Consumer e-commerce has been a large target for criticism during the past six months. Unfortunately, when so much criticism builds at once, much of it is misleading, and yet it goes unchecked. Why? Because it is easy to hit something when it's already down, and, often during dark periods, nobody will investigate the accuracy behind the punches.
Today we investigate some of the most popular claims of e-commerce bears.
Misconception # 1: Expensive, ongoing marketing costs, which are vital to survival, destroy the potential for meaningful profitability.
Counter-argument: When arguing about marketing costs, the e-commerce bears have always tried to have their cake and eat it, too. Held to scrutiny, the combined bearish arguments are greatly flawed.
First, doubters say that expensive marketing is necessary to build and maintain an online customer base. Marketing is a necessary and giant cost. From the other side of their mouths, however, doubters tell us how ineffective marketing has been for online retailers. It has been an extreme cost without great benefit. "It simply doesn't work," they laugh.
Yet, illogically, they continue to argue that it is necessary!
Spending large sums of money on marketing has not made any online business a success. The most successful online companies grow mainly by word of mouth, or viral networking, which happens organically -- essentially free of charge. Yahoo! (Nasdaq: YHOO), eBay (Nasdaq: EBAY) and Amazon.com (Nasdaq: AMZN) have grown mainly by word of mouth because they offer a unique experience and they have brand recognition that was gained partly by being the first mover. The first mover gets all the free press!
So, bears, if expensive marketing doesn't work (as you argue), then established companies can lower this expense and not meaningfully damage long-term customer attraction and retention. At any rate, companies don't need to continue spending tens of millions ineffectively.
My conclusion: High marketing costs will not be a necessity for established online companies. Further, many small competitors will fail by draining their funds on marketing in hopes of getting to scale. The failures will make it even less necessary for recognized leaders to market themselves. The final lesson here is that websites need to generate word-of-mouth buzz if they hope to succeed on a large scale, because marketing will almost never do it.
Misconception # 2: The shipping of customer orders is a large additional cost for online retailers and drains the potential for profitability.
Counter-argument: In actuality, efficient e-commerce companies can and will make a gross profit from their shipping operations, just as Amazon did the past three years. Amazon's outbound shipping revenue outsized the company's inbound and outbound shipping costs every year since 1996.
In 1997, Amazon saw a $4.4 million gross shipping profit. In 1998, the company made $18 million in gross shipping profit. In 1999, Amazon built out its distribution network so costs rose. Still, shipping revenue was $239 million and shipping costs totaled $227 million, meaning that the gross profit was $11.7 million -- or only 5% as compared to 1998's 19% gross margin on shipping. Once new warehouses are fully utilized, Amazon could have 10% to 20% gross profit margins on shipping.
Amazon has eight distribution centers that cover most of the country with next-day ground transportation. Being in close proximity to shippers and customers means that Amazon can ship many items "next-day" or "second-day" at little or no additional cost, but it will charge customers considerably more, as usual, for the service. Through these efficiencies, Amazon's shipping centers should be profit centers.
That said, most e-tailers do not have the distribution network of Amazon. So, to give credit to the e-commerce bears, the argument that shipping is a significant cost drain for most e-tailers is indeed true. It is only a misconception when applied to leaders such as Amazon and Wal-Mart (NYSE: WMT). These companies should turn shipping into an asset, because shipping will be a profit center.
Two more widespread misconceptions about e-commerce exist. They are:
Misconception # 3: Cutthroat pricing among competitors will always limit the potential for online consumer retail companies to have meaningful profits.
Misconception # 4: We already have proof that consumer e-tailing isn't an attractive business. For more than three years, Amazon has dominated online market share and yet it has only lost money! The proof is in the pudding.
We'll combat these two arguments the next time I write. For today, please finish your Rule Breaker reading by participating in our new Rule Breaker Survey! Over the next few weeks, we are conducting a near-daily poll so we can improve our daily Rule Breaker offerings for you. We start with the basics today -- the Rule Breaker Survey starts here:
For how long have you been investing your own money?
Thank you for participating, and Fool on!
