Online retailing in 2005: traditional retailers should dominate

[March 28th 2001]

Online retailing is fast becoming the domain of traditional retailers as they are best positioned to master the economics of online retailing and capture growing consumer demand. According to a new BCG report, The Next Chapter in Business-to-Consumer E-Commerce: Advantage Incumbent, bricks-and-mortar retailers have a golden opportunity to use their inherent advantages to grow customer share dramatically.

"Online retailing is entering a new phase in its evolution," says Michael Silverstein, Senior Vice President and Global Leader of BCG's Consumer practice. "What was once an industry characterized by entrepreneurial dot-coms, targeting the discretionary spending of the Internet-savvy consumer, is fast becoming the domain of traditional retailers, selling both necessities and discretionary items to the broader population."

"The incumbents who hesitate, or choose to stay out altogether, could see some of their most coveted customers switch to incumbent competitors who do go online," he adds. "Consumers are now migrating to the big brands with an online capability. While they want the convenience of 'always available' shopping, they are also demanding higher levels of performance from retailers in all aspects of the online shopping experience. The next chapter in online retailing will be about the revenge of the sophisticated incumbent."

The long-term prospects for online retailing are strong. Demand for goods and services online will continue to grow as consumers become more accustomed to multichannel shopping. Sales in the nine leading online categories have the potential to grow from $34 billion in 2000 to $168 billion by 2005. Most of the growth will take place in the leisure travel, grocery, and clothing categories.

According to the report, the grocery category offers a tremendous opportunity for online retailers but also a substantial challenge. While it is a difficult business to execute, the grocery category shouldn't be ignored: half of consumers anticipate spending some part of their food budget online within the next five years. If online grocers are able to overcome the logistical challenges of their industry, the category could grow beyond $25 billion by 2005.

By and large, the economics of online retailing are not working well. In most categories, margins are simply insufficient to cover high fulfillment and marketing costs. Collectively, however, only catalogers have been able to generate positive contribution margins after marketing costs are factored in.

"Catalogers have adapted to the online medium with consistent success," says Peter Stanger, Vice President and Leader of BCG's B-to-C topic area in North America. "They enjoy the advantages of established brands, existing infrastructure, and extensive experience in selling to customers at a distance. They know they will succeed if they focus on the best customers, rather than allocate huge sums to attract customers whose purchases won't justify their acquisition costs."

While the report argues that incumbents are best positioned to succeed in the online market, there are two other types of retailers that will succeed.

• Attackers are the pure-play retailers that have achieved the scale needed to reduce their total systems costs and build competitive advantages in key areas such as brand strength, procurement, fulfillment, customer acquisition, and service. Amazon is currently the only attacker to have crossed this threshold in the book category. It has yet to demonstrate long term success as it faces a number of hurdles in categories it entered more recently, such as low margins, high fulfillment costs, and aggressive local competitors.

• Niche Players are small bricks-and-mortar retailers and start-ups that have built a strong and loyal franchise with a limited target population. Strong ties to a select consumer segment benefit both the revenue and cost sides of the business. These retailers' loyal customer bases ensure a stream of future revenues and eliminate the need for continual spending to acquire new customers. Given the scope and size of niche players, however, they will have only limited influence.

The greatest opportunity belongs to traditional retailers that can establish multichannel relationships with their customers, blurring the distinction between channels and fundamentally altering the way people shop. The report offers ten priorities to address the strategic and operational challenges of the online marketplace:

1. Leverage the brand. With well-developed brand recognition and trust, incumbents should have lower customer acquisition costs and higher conversion rates from the day they go online.

2. Create incentives to entice customers online. Given that the cost to serve a customer can be lower online than it is elsewhere and that the Internet offers opportunities to increase share of customer wallet, multichannel players should actively encourage their customers to use the Internet.

3. Make the most of customer information and relationships. The rich knowledge base and strong relationships that traditional retailers have developed over the years allow them to anticipate their online customer needs in ways that no pure-play competitor could possibly match.

4. Integrate online and offline channels. The multichannel customer is expecting a seamless shopping experience, which means integrating all aspects of retailing - including branding, inventory forecasting systems, and product returns.

5. Leverage offline scale. Purchasing power is one of the greatest assets a traditional retailer possesses. They must use their offline purchasing power to deliver cost advantages to their online operations.

6. Use distribution infrastructure to advantage. Distribution infrastructure is difficult to build from scratch. Catalogers are extremely well positioned to leverage established systems for the online channel.

7. Manage channel conflict. Moving online can trigger conflict between channels. Incumbents need to find creative ways to avoid conflict within the company and its supply chain.

8. Exploit opportunities for partnering. Partnering can speed execution, give access to critical skills, and generate additional equity from incumbents' assets.

9. Target total customer wallet. Incumbents should aim high and seek to capture 100 percent of category spending from each customer household.

10. Use your best customer to model future improvements. Online retailers need to gain market understanding that is based not on averages but on in-depth dialogue with their best customers.

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