The Next Power Play: Online Retailers Catch Up to Their Customers

After the tech stock bust of 2001, all bets were off for online retailers. Since then, a new crop of retail power players has emerged-individual consumers. Today, they are teaching online retailers some important—sometimes painful—but increasingly profitable lessons.

What a difference five years makes. In 2001, we described how leading online retailers were spearheading the creation of the e-commerce marketplaces. 1 These were power players of the day. They had the weight—and force—of decades of experience behind them, but they were fighting off the internet-only competitors that were moving at lightning speed. Both sides tried to outpace each other in terms of making their name in the dot.com world and capturing online market share.

The dot.com babies did this in part by luring customers with stratospheric marketing budgets. In the early days of the net market boom, spending as much as $5 to acquire just $1 of revenue online was de rigeur. A crazy strategy, no doubt, but as a sign of the even crazier times, the stock markets rewarded such behavior: At the peak of the bubble, Amazon's share price soared even as its results sank quarter after quarter. It also captured market share from Borders, Barnes & Noble and Books-A-Million and drove down margins. For these and other retailers across the board, the dot.com wave was the equivalent of Wal-Mart taking over in three years rather than 30.

When the market finally crashed, online retailers—both start-ups and industry incumbents—either hunkered down, got acquired or disappeared. Five years later, who emerges as the victor? Instead of the industry powerhouses or even dot.com survivors walking around the ring with their arms raised, the little guys—individual consumers—have quietly emerged as the true leaders of online retail.

And it's time for retailers to follow.

Following the Consumer

In his book An Army of Davids, Glenn Reynolds argues that the growing power of consumers—armed with their array of technological gadgets—comes from more broadly distributed computing and communications capabilities. 2 Although everyone declared the arrival of the broadband world early and often, it is now becoming a reality.

Five years ago, a farmer checking a PDA for commodity prices in the middle of a field would have been an unlikely sight. Today, it would barely raise an eyebrow. Using one  gadget or another, most of us are within reach of the Internet 24/7 and use this connectivity to drive or assist almost any purchase imaginable. And in many cases, the Internet is a mandatory precursor to handing over a credit card: Nearly three-quarters of consumers research a new car online before taking it for a test spin. Stocking up on new music now means logging on, as illustrated by iTunes' one-billionth download earlier this year.

Indeed, the way that consumers use technology maps out what constitutes an acceptable shopping experience. For some retailers, following this map means overhauling the entire business model. Dixon's, the venerable U.K. consumer electronics retailer, is closing the doors on its 69-year presence as an anchor high-street retailer to concentrate on being an online retailer. In making the announcement, John Clare, CEO, also cast doubt as to whether or not consumer electronics retailers had a long-term future on the high street.

He argued that high rents coupled with shrinking margins and fierce competition from online retailers made staying in shopping centers unsustainable in the longer term. "The bottom line is I don't know whether electrical retailers will still exist on the high street in 10 years' time. Two thousand square foot stores next to Marks and Spencer is the most expensive real estate you can find up and down the country," he said, "and electrical will not have a long-term future in that space." 3

For most retailers, meeting consumer expectations won't require such drastic action, but it will require significant improvements in their online business units.

Moving Beyond 1999

Many companies are still using the technology they began with. In the late 1990s, companies created many of today's direct-to-consumer channels under incredible pressure and in very short time frames. The initiatives they designed and implemented for staffing, process and technology were often created to serve an 18- to 24-month horizon. Companies built these business units with either homegrown or early-stage, venture-backed technologies, and implemented them with only bare-bones attention to organizational design, business practices and processes. To hit aggressive milestones, many retailers dramatically scaled back comprehensive programs with the expectation that they would address secondary needs as the business grew.

Since then, business has indeed soared. In the United States, online retail sales topped $172 billion this year, a 22 percent increase over 2005, which itself was a 24 percent  increase over 2004. The pace is just as brisk in other markets: Online sales in Europe are expected to reach $337 billion by 2011.

Those secondary needs, however, are still unmet. With limited investments over the past five years, all dimensions of online business—people, processes and technologies—are under enormous pressure. These channels aren't able to handle the day-to-day business and transaction activities resulting from five years of more than 20 percent growth. As a result, CFOs are dealing with an increasing number of requests for substantial capital investments.

Despite the temptation to postpone a hefty expenditure, upgrading online sales capabilities is long overdue, making it time to invest in processes that can grow with the online sales channel.

Knowing Where to Invest

With so many interdependencies and cross-channel selling influences, companies have a tough time pinpointing what their online business is truly worth, and where to invest company resources. The technology behind leading websites continues to become more complex as marketers find innovative ways not only to sell products online but also to  support bricks-and-mortar stores and the company's overall brand.

Different retailers face different growing pains, but there are some key strategies that should resonate with all companies:

Adopt the right technology. Updating IT systems for e-commerce doesn't necessarily mean buying leading-edge technology, but it does mean having the right infrastructure, as well as tools and processes that can grow with your business. In our experience, however, if 30 percent of a company's volume is from online sales, executives should consider investing commensurately in the software to support such operations.

Companies should also examine the potential synergies between online investment and traditional operations. For example, about 85 percent of consumers visit retailers'  websites and use online features such as wedding registries and store locators. 4 Sears (www.sears.com, www.landsend.com) and Macy's (www.macys.com) are finding that their websites not only generate revenues but also create a runway into their stores. Investing in technology directly translates into in-store sales.

Look at the numbers—again. Shoppers behave differently in front of their computers than they do at the racks, which makes the company website an entirely different beast than a physical store, both in terms of how customers approach it and how they make their decisions. Online shopping channels offer companies a wealth of data into the different behaviors—sometimes almost too much. However, with proper filtering systems, executives can use the customer data to get an idea of what customers view, what they buy, what they abandon—and at what point they abandon it. Having knowledgeable managers to interpret this data is equally important, and experts in direct-to-consumer inventory management will help ensure that you have the right processes and analytics in place. Consider as an example that Meredith, publisher of Better Homes & Gardens and Ladies' Home Journal, maintains a database of more than 80 million consumers with useful segmentation data that allows its marketers to target promotions better and reduce the costs of acquiring new customers and subscribers. Similar thinking drove Altria, the maker of Marlboro cigarettes, to create a line of clothing as a way to get better lifestyle information on consumers who are so loyal to their cigarette brand that they will wear the logo on their sleeve.

Update ordering and fulfillment systems. When companies "bolted on" their online business units, many warehouse and distribution systems followed existing bricks-and-mortar models—an approach not conducive to best-in-class online business performance. There are few systems that can adequately handle both warehousing and distribution, so scaling up for the online business may require separate warehouse and distribution systems, whether or  not they remain in the same physical location. Having a fulfillment system dedicated to direct-to-consumer delivery improves both the time and cost it takes to get products to customers.

But this isn't always easy. Federated Department Stores learned this the hard way when it bought Fingerhut in 1999. Federated acquired Fingerhut, a national leader in mail-order distribution, to support its growing online sales divisions. Poor execution in merging the businesses and creating a seamless system quickly turned the acquisition into a hot potato. After three years of heavy losses, Federated sold it for about $500,000 less than the purchase price. Even the doughty Amazon.com was nearly hobbled until it made the decidedly old-school investment in a distribution center. But distribution doesn't fix everything. California online grocer Pink Dot learned this after it invested in one of the  most advanced distribution technologies for single-item pick and pack, and it still hasn't been able to crack the code on product mix and scalability.

Perhaps the most intriguing development in this area is the peer-supported networks created by companies such as eBay, in which individual users become nodes in a vast and far-reaching distribution network. Participants monitor each other's distribution performance and quality, and provide quick and pointed feedback. Getting a low rating on eBay has a more dramatic impact on a seller's ability to make the next sale than a pile-up of unhappy customers on a company's customer hotline.

In terms of shipping, the goal should be to break even. Gone are the days when online start-ups would offer free shipping on everything from 40-lb bags of dog food to dining room sets in the name of increasing customer loyalty. At the same time, online shoppers are extremely price sensitive: A study by NetIQ, from 2004, found that 52 percent of online shoppers abandoned their carts because of delivery charges. 5 And about 60 percent of retailers report that "free shipping" offers are their most successful marketing tool. Companies must determine what their customers' threshold is for paying shipping costs, and then balance product costs or adopt tiered pricing strategies. Even Amazon continues to try out new strategies: In 2005 it introduced Amazon Prime, in which consumers pay an annual fee of $79 for free two-day shipping and $3.99 for overnight shipping (versus $16.48) on all of their purchases.

Call in the experts. As online retail sales soar, many companies are struggling to maintain the same level of customer service as in their physical stores. Many have set up call centers to deal with customer inquiries and complaints. But operating call centers is often beyond a retailer's area of expertise, and few can easily scale up or down according to seasonal demand. And the fear of losing in-house expertise has kept many from outsourcing their call centers to third parties. Getting past this reluctance may be a critical step to online success. Today's third-party call centers are much more sophisticated and flexible than they were even five years ago. A good provider works with retailers and offers dedicated employees who have the necessary product and company knowledge to ensure that customers receive consistent levels of service and the brand integrity remains strong.

Tearing Down the Silos

It's the mantra of dot.com 101: Consumers expect a seamless shopping experience across retail stores, websites and catalogs. They want to use all of these channels to get information, learn about promotions, purchase goods and, if necessary, return them—all without a single disconnect. Surprisingly, the answer of seamless service is not to integrate channels. After years of operating independently, forcing groups to merge and cooperate will quickly turn into an exercise in post-merger integration. What should or shouldn't be combined? Joint technology? Joint inventory? Joint organizations?

Operating separately is also not the answer. Although many large retailers have tried to run their online business units as separate entities, it works only when the online business is 5 percent of total sales. But as online sales move into the 35 percent of total business realm, operating separately is no longer an option. When the business gets this big, too many processes and investments are duplicated.

The answer is to leverage the strength of all channels and connect them where appropriate. Your online and bricks-and-mortar channels might have separate back-end distribution systems and technology infrastructures, but the customer should never know it. The whole thing should work from a multi-channel business model in which the organizational structure (including performance metrics and rewards), the physical distribution network and inventory deployment all work as one. It is time to weave what was once a standalone, separate e-commerce unit into the overall fabric of the business.

Perhaps the most difficult challenge of weaving it all together comes from how retailers account for their sales and encourage their people. Consider the deceptively simple strategy of allowing customers to buy online and make returns at the store. This can create tremendous conflict within the retailer's organization. As soon as "my turnover" is affected by "your mistake" there is bound to be trouble. When inventory management systems are unable to track products as they move from one bucket to another, sales numbers will be off and rivalries among units will thrive.

Indeed, this issue has a long history with retailers. Until the 1980s, many companies balked at accepting returns from other stores in the network, let alone other channels or other businesses. Even Victoria's Secret, which runs both a terrific online service and bricks-and-mortar chain, is still working on this. While retailers can be forgiven for thinking that such changes to fundamental business models is something to tackle in the future, there are enough new entrants to make this a more serious strategic concern for today.

Reconnecting with Customers

Companies can no longer avoid the issues with their online channels. It is time to heal the growing pains that have emerged from fast-growing online sales and tear down the silos that prevent customers from having the critical seamless experience they demand. For business-to-consumer e-commerce to be truly effective, it will be necessary to revise core elements of existing business models. Indeed, for retailers fighting for that elusive competitive edge, this is the next big power play.

Consulting Author

Mike Moriarty is a vice president in A.T. Kearney's Chicago office and leads the consumer industries and retail practice for North America.

He can be reached at  This e-mail address is being protected from spambots. You need JavaScript enabled to view it

1 Michael Moriarty and Bruce Klassen, Power Play: The Beginning of the Endgame in Net Markets, (John Wiley & Sons, 2001).
2 Glenn Reynolds, An Army of Davids, (Nelson Current, 2006).
3 "Online Competition Evicts Dixons from the Street," Financial Times, 6 April 2006.
4 "Consumer Buying Intentions Slip, but Interest in Internet Remains Strong," www.internetretailer.com, 5 May 2006.
5 "How the Offer of 'Free Shipping' Affects On-line Shopping," http://knowledge.wharton.upenn.edu/, 19 April 2006..