Category? • Information Rich Products – Best fit for consumers – Multiple consistent deliveries of sales pitch • Large Selections • Little need for hands-on Service or a product trial • High value to Weight • Easily Customizable Products • Rapid Changes to Stock Availability • Replenishment Driven • Unpleasant Brick-and. Mortar Retailing Environments © 2003 UMFK.

8 Barriers to Online Shopping • Consumer concern about Credit and Privacy • Consumer lack of familiarity with Brand – Virtual Presence versus physical presence • Delivery concerns – People are often not home to accepted delivery © 2003 UMFK.

9 Types of Shoppers • E-Bivalent newbie's – Least likely to buy • Time-sensitive materialists – Interested in saving time • Clicks and Mortar – Shop online – Buy offline • Hooked, Online and Single – Young single males with high incomes • Hunter-Gatherers – Compares and analyzes • Brand Loyalists – Go directly to site – Spend the most online © 2003 UMFK.

10 Economic Advantage 1 reduced cost XYZ. com Product Margin Freight In Credit Card Charges Shipping Revenue, Net Gross Margin Store Occupancy Costs XYZ Superstore 28. 0% -2. 5% 1. 5% 25. 0% 40. 0% -1. 0% 0. 0% 38. 0% 10. 0% Store Operating Expense 14. 0% Distribution and Customer Service 12. 0% R & D/Tech Costs 3. 0% Gross Advertising Co-op reimbursement/Ad Sales 7. 0% -3. 0% 4. 0% -2. 0% G&A Total Operating Costs Operating Margin 1. 0% 20. 0% 5. 0% 3. 0% 29. 0% © 2003 UMFK.

11 Factors affecting Operating margins • Gross Margin • Distributions and Customer Service Expenses – Pick and Pack operations – Call Centers • Website Development – Should be fixed independent of scale • Sales and Marketing – Pure play must spend lots for Branding • General and Administrative (G&A) – Not a factor of sales but of size and complexity © 2003 UMFK.

12 Less Working Capital • This is the 2 nd Economic advantage – More inventory turns • 10 times for online vs. 2 -5 for offline • Less stock in few warehouses than lots of stock at lots of stores • Not tied to a printed catalog – Price changes – New items – Out of stock items – Minimal receivables – 60 days net for suppliers • Most online retailers have negative working Capital – Online retailer have positive cash flow! © 2003 UMFK.

13 Less Fixed Capital • No stores, minimal real estate • Property, Plant and Equipment (PP&E) – 5% of sales for Amazon – 19% of sales for Borders • Results – Greater return for Capital invested – Stock buyers frenzy STILL © 2003 UMFK.

14 2001 • • • 2001 online revenues were $51. 3 billion (USD), up 21 percent over 2000¹. Online revenues are estimated to grow 41 percent this year to $72. 1 billion. Online sales were 2. 4 percent of total retail sales in 2001 and are projected to grow to 3. 2 percent for 2002. 56 percent of retailers reported profitable online operations in 2001, up from 43 percent in 2000. Overall operating margins have improved from a loss of 15 percent in 2000 to a loss of 6 percent in 2001. Operating margins are supposed to be zero or positive in 2002. The average cost of customer acquisition has continued to improve, coming down to $14 in 2001 from $29 in 2000 and $38 in 1999. Repeat buyers account for over half of sales, with 53 percent of revenue in 2001, up from 40 percent in 2000 and 31 percent in 1999. Conversion rate of visits into orders has improved from 2. 2 percent in 2000 and 1. 8 percent in 1999 to 3. 1 percent in 2001. Source The State of Retailing Online 5. 0, a Shop. org annual study conducted by The Boston Consulting Group with market-sizing data supplied by Forrester Research © 2003 UMFK.

15 GBF? ? • Preemptory strikes – Get market share now – Easier for online than offline • Don’t have to build multiple stores • Push to Web Site • Examples – Amazon 1 billion in sales in 3 years – Home Depot, Wal-Mart and Staples took 2 to 3 times as long • 60, 229 and 174 stores © 2003 UMFK.

16 GBF factors • • • Online retailing: dubious gbf payoff Network effects: basically, none! Scale economies: some, but weak compared to other business models – Purchasing economies with volume growth: buy direct from manufacturers and capture wholesaler’s margin (and coop funds) – Modest scale economies in fulfillment and customer service operations – Big scale economies in website development and G&A – Mc. Kinsey: boosting sales from $100 million to $1 billion improves operating margin from 6% to 8% for pure play online apparel retailer, and from – 3% to 9% for pure play online computer retailer • Intrinsic retention rates: weak – – – Familiarity with navigation Customer service quality Personalized recommendations (better with more history) Investment in data entry (replenishment ordering) Loyalty programs © 2003 UMFK.

17 Tactics for Success • High Quality Customer Service – – Stock availability Site Design Reliable delivery Responsiveness to customer inquiries • Build Community – Forums, Chats groups • Personalization's – Increase Switching costs © 2003 UMFK.

18 Issues Facing Offline Incumbents • Advantages – – Already Branded Existing Supplier relationships Already have Fulfillment and Customer Service Cross-Channel Delivery (Buy online-Pick up at the store) • Disadvantages – Cannibalization – Channel Conflict • Fulfillment • Pricing © 2003 UMFK.

19 Other Issues • Shopping Bots – Price compression – Does an online retailer

20 Hybrid Business Models • Online retailing with content providing – Garden. com •

21 EToys Example • Euphoria – – • EToys launches late 1996 $30 million in revenue by F 98; 5 th most popular shopping site in December 1998 with 7% reach Overtrading – – May 1999 IPO; valuation exceeds Toys “R” Us’s by 35% and peaks at $10 billion in the Fall In 1999, competitors emerge: • • Smarterkids. com; Toytime; Disney’s Toysmart; Viacom’s Red. Rocket; Amazon Toys “R” Us response – – – Gorilla (tied with Wal-Mart – each has 17% share of $22 billion toy business): huge offline scale affords them a 7% gross margin advantage over e. Toys; knows how to predict fads April 1999 enters JV with VC Benchmark Disagreements over: 1) allocation of hot toys to dot com; 2) dot com ability to undercut store prices; 3) governance By August, Benchmark bails out and Toys “R” Us CEO that engineered the deal is booted for online fiasco and poor earnings/stock price Infrastructure not ready for Christmas 1999; • • • 40% of site visitors turned away in November. Site riddled with glitches. 3% of orders not delivered on time. © 2003 UMFK.

22 EToys Example • Christmas 1999 debacle – EToys, having outsourced 50% of fulfillment to Fingerhut, fails to deliver 4% of orders on time – Amazon writes off $39 million in inventory (50 week supply of Kermit phones) – Overall $220 million in advertising spent to sell $215 million worth of toys • Revulsion – Toysmart, Toytime, and Red. Rocket pull the plug during the Summer of 2000; KBKids. com pulls its IPO; e. Toys and Smarter. Kids. com stock prices decline 90%+ • Toysrus. com response – – Secures $57 million from Softbank in February 2000 for 20% of company Merger proposal to e. Toys in Spring 2000 rebuffed Fixes website and fulfillment (spends $70 million on latter) In August 2000, merges operations with Amazon, which will handle fulfillment and customer service. Toys “R” Us to handle procurement and merchandising © 2003 UMFK.

23 EToys Example • e. Toys response – – – – – Pulls most fulfillment inhouse; accelerates construction of giant automated fulfillment facility. PP&E rises to $124 million in September 2000, up from $23 million year earlier Given fixed costs (including about $50 million/year to maintain sophisticated website), requires $750 -900 million in revenue to breakeven Cuts marketing expenditures Christmas 2000 revenue up only 30 -40% over prior year, versus doubling originally projected. Revenue for fiscal year ending March 2001 about $200 million EToys missed window in late 1999 early 2000 for secondary stock offering. Later forced to raise $100 million in private placement from bottom fishers. Subsequently tries to raise $100150 million or sell company; no takers. Cumulative losses: about $350 million Big layoffs, then pulls plug in early 2001 as cash runs out K·B Toys, an 80 -year-old toy retailer, purchased e. Toys' intellectual property and software on May 17, 2001 and warehouse on August 9, 2001. e. Toys was re-launched on October 10, 2001. More at • • http: //www. etoys. com/help/about. Etoys. Direct. html http: //www. amazon. com/exec/obidos/tg/browse/-/227141//ref=halloween-stripe/002 -0029230 -1524853 – © 2003 UMFK.