BUAD 307
Marketing
Fundamentals

 

 

 

MIDTERM REVIEW

04--Considerations in involving suitability for products and services for sale online

PowerPoint Narration

Some people have suggested that the Internet may be a less expensive way to distribute products than traditional “brick-and-mortar” stores.  However, in most cases, selling online will probably be more costly than selling in traditional stores due to the high costs of processing orders and direct shipping to the customer.   Some products may, however, be economically marketed online.  Some factors that are relevant in assessing the potential for e-commerce to be an effective way to sell a specific products are:

  • “Value-to-bulk” ratio.  Products that have a lot of value squeezed into a small volume (e.g., high end jewelry and certain electronic products) are often more cost-effective to ship to end-customers than are bulkier products with less value (e.g., low end furniture).
  • Absolute margins.  Some products may have a rather high percentage margin—e.g., a scarf bought at wholesale at $10 and marked up 100% to be sold at $20.  However, the absolute margin is only $20-$10=$10.  In contrast, a laptop computer may be bought at $1,000 and be marked up by only 15%, or $150, for a total price of $1,150.  Here, however, the absolute margin will be larger--$150.  This allows the merchant to spend money on processing, packaging, and shipping the order.  Ten dollars, in contrast, can only cover a small amount of employee time and very limited packaging and shipping.  Some online merchants do charge for shipping, but doing so will ultimately make the online merchant less competitive.
  • Extent of customization needed.  Some products need to be customized—e.g., checks have to be personalized and airline tickets have to be issued for a specific departure site, destination time, and travel time.  Here, online processing may be useful because the customer can do much of the work.
  • Willingness of customers to pay for convenience.  Some consumers may be willing to pay for the convenience of having products delivered to their door.  For example, delivering high bulk, generally low value groceries is generally not efficient.  However, for some customers, it may be worthwhile to pay to avoid an inconvenient trip to the grocery store.
  • Geographic dispersal of customers.  Electronic commerce, when value-to-bulk ratios and absolute margins are not favorable, is often not viable when customers are located conveniently close to a retail outlet.  However, for some products—e.g., bee keeping equipment—customers are widely geographically dispersed and thus, a centralized distribution center may be more economically viable.  Specialty books—e.g., for collectors of vintage automobiles—may not be worthwhile for bookstores to stock, and these may thus be economically sold online.
  • Vulnerability of inventory to loss of value.  Some products—especially high tech products—have a very high effective carrying costs.  It has been estimated that because of the rapid technological progress made in the computer field, computer parts may lose as much as 1.5% of their value per week.  If shipping directly to the customer can reduce the channel time by five weeks, this potentially “rescues” as much as 7.5% of the product value.  In such a situation, then, trying to reach the customer directly may make sense, even if the direct costs of distribution are higher, because of the inventory value issue.

A chart distributed with the PowerPoint handout for this topic also discusses these factors. A handout on collaborative filtering is also included.

At the firm level, some will be better able to efficiently and effectively sell on the Internet than others.  These are some considerations:

  • Firm reputation/credibility.  Since the customer is buying a product without the opportunity to inspect it, and since the customer will need to have a certain confidence that the merchandise ordered will actually arrive, firms with stronger reputations will be more likely to receive orders.
  • Volumes soldOne way to limit the labor costs of online sales is to automate the process as much as possible.  For example, rather than having people go around in a warehouse to pick up and assemble different parts of an order, an automatic conveyor belt that will pick up the different products of a customer’s order at different “stations” will do much of the work that the customer does in a traditional store.  The up-front investment in automation is heavy, however, and thus, this investment needs to be spread over a large number of units. As with conventional retail chains, those that buy large quantities have greater bargaining power to get prices down.  This allows for greater margins and/or greater quantities sold at prices lower than what certain competitors can match.  Firms shipping more packages can also negotiate lower shipping costs per unit.
  • Ability to sell multiple items together.  It is useful to be able to spread the costs of packaging and shipping across a number of different items.  The more different but complementary items that an online vendor carries, the more likely it is that customer orders will tend to include a number of different items.
  • Synergy with traditional retail store operations (“bricks-and-clicks”).  Well known retail chains—e.g., Staples, Costco, and Nordstrom’s—tend an established reputation as discussed above and are thus more likely to be trusted.  Having retail locations also makes it easier to accept returns, and the combined sales of online and brick-and-mortar outlets make for a greater bargaining power.
  • Location for minimization of sales taxes.  Some states either do not collect sales taxes or have a small population so that sales within the state are modest.  The rules of taxation of items sold out-of-state through Internet orders are complex.  An increasing number of online merchants, including Amazon, have now agreed to collect sales taxes on shipments to California and a number of other states.  There are, however, still some online merchants that manage to avoid collecting sales tax on merchandise shipped to certain other states.  Internationally, there may also be opportunities to avoid sales and duties—sometimes legally and sometimes not. 
  • Location for low labor and land costs.  With ready access to shippers such as UPS and Federal Express in most of the Continental U.S., there is no significant advantage in being located in a major city.  Small towns often have much lower real estate costs.  Firms can also locate in areas where wage levels tend to be lower (e.g., because of high levels of unemployment or other economic depressors).
  • Potential for repeat sales to the same customer.  Just as in traditional brick-and-mortar sales, it is often more cost effective to sell to existing customers than constantly trying to reach new ones.  This is true online as well.  In addition, based on knowing what the customer has bought in the past, it is possible to identify other customers who have bought these same items and identify additional common purchases among these relatively similar individuals.  This process, known as collaborative filtering, is discussed below.

 

There are a number of economic realities of online competition:

  • As discussed, costs of handling online orders is often higher than that of distributing through traditional stores.
  • Even if online selling is more cost effective in some situations, a firm selling online will, in the long run, be competing with other online merchants—not just against traditional “brick-and-mortar” stores.  By the forces of supply and demand, online prices will then be driven down so that the profit from selling online will be no greater than that from traditional retailing.  Any reduced costs would then be expected to go to customers.
  • Competition will be greater for products that have large markets than for those where markets are smaller and more specialized.  Amazon.com, for example, has found it necessary to discount best selling books deeply.  Higher prices—closer to the list price—can be charged for specialty books, but for a large part of the market, competition will be intense.
  • A new online merchant will face competition from established traditional merchants.  These will often have the cash reserves to stay in business for a long time even with temporary competition.  The online merchant, if it has no cash reserves other than stockholders’ investment, may run out of cash before it can become profitable.

 

In comparing the cost of selling online with of selling through the traditional retail structure, it appears to absolute margins and the extent to which the assembly and shipping process are automated are two of the most significant factors.  In looking at the structure of costs, we find the following:

Cost Component

Brick-and Mortar Store

Online sales

Combined (“Bricks and Clicks”)

Ordering cost (from wholesaler or manufacturer)

Average cost per unit will be lower (and the firm will have better bargaining power with suppliers due to volumes bought)

Inventory holding

Possibly lower due to faster turnover and lesser safety stock

May benefit from economies of scale

Inventory space

Probably lower due to use of less expensive real estate

Combination of the two (some expensive and some cheaper) with possible savings from joint use

Retail store space

 

For physical store outlets

Stocking

Assembling order

 

• (May be reduced by automation)

For online component (May be reduced by automation)

Packaging order

 

•(May be reduced by automation)

For online component (May be reduced by automation)

Cost of shipping to customer

 

For online component

Store sales staff (non-checkout)

Possibly for online support (“chatters”)

For physical store component and possibly for online support (“chatters”)

Credit card charges or allowance for bad checks, if accepted (assuming no cash payments)

Loss of inventory value over time

Greater

Smaller

In proportion to the relative sales by each method

Handling of returns

Smaller

Greater

Smaller

Note: • indicates that a cost is present.

            One of the key issues from this table is the cost of non-checkout sales personnel.  Analysts have suggested that Best Buy has relatively high costs in part because of the high rents they must pay for many of their retail locations and in part because of the high cost of the “blue shirt” sales people.  To the extent that selling online is a way to reduce this labor cost, there might, in principle, be a strong argument for cost savings.  However, it should be noted that Wal-Mart and certain other self-service brick-and-mortar retail chains have considerably lower cost here:  The customers usually select their own items, put these in their carts, take them to the cash register, and then bring the purchases home.  If a retailer needs to have sales people bring out items for a back storage facility, that may, indeed, be inefficient.  However, if the sales people help answer customer questions, the question arises as to whether an online site can answer such questions in a way that is equally convenient to customers.  A great deal of information can be put in a product description, and other information can be made available in areas such as FAQ sections, but some customers may have more difficulty finding this information.


Because the random variations in demand for different retail stores largely cancel out each other when orders are handled from a much larger facility handling online orders for a particular region, there is less need to carry extra or “safety” stock.  The opportunity cost of sales foregone because of stockouts will also be smaller.

 

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