When Amazon sneezes, retailers catch a cold
Normally, Amazon’s quarterly reports are happy occasions. In 5 years, its share price is up nearly 500% – an amazing achievement for a period marked by multiple financial crises.
But on October 25, the company shocked investors by reporting a sharp decline in income, despite continuing its strong revenue growth. In one day, the company lost almost 10% of its market capitalization.
Amazon’s challenge put the spotlight on what I think will be a major trend for 2012 in online retailing – the fight for profits. Up until now, the growth possibilities in e-commerce have stolen the spotlight. But it is becoming increasingly clear that in the 2010s, the question is not if you can grow your sales online, but how you can grow your sales online profitably.
Interestingly, while Amazon’s lousy results received a lot of attention, Amazon might be one of the companies that need to worry the least. Underneath the hood, their gross margins are stable, their sales are growing and their marketing expenses under control. Much more worrying are that other major online retailers, such as Overstock.com and Bluefly are reporting falling gross margins and much smaller sales growth.
The causes for the profitability problem are not hard to find:
- More choice as more retailers move online, borders to international trading are eliminated, and new business models emerge (e.g. private shopping clubs)
- More knowledgeable consumers who have learned how to shop around for a bargain (e.g. using price comparison sites and coupon sites)
- Increasing costs of advertising online
- Increasingly complex demands on the e-commerce platform
- Stagnant personal incomes in much of Europe and the US
The key question – which is hard – is what to do about it? None of the causes listed above can be reversed or battled. You have to cope with them.
I think the solution can be summarized as active retailing. The core concepts in online retailing – how we design and structure an e-commerce site – stem from a world where the key challenge was to get people to start buying online. Low prices, a wide assortment and a search box (because people always knew what they wanted to buy) was enough. In that passive retailing mode, people were expected to inspire and convince themselves what to buy.
Today, online retailers are increasingly competing against other online retailers, with similar cost structures and assortments. You can still win the customer by offering lower prices, but only if you can compensate the loss of profit in other ways. As more and more sources of new customers are perfect markets – traffic goes to the highest bidder or deepest discounter – the price for a new visitor is set, and the only thing that determines if you can place the highest bid is that customer’s lifetime value.
In other words, the path to profitability lies in actively extracting the most value from each new visitor to a site – converting them, up-selling them, cross-selling them and remarketing to them through emails and ads. It is a continuous, relentless process.
But unlike physical retailing – where you can force people around your store, the IKEA way – online retail sites must be geared to actively sell to the consumer at every chance while still making it entertaining. Pricing, product selection and visual display must all come together to make customers feel inspired, not forced, to buy more and come back for more. Sophisticated personalization will be key in this process, as the retailers which are able to service customers on an individual level will be able to outsell those that are stuck in one-size-fits-all approaches.
As Winston Churchill put it, “If you mean to profit, learn to please”.