A framework to understand the e-commerce exuberance
E-commerce can drive passions. Supporters think that it will change the world and that we are at just the beginning of the e-commerce trend, whereas detractors think that the business model is flawed and most sales are driven by discounts and promotions. E-commerce is relevant not just for venture capitalists but also for brick-and-mortar retailers, and also for people associated with commercial real estate in the form of malls and high street stores. Without getting into the valuations debate, let us look at a framework to understand e-commerce.
There are broadly two kinds of e-commerce. The first kind is where the fulfilment is virtual. There is a whole category of commerce where the customer need is fulfilled via the Internet. Think about digital media (music, movies, e-books), apps, software, ticketing (travel, movies, concerts), matching counterparts (marriage, dating, taxi services, classified), and others. In such areas where the fulfilment is virtual, the Internet has a huge advantage over traditional ways of doing business and most people recognize this. Hence, even detractors of e-commerce will not argue that brick-and-mortar air travel agents, for example, have a bright future in the face of competition from travel booking portals.
The second kind of e-commerce is where the fulfilment of the customers’ needs has to happen in the real world. This is where things become somewhat tricky. In this sphere, e-commerce has both advantages as well as disadvantages compared with the brick-and-mortar stores. Let us look at this to get some understanding about the future.
Advantages of e-commerce in the physical world fulfilment relate to wider choice to customers, efficient inventory management, lower search and friction costs, better access for customers, lower staffing and rental costs. Disadvantages pertain to higher costs on logistics for delivery of each individual order, lack of touch and feel and trial of the products, lack of human interface for customers and longer lead time to fulfilment.
To understand whether a particular e-commerce venture will succeed or whether its brick-and-mortar competitor will rule, one has to check whether the e-tailer is able to leverage the advantages of the virtual world while minimizing the disadvantages. The various variables play out as under.
Number of stock keeping units (SKUs): If the number of SKUs in a business is very large, e-commerce has an advantage. But if the number of units is small, a brick-and-mortar store will have an advantage. For example, in the case of printed books, there are far too many books for a local book store to offer a good collection and, hence, online booksellers have an edge. However, for toothpaste, the corner grocery store has an advantage.
Search and friction costs: Many a times people have a need for a product but simply do not know where to buy it, what kind to buy and what would be the right price. An amateur astronomer may feel like buying a telescope but would not know the right place to buy, the right type to buy and whether the price quoted by the seller is correct or not. E-commerce eliminates or reduces this search and friction cost, and enables a transaction to take place.
Immediacy of need fulfilment, and perishability of product: There are some products where the customer cannot wait. Here, e-commerce has a huge disadvantage. In many cases, the product itself has a limited shelf life. Further, many of these products individually have a low price per unit and delivery cost per unit would be too high for e-tailers. Hence, for things such as milk, bread or medicines, e-commerce may have a very tough competitor in brick-and-mortar stores.
Touch and feel of the product: I am aware that we have portals trying to sell clothing, shoes and even things such as prescription glasses online. Anecdotally, there are also some sales happening in these categories. However, theory will say that wherever some element of personal interface with the product is required, a brick-and-mortar store will have an advantage. One can surely buy a shirt online but the possibility that it may not fully satisfy the customer is high because the fabric, precise colour, fit and other such elements have not been tried by the customer before purchase. Here, the e-commerce business proposition is tricky.
A point worth noting is that e-commerce businesses and consumers have been morphing processes in such a manner that traditional businesses have not been able to cope up. A business of selling printed books, CDs and DVDs, where the product had to be fulfilled physically, morphed into virtual fulfilment. Products requiring touch and feel and human interface started seeing the phenomenon of “show-rooming”. Show-rooming refers to the practice where a customer goes to a physical store to see the product, interact with the sales person and do comparisons and then does the final purchase online. This is the worst nightmare for the traditional store where all the costs associated with the business (rentals, air-conditioning, salaries, inventories) are borne by the brick-and-mortar stores while the sales happen online.
In conclusion one can say that e-commerce will succeed in some categories and is likely to fail in others. It will not be a world with either e-commerce or brick-and-mortar stores, but both. Traditional retailers will have to be agile in responding to the developments in the e-commerce space and make use of tactics such as omni channel offerings (traditional + online).
End note: For those wondering why online retailers offer heavy discounts and are aggressive in trying to grab market share, it is worth noting that in the digital space, many a times it is a winner takes all game and there may not be a prize for the runner-up.
Rajeev Thakkar is chief investment officer and director, PPFAS Asset Management Pvt. Ltd.