Sunday, November 30, 2008

The Staples 2.0 Effect

Lately, comScore has been the bearer of a lot of bad eCommerce news. On November 18th, comScore issued a press release stating: “U.S. Retail E-Commerce Growth Slows to 1 Percent in October as Concerns about Inflation, Jobs and the Financial Markets Cause Consumers to Curb Spending.” On November 25th, they followed up with another press release that had more bad news, “comScore Forecasts Flat Growth for 2008 Holiday E-Commerce Spending.” And today, comScore’s most recent press release, “Black Friday Sees $534 Million in E-Commerce Spending, Up 1 Percent Versus Year Ago.”

After comScore’s first press release, the NYTimes followed with an article bemoaning the difficulties facing online retailers. “Internet retailers, trying to navigate what is shaping up to be the first truly dreary holiday shopping season ever on the Web, are engaging in price-cutting and discounting so aggressive that it threatens their profit margins and, in some cases, their very survival.”

The insinuation, from the NYTimes in particular, seems to be that consumer spending is so bad this season, it is putting not just brick and mortar retailers but the once unstoppable e-retailers out of business. Even Henry Blodget of Alley Insider described the comScore and NYTimes news as “frightening” and “shocking” in his post, “Depression 2.0 Comes To eCommerce”. He goes on to summarize, “The bottom line: Lots of [eCommerce] companies are toast.”

But this isn’t the full picture. Yes, many eCommerce companies will buy their last keyword this season thanks to the shopping “Depression 2.0”, but the slowdown in consumer spending is not the only market trend at work. Instead, eCommerce is going through a fundamental shift in its makeup – call it a Staples 2.0 effect.

When superstores like Walmart and “category killers” like Staples and Home Depot moved into our neighborhoods, their lean supply chains, operational efficiencies of scale, and national marketing budgets, put many mom and pop stores out of business. Now that eCommerce sites like Zappos, BlueNile, NewEgg, and others are reaching category killer scale, we’re seeing a similar thinning of mom and pop e-tailers.

So when the NYTimes highlights the experiences of e-tailers ranging from Lori Andre of Lori’s Designer Shoes, to Tony Hsieh, CEO of Zappos, they conflate two very different companies. Despite Lori’s claim, “We’ve been in business for 25 years, and never seen the bottom drop out like this,” the eCommerce sky isn’t falling. It’s no surprise that a website like Lori’s Designer Shoes, which sells designer shoes and other designer items, is struggling right now. Lori’s Shoes (11.5k uniques in October) is competing against one of the new goliaths in eCommerce, Zappos (4.5m uniques in October). That’s an uphill battle. Just take a look at their traffic:

Even on the internet, size does matter. Putting aside the traditional efficiencies that come with scale (e.g., Zappos can probably get better prices on its inventory than Lori’s can, has a more efficient warehouse, etc), there are several benefits of scale unique to e-retail:

First, because Zappos can offer such an extensive catalog of SKUs on its site, it is able to cross sell more products to each customer and drive a much higher average basket size than Lori’s Shoes. A higher basket size for each customer visit means more profit from each customer given an average marketing acquisition cost, and it also means Zappos can afford to do things like throw in free shipping (or in Zappos’ case, hassle-free returns), which subscale Lori would have more trouble doing. Moreover, because Zappos can drive better profit margins than Lori’s, it can afford to spend more money on online advertising than Lori’s.

Second, when it comes to building a successful and profitable eCommerce company, it’s all about building a brand. Once an e-retailer has the brand recognition, I don’t know how a mom and pop can compete. If someone is searching for designer shoes and sees a Zappos sponsored link or a Lori’s Shoes sponsored link, even if Lori’s was willing and able to bid more for its keywords, a consumer is more likely to click on the Zappos link than the Lori’s Shoes link because the consumer recognizes Zappos’ brand, they may have even had a friend tell them what a great experience they had ordering from Zappos. Because of the way way Google's algorithm determines sponsored link placement, Zappos' higher likelihood to convert would drive Zappos' placement up the list. Consequently, Zappos and other online retail “category killers” can acquire traffic more cheaply than Lori’s ever could.

And there's the rub. Once an e-retailer like Zappos has attained this brand recognition, price competition is the only way an e-retailer like Lori’s Shoes can hope to compete, and we all know that’s a losing proposition. Meanwhile, Zappos and other category killers continue to pick up market share of online and offline shopping dollars. This will only be helped by brick and mortar retailers like Foot Locker, Circuit City, Home Depot and others that are trying to reduce their fixed costs by shuttering retail store locations.

Sure, it's not pretty now, but I think the eCommerce category is only going to emerge stronger from this recession. Just don't expect it to look like it does now.

8 comments:

Adam said...

Interesting post. My one quibble is that I think that the correlation between brand recognition and ad CTR is likely much lower in practice than in theory.

CTR on an ad is dependent on a bunch of things. Having a big brand helps, but writing good ads plays a big role. There are a lot of junky ads out there, and most people aren't going to click on ads that are either 1) completely irrelevant to whatever their search query was, or 2) kinda sorta describe what they were looking for, but are really generic and not tailored to their exact need (ever tried to click an ad from a travel aggregator like Expedia lately?). In contrast, people are much more likely to click on stuff that discusses exactly what they searched for.

This where a Zappos's scale can be a liability rather than an asset. Zappos stocks thousands of shoes and probably can't write unique, natural-sounding ads for every single niche. There's just too many potential queries out there and their time is usually better spent optimizing for value on the high-traffic keywords that bring them a healthy percentage of traffic (think "shoe store"), rather than on all the stuff that gets relatively tiny amounts of traffic ("ferragamo varina patent").

On the other hand, a small boutique might only have a few dozen pairs for sale and can write compelling ad texts for all of them. So for keywords related to their niche, I'd expect the small guy to get a significantly higher CTR (controlling for all other factors like ad position) than Zappos.

So I think that there's still the opportunity to be competitive on AdWords or YSM, even if you're a small retailer, as long as you're clever. It's the medium-sized guys who have the most to worry about - the generalists who want to be Zappos, but aren't there yet. Like the tiny fish, they have little brand recognition, but unlike them, they're stuck with an inferior value proposition, since they're trying to be more or less like Zappos rather than consciously differentiate their business from that big brand.

Anonymous said...

Great analysis. @Adam, zappos would presumably want to target the top selling or most highly searched inventory for SEO. I agree that the smaller players could more effectively SEO the long tail, but the old retail rules still apply to e-tail. The right selection of product, service, and "location" (in e-tail's case it's SEO for the most popular stuff), still make the big winners. And I buy the argument presented here that the winners are consolidating the long tail in this soft environment.

Sarah Tavel said...

Adam, thanks for the comment and feedback. You have a good point about the importance of writing a good ad. But I'm still a bit skeptical that that would overcompensate for brand equity, in large part because I think mom and pop's tend not to be as sophisticated as larger online retailers when it comes to PPC ads. Consequently, I think Zappos would be better positioned to capture the long tail of search queries than a small online retailer. That said, I'll agree that there is an opportunity to be competitive with the zappos of the world, but I think that has to come from some other "gimmick" (e.g. personalizing tshirts a la zazzle or threadless) than better ad copy.

Sarah Tavel said...

@Anonymous, thanks for the feedback. You raise another good point which I didn't talk about because my post was getting too long, but it's the SEO benefit large e-tailers get from having a community (i.e. user reviews). Folica is a great example of an eretailer that likely benefits from a lot of SEO because they have so many user reviews of hair products. It's hard for a small eretailer to compete with that size community.

Phil Michaelson said...

another benefit of scale, and of having a community both within and outside your site, is an improved organic search ranking. this lowers marketing costs.

while great physical real estate can often be bought by a newcomer, great virtual real estate must often be earned over time.*

*exceptions include is the plight of Starbucks in New England, which is thwarted by Dunkin Donuts. Or the domain coupons.com

r said...

Sarah, great post. You've highlighted what I've always thought is a remarkably underrepresented conclusion that e-commerce will come to more closely resemble retail in the long run. My thoughts got a little long, so I put them into a blog post:

http://rodgerv.wordpress.com/2008/12/05/staples-20-when-online-resembles-offline/

Qlubb-Andy said...

You're right! While the Internet certainly removes some barriers to compete against the bigger players, it does not equalize brand, operating cost advantages and a whole host of other things that make businesses successful.

It all comes down to a smaller firm able to compete in a particular niche market segment in a way that matters to the customer enough to tear the person away from the advantages of incumbency. It might be much better price, it might be more prestige, it might be customer service, it might be a way to be different - whatever, it just has to matter enough.

JAS said...

BTW (forgive the pun), one last thing. AMZN and other big guys have the distinct advantage of data. They know the best keywords to buy, and have unique insight into the "land grab" at exactly the right times. An advantage that shouldn't be overlooked.