E-Commerce: Misconceptions Go Online

Early stage Internet failures are piling up, but the lessons for logistics specialists are flowing through the Web

Air Cargo World, February, 2001
by Satish Jindel

As countless businesses surely must have learned by now, electronic commerce is not about simply having a Web site to peddle products to consumers. It involves the use of electronic media in the trade and delivery of goods and services that enhances enterprise resource planning and eliminates supply chain links that do not bring value.

The mass availability of Internet technology in offices and in many homes was to give the producers of consumer goods a more efficient channel for marketing, selling and distributing goods. Although most manufacturers were slow to realize this opportunity and others were afraid to disturb their existing distribution and retail channels, the investment community poured billions into e-tailing companies under the impression that investors would gain from a consumer market that would become infatuated with e-commerce.

Obviously it has not worked out that way.

The collapse of many Internet-based businesses came about for several reasons, but one common theme has been a striking lack of understanding of the logistics process and its impact on any business's ability to reach its customer in a way that is both timely and profitable.

At the same time, logistics operators also have not understood the impact of the Internet and how the widespread availability of such rapid communications may open new channels of opportunity, creating new markets that may demand unique approaches in the way goods are ordered and delivered, whether to consumers or within business enterprises.

The good news for those companies that have been slow to embrace the Internet is that the greatest benefits may be yet to come. As Andrew Grove, chairman of Intel, has put it: "The real big things are going to happen when you start connecting databases of one place to the decision systems in another place, and you evaluate options on the fly."

What better way to do that than through a global Internet? This is as true in 2001, a gloomy year so far for Web strategists, as it was during the large growth days of a couple of years ago.

In understanding how logistics management may change over the Internet, it is important first to understand where so much of the business world went wrong.

First, let's look at some e-tailing myths.

The first myth is that the business-to-consumer e-tailing business marked a new business model at all. It is a new marketing channel.

The introduction of the Internet as an information network recalled the decision by mail order companies to start taking orders by telephone. Those orders did not change the fortunes of the mail order companies. A comparison of cost structure of select cataloguers from the old economy with the e-tailers of the new economy suggests e-tailers do not hold any cost advantage over cataloguers but face much higher costs for marketing and attracting customers.

The larger the target customer base, the more expensive it is to reach them. Toysmart.com, an Internet venture funded by the Walt Disney Co. was spending $2.6 million in advertising per quarter to generate $66,000 in sales. The result of its marketing approach was that it spent an average of $200 to obtain each customer and that a single customer spent an average of $44.

It does not require a finance degree from Wharton to see the problem with that business scheme.

But the problems with these businesses get worse further down the supply chain. The logistics needs of business-to-consumer online retailing were simply not recognized.

The entrepreneurs and their venture capital partners grossly misunderstood and underestimated the challenges with inventory management, taking orders, fulfillment, shipping and handling returns. The expectation was that once the demand was created, these systems would evolve.

Yet the logistics industry knows how complex and difficult such systems are. It took over two years for FedEx to introduce its home delivery service, which still does not offer full coverage in all 48 continental states.

According to the second annual U.S. E-Fulfillment study from consultant Accenture, traditional retailers taking Web orders and mail-order cataloguers were 7 percent better at on-time delivery than pure e-tailers.

Another factor that has contributed to the demise of the sector has been, paradoxically, the easy access to venture capital. The hunger of venture funds to get in on the new "easy money" allowed companies without sound business models and track records to get millions of dollars to start a business. Traditional catalogue companies with revenues and profits to show were seen as out of step with the new retail model.

However, Internet poster child eToys spent $20 million last year on a highly automated 440,000-square-foot facility in Blair, Va., because its third-party fulfillment operator showed a 1 percent failure during the prior Christmas season. No catalogue company would have doubled its capacity in one year with such large capital expense using its internally generated funds.

In its haste to strike it rich, the investment community also mislabeled many "old economy" business models as "new economy." But just look at Kozmo.com and UrbanFetch.com, two classic "dot-coms" whose business models are no different from those of local courier companies that have been in business for decades.

Yet the market cap for the business-to-consumer Kozmo. com was far richer than that of courier companies in the business-to-business world. In 1999, Kozmo.com had a net loss of $26.4 million on revenue of $3.6 million. Commenting on these results, the company said it had realized that the delivery business is very "labor intensive."

Surely there must be a less expensive way to get such basic lessons in the delivery business.

E-tailers also have relied too heavily on Christmas sales. Yes, many traditional retailers make their profits during the Christmas holiday season. But e-tailers have long hoped to recoup losses and merely stay in business on this revenue from a very limited time period. This compounded their failure in managing the distribution and delivery to homes in the last couple weeks before Christmas. United Parcel Service, which delivers more than 60 percent of all parcels to residences, sees its parcel volume more than double during this period. UPS and other express carriers suspend their guarantee on most deliveries to commercial and residential addresses during the holidays. The result is that it is even more difficult to ensure timely arrival of gifts for Christmas.

Just as investors had unrealistic goals from the Internet, many companies led consumers into unreasonable expectations.

The e-tailers and their venture partners totally overlooked all past experience and studies of consumer purchasing behavior. They believed that once people got used to having chewing gum or videos delivered on short notice for free, they would eventually pay a huge premium for such service. In reality, many consumers still visit several stores to get lower prices for even small ticket items. The few who might pay that premium will not provide sufficient density to support business models aimed at millions of consumers.

Wall Street has its share of responsibility for business failures and loss of capital of titanic proportions. Instead of focusing on the technology companies developing Internet infrastructure, Internet analysts at major Wall Street investment firms were asked to analyze e-commerce and e-tailing companies. While eToys and Kozmo.com fell under the preview of Internet analysts, courier companies such as Consolidated Delivery & Logistics are covered by transportation analysts and Toys 'R' Us by a retail analyst.

The lack of specific industry knowledge among Internet analysts limited their ability to benchmark the cost structure and value proposition of eToys against Toys 'R' Us and Kozmo.com against couriers.

Last, and perhaps most troubling, is that most of these businesses failed to understand the true value of the Internet. The invention of the telephone, and several decades later of the television, came in a world already populated by mail-order firms. But providing customer service over the phone did not make catalogue companies into telecommunications firms. And marketing by television has not led the Home Shopping Network or QVC to take the place of Sears or Wal-Mart.

Both developments changed business patterns among cataloguers, but there were not the wild predictions that the new tools would create a new form of commerce.

The most important attributes of the Internet are: information availability across national and physical barriers; information processing with full compatibility; and information (pictorial and data) transferability between seller and buyer.

The e-tailers have failed to exploit the most important attributes of the Internet, such as sharing information with the customers about the status of their order.

But the disconnect between the Internet's potential and its reality is more evident in the way manufacturers - the world's shippers - have failed to enhance the flow of information between all parties.

Many producers and manufacturers of goods that have strong brand-name recognition in the market should take special note of the changes the Internet can help bring to their business model. The manufacturers are concerned about not disturbing their relationship with the existing distribution channels - the wholesalers and retailers - these same retailers are aggressively introducing their own store-branded products to compete with the national brands.

Supermarkets, for instance, offer a wide range of house brands that compete on the shelves with large food-sellers. But manufacturers have been reluctant to market their products directly to the household consumers for fear of alienating existing distribution channels. For manufacturers that have already fallen into this situation and lost their national brand identity, it will be difficult to reverse the trend.

However, for those that still have name awareness and loyalty among the consumers, they need to move rapidly to protect the value of their brand name and margins. The manufacturers need to break out of the mold that prevents them from using new distribution channels, because only the channels that work best for the consumers will ultimately survive.

Just as retailers are leveraging their brick-and-mortar presence in local markets and in close proximity to consumers, the manufacturers need to leverage their production, product development and brand awareness to market their products directly to the consumers.

But the area of greater interest to a wider range of logistics providers may be the less-discussed realm of manufacturer-to-business commerce that is facilitated by the Internet.

Large corporate consumers have dealt directly with the manufacturers for years. After all, when UPS wants to buy its brown package trucks, it does not go through a dealership. However, small and medium-size businesses have been limited in their ability to deal directly with the manufacturers to obtain the lowest prices.

The Internet changes that equation, allowing for the economical and efficient flow of information among a large number of businesses, perhaps acting in cooperation and with varying levels of technological capability. This developing world of M2B has great implications for the way industrial goods are purchased and moved, and that will have a significant impact on all elements of the logistics world.

This movement is already having an impact on parcel delivery. With real-time availability of standard transit times, actual delivery time and name of person accepting the shipment, parcel shippers are now able to provide better information and more detailed information on their shipments.

These enhanced information capabilities allow shippers to better manage their accounts receivable. They can efficiently search out delivery commitments and choose the least expensive alternatives - perhaps ground over air - to meet the required date.

Shippers can provide ship notification to the customers with not just ship date but the expected guaranteed delivery date and time, the contents of the shipment and type of service used to ship.

At the same time, consignees can better manage their inbound shipments to minimize the inventory cost.

Carriers also can reduce their cost of providing shipment information. For UPS, a telephone tracking request costs about $2 per package compared to 10 cents per online tracking request. With 6.5 million tracking requests on one day during peak season last December, the day's savings to UPS from having customers go online amounted to $12.35 million.

That is why the early stage failures of Internet companies may not be so important in the long run. There are, in fact, real benefits flowing from the Internet to shippers, consignees and carriers. They are being driven largely by one of the Internet's most basic attributes - the ability to provide universal access to information around the globe in a cost-effective manner and in real time.