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Internet Retailing Feasibility

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By swapusa
March 16, 2001

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As both a brick & mortar and online retailer for seven years, I feel compelled to jump into this discussion and give my take on Internet retailing and its viability.

First some background: I am a small retailer in the Atlanta area, selling such mass market products as video games, game systems, Pokemon cards, action figures, and hot toys. I actually started my business on the Internet in 1993, before there were any web browsers (Mosaic was just being introduced) and later in 1994 quit my corporate job and opened a store that has since grown into three small stores. We now sell new and used games and toys both in our stores and on-line via our web site and on eBay. We are very, very small compared to the behemoths of retailing, but thank god, we are profitable.

Now, we sell mass-market products and we do indeed compete with the likes of Wal-Mart, Toys R Us, Best Buy, Amazon, etc. In a brick & mortar store, we can indeed sell low price items like guide books, action figures, and Pokemon cards that have a very high profit margin and make money. But we couldn't sell the same low price products on our web site or eBay and make a profit, even though these products have as much as 100% or even 200% markup. At least we couldn't sell them one at a time and make money. You see, it is not the profit margin that counts, it is the dollar amount of profit that you make on each item that matters. (I haven't mentioned new video games because they have both very low margin and low dollar profit.)

Every time we sell an item on our web site or on eBay, aside from the front-end expenses of maintaining the web site and listing auctions on eBay that are minimal, the back-end order processing and handling is what is killing our potential profits. We have figured that every time we sell one item and ship it, it costs us about $4 to $5 in handling and fixed costs. The only way we can make profit on our online sales is if we sell products that have not necessarily a high profit margin, but a dollar profit of at least $10 or more.

Now, you cannot find many mass-market, commodotized items that give you that kind of profit. Music CDs, video games, DVDs, and videos are used by big superstores as loss leaders and they are often even sold below cost. That is why most online retailers who are selling mass-market products like the above are not successful.

But, I am not saying that Internet retailing cannot be successful. On the contrary, it can be very, very successful if you have the right product to sell. Products that do give you a high dollar profit, regardless of the profit margin. If I can sell an item for $300 and make $20, my margin is less than 7%, but at least I will be cash-flow positive, and cash flow is the king of any retail business.

Currently, there are many medium-sized highly profitable Internet retailers out there. They sell things like mountain bikes, photographic equipment, luxury items, expensive watches, art work, musical instruments, etc. that are not mass-market products and enjoy a healthy profit. Computers can be considered mass-market products, but they are so high in price that they do offer a high enough profit to take care of all the handling expenses.

Amazon's entry into electronics and photo and camera was probably its best move. Consumer electronics have low profit margin, but due to their high price they have high dollar profit and can quickly make you cash-flow positive. The only risk of electronics is obsolescence. Books can also be profitable because they not only offer a good dollar profit (as long as selling price is more than $20), but also they are returnable if they don't sell, so the inventory risk is not high.

So, for Amazon to become profitable on all fronts, they need to do more deals like the Toys R Us deal and get out of selling music CDs and DVDs. With the Toys R Us deal, they no longer have to carry or handle mass-market products like toys and video games that don't offer high enough dollar profit, and they no longer have to worry about obsolete toys and video games. Amazon cannot leverage loss-leader products like games, music, and DVDs to lure customers into the store, hoping that they buy a stereo set. I wouldn't be surprised if Amazon makes a deal with someone like Blockbuster Video to handle video and DVD sales, and a large music seller like Media Play for its music business.

Now, if a day comes that games, music, and movies can all be downloaded, a provider like Amazon can make a killing with very little profit per order. Once the manual handling of orders goes away, profits are easy. Think of a very profitable vending machine business that sells $0.25 gumballs, keeping $0.225 or 90% of the profit. However small, there is not much handling and profits add up.

Amazon should also get into selling higher profit items like mountain bikes, expensive watches, and computers, and they wouldn't even have to carry them. PCs and bikes are custom made anyway and the PC maker or the bike shop can customize the order coming from Amazon and ship it. They need to sell appliances and make a deal with GE similar to the deal that Home Depot and Wal-Mart have. Home Depot and Wal-Mart take the order from customer, and GE logistics delivers the item to the customer's home the next day. In summary, they need to start thinking about selling non-mass-market products before it is too late.

Cheers,

Mehran
SwapUSA