Profits likely to elude e-commerce vendors

Profits turned by electronic-commerce ventures that trade in "quasi-commodity"goods like books, toys, videos and music CDs are likely to remain "low at best and frequently completely elusive" as those markets face a second wave of competition, according to a Massachusetts Institute of Technology (MIT) management professor.

Still, there is plenty that e-commerce vendors and those who want to break into online markets can do to succeed on the Internet, John M. de Figueiredo suggests in the article, "Finding Sustainable Profitability in Electronic Commerce," in the summer edition of the Sloan Management Review, which is published by MIT in Cambridge, Massachusetts.

Differentiation is the key for vendors like Amazon.com Inc., which could find success in its strategy of offering more than books and with its plans to provide chat rooms and affinity groups at its Web site. The company's strong internal search engine as well as its strong branding also are key to the competitive advantage Amazon has built as an early mover in online sales. Sites selling books, music, toys and similar consumer products will find favor by offering lower prices than competitors on goods delivered quickly and purchased using secure transaction systems, the assistant professor of strategic management wrote.

Trickier, though, is the market for "look-and-feel" goods like furniture, clothing, used cars and homes, de Figueiredo said. Items such as used cars and homes, in fact, are not likely to find a market niche online for years to come -- at least until technological advances come along.

"Technology is being developed to allow Web browsers to more finely examine texture and minute details. In addition, software and hardware advancements will soon allow consumers to review the actual products they are selecting in real time and then take quick delivery," he said. "Developments like these will help make this product segment accessible to e-commerce vendors, but some product markets, like used cars and homes, will always be difficult to penetrate. In these segments, technological barriers will prevail for years, and intermediaries will need to arise before such problems can be solved."Until then, price and reputation are crucial. Companies with already-established reputations will find it easier to succeed. Lingerie and clothing manufacturer Victoria's Secret, for instance, as well as car maker Saturn have done well online because consumers who buy from them over the Web tend to already know how the clothes look, fit and wear and how the cars look and drive.

But there are exceptions among established companies. De Figueiredo pointed to Merrill Lynch & Co. as an established financial company that was slow to launch online and for whom "success is uncertain." Conversely, competitor Charles Schwab & Co. was quick to get online and had an existing business model more easily adapted to the Internet. Schwab's telephone trading system existed long before the Net, and its computer systems also made a relatively smooth transition to the Internet, he said. The company further has a corporate culture that supports providing customer service at a distance.

Even with an existing strong IT focus and a quick move to the Internet, many e-commerce companies are still likely to realise slim, if any, profits because of high barriers to entry and strong competition. However, it is possible, he wrote, to "crack the code" and make a profit from e-commerce. Companies have to work to insulate their goods from price competition, create customer loyalty programs and "Web-site stickiness."Good customer loyalty programs aren't going to consist of offering return consumers frequent flier miles, de Figueiredo said. In part, that's because so many companies have gone that route. Instead, e-commerce vendors need to offer "site-specific loyalty and reward programs," as those will lure consumers back to buy again.

De Figueiredo opens his article commenting about the extreme market capitalisations of e-commerce vendors like Amazon. Although the company has yet to realise a profit and has been hammered recently by the stock market and by analysts, it maintains a market cap, as of Monday, of $US12.14 billion. When de Figueiredo wrote his article, he cited the company's April 20 market cap of $US18.3 billion, calling it "stunning" and comparing it to "the mere $US14.2 billion market value of Sears, Roebuck & Co." That established retailer had $US1.3 billion in net income on annual revenue of more than $32 billion, de Figueiredo noted.

The question he raises is whether e-commerce vendors like Amazon can ever realise their market caps. He proposes a framework under which profits can be made online. Even so, "only a small fraction of these companies will be very successful and generate the supernormal profits their valuations suggest," he concluded. Those that can best exploit competitive advantages in their markets will have a better shot at "justifying their valuations," he said.

The Sloan Management Review can be found online at http://mitsloan.mit.edu/.

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