When Dinosaurs Fly

Move over, Jurassic Park. Brick-and-mortar retailers have not only survived the mass extinction of dot-coms but evolved into a new, hybrid species of merchant

It wasn’t long ago that analysts warned that traditional brick-and-mortar retailers would soon go the way of the dinosaur, driven to extinction by “pure-play” dot-com merchants who could blithely sell their wares on the Internet without the huge cost of maintaining physical stores. But that was before the stock market turned south, venture capital for Internet start-ups began to dry up, and dot-coms started dropping like Florida chads. Moreover, after a lumbering start, many traditional retailers have demonstrated that far from being dinosaurs, they are in a better position to take advantage of the Internet revolution than their born-on-the-Web rivals.

“A lot of traditional businesses were cowering in fear of the dot-coms, but they have no reason to be afraid,” says Jack Ampuja, senior vice president for logistics at Fisher Scientific Co. in Pittsburgh and an ardent apostle of the business benefits of the Internet. “Pure-play Internet companies don’t have to pay for stores, but they also don’t have the strong customer base, brand identity, and history of traditional retailers. It’s a lot easier to take an existing business and build a successful Web site than the other way around.”

Of course, having a well-recognized brand, a loyal customer base, and a catchy Web site are not enough to guarantee success on the Internet. Retailers must also provide superb customer service and near-flawless fulfillment. What’s more, they must integrate their e-commerce channel with their existing operations in a way that makes economic sense and is compatible with the company’s organization and infrastructure. What are the key steps traditional retailers should take – and common pitfalls they should avoid – to succeed on the Internet? To find out, Operations & Fulfillment talked to a number of e-commerce experts and brick-and-mortar merchants who have successfully adapted to a radically different way of doing business.

Make it bullet-proof Most experts agree that fulfillment – getting the right order to the right customer at the right time – is the acid test for any e-commerce channel. Despite the explosive growth of the Internet, many consumers are still wary about purchasing products online. “The retailers that are going to win on the Web must provide bullet-proof fulfillment,” says Natt Fry, manager of e-strategy at IBM. Retailers that fail to meet or exceed customer expectations will pay dearly. That lesson was made painfully clear during the 1999 holiday season when the Web sites of several major retailers were overwhelmed by customer demand. Macys.com and toysrus.com, among others, were slapped with substantial fines by the Federal Trade Commission for failing to deliver products to customers on time. Even more costly, perhaps, was the damage to consumer confidence.

Traditional retailers that have opened successful e-commerce channels have pursued a variety of fulfillment strategies. Some companies have chosen to handle fulfillment entirely in-house. Others have opted to outsource to third-party specialists. Still others have chosen to acquire or form strategic partnerships with companies with e-commerce expertise. And still others have outsourced some parts of the fulfillment chain – call center operations, warehouse operations, or logistics and delivery services, for example – while keeping others in-house.

Although there are no hard-and-fast rules about which strategy is best, using assets you already have is a safe option. “If fulfillment is a core competency, it’s probably to your advantage to leverage existing distribution channels,” says Bill Luckert, vice president of LakeWest Group, a leading retail consultant based in Cleveland. “If you have poor competency in fulfillment or struggle from time to time, it probably makes sense to build on your existing infrastructure or find a good third-party provider.”

Touch the customer Building an in-house e-commerce fulfillment capacity offers a number of advantages. It enables retailers to capitalize on their existing personnel, facilities, and systems and to integrate all their sales channels. It reduces the chances that confidential customer information and proprietary business practices will fall into the wrong hands. And it enables companies to exert maximum control over the day-to-day operations of the channel. “Fulfillment is what touches the customer, and some companies want to maintain control,” says Julie Breen, an e-commerce analyst at Boston Consulting Group.

But there are also disadvantages to in-house fulfillment. For one thing, it requires expertise about e-commerce and DTC fulfillment that many traditional retailers lack. It also requires a larger initial investment in money and time either to build a dedicated operation from the ground up or revamp an existing one to accommodate the special demands of e-commerce.

Outsourcing fulfillment, on the other hand, enables retailers with little or no experience in DTC fulfillment to focus on their core competency – selling products in stores. In general, the cost of entry is lower and the time needed to launch is shorter. But the fulfillment provider selected must be familiar with the merchant’s products and processes, and both partners must iron out any kinks in the system well before the peak selling season.

The downside to outsourcing is that it reduces a retailer’s ability to leverage current assets such as personnel, facilities, and processes. It can also hamper efforts to integrate e-commerce with other sales channels. Furthermore, outsourcing requires brick-and-mortar merchants to dedicate inventory to a separate channel, as opposed to using a pooled inventory system that feeds all the company’s sales outlets. A dedicated inventory system tends to tie up more working capital and restricts the movement of merchandise across channels, and that, in turn, hampers efforts to deliver the right product to the right place at the right time. “When you put stock in the hands of others, it takes away your flexibility,” says LakeWest’s Luckert.

Going it alone A number of major retailers, including Kmart, Wal-Mart, and Barnes & Noble, have formed autonomous companies to run their e-commerce channels. This strategy creates a financial “firewall” between the e-commerce unit and the parent firm, reducing the latter’s bottom-line risk. But experts caution that this tactic can create serious barriers to integration. “If you have a separate entity that isn’t linked to the organization’s management and infrastructure, it can be difficult to keep the businesses aligned,” says IBM’s Fry.

Kmart, the giant discount retailer, initially launched a lackluster site with an in-house team that lacked Internet experience. So in December 1999, Kmart formed a partnership with Japanese conglomerate Softbank and with Martha Stewart Living Omnimedia to launch BlueLight.com, an independently owned (Kmart holds a 55% stake) and operated business that outsources fulfillment to SubmitOrder.com, an e-commerce specialist based in Dublin, OH.

Alex McNealey, director of operations for BlueLight, says the decision to outsource fulfillment was a relatively easy one. It didn’t make financial sense to build an entire fulfillment operation when SubmitOrder already had the expertise Kmart needed, McNealey says. “Their capabilities, matched with Kmart’s, meant we could quickly meet the demand seen on our site and easily ramp up for busy times like the holidays.”

Although BlueLight and Kmart maintain separate warehouses and inventory, BlueLight benefits from the huge buying power of Kmart because it carries most of the same products. The two businesses are integrated on other levels as well. Items purchased at BlueLight can be returned to any of Kmart’s 1,200 stores. In addition, each store features several kiosks where customers can order products from BlueLight that they can’t find on the shelves. “The kiosks virtually expand the aisles of Kmart’s stores,” says McNealey, because BlueLight carries more than 250,000 products, compared with 75,000 products in the typical Kmart store.

BlueLight also takes advantage of Kmart’s huge reach and marketing power to promote its Web site. (Thirty million people visit a Kmart store every week, 85% of Americans are within 15 minutes of a Kmart store, and the retail giant’s Sunday advertising circulars reach 72 million households a week.)

Another traditional retailer that adroitly leveraged its assets when it migrated online is Sears. The venerable retailer organized its e-commerce offering around two of its most powerful brands, Kenmore appliances and Craftsmen tools, both category leaders. Sears already had in place the necessary logistics systems – direct delivery for appliances, centralized distribution of tools – that could easily be adapted to e-commerce.

Out and back Some retailers have opted to contract with a third-party fulfillment company until they have established a foothold in the new channel, and then moved fulfillment in-house. One merchant that followed this path is KBkids.com, which was formed when KB Toys, the number two toy-store chain in the U.S., acquired BrainPlay.com in the summer of 1999. In order to quickly launch its e-commerce channel for the upcoming holiday season, KBkids outsourced fulfillment to Keystone Internet Services, the third-party fulfillment specialist of cataloger Hanover Direct. Although KBkids experienced some fulfillment problems during the 1999 holiday, it weathered the season and established a presence in the new channel. Once demand slackened in the spring and summer, KBkids terminated its agreement with Keystone and built its own DTC distribution center in Kentucky.

Other retailers have purchased a fulfillment specialist outright. Discount titan Target followed this strategy by acquiring Rivertown Trading Co., a direct marketer with extensive experience in and resources for DTC fulfillment. While this strategy requires a large initial investment, experts say it may be less costly in the long run than either outsourcing or developing an in-house capability. As many pure-play dot-coms struggle to survive in the current market shakeout, analysts note, they make appealing takeover targets for traditional retailers with a strong brand but little e-commerce experience. “Some companies may decide, instead of stubbing my own toe, I’ll take over the best e-commerce player in the niche,” Luckert says.

Another option is to form a partnership with an experienced e-commerce operation. The most prominent example of this strategy is the alliance between toysrus.com, the independent e-commerce channel of toy behemoth Toys `R’ Us, and Amazon.com (see sidebar on page 18). Jeanne Meyer, a toysrus.com spokeswoman, says the deal has freed the toy merchant to do what it does best – sell toys. “We use all our seasoning and relationships and know-how to focus on merchandising of toys, and let Amazon handle fulfillment.”

Whichever fulfillment strategy a retailer pursues, experts say companies should strive to integrate their e-commerce channel with their other sales channels as much as practicable. Meshing inventory management and fulfillment will only increase in importance as new channels (such as mobile commerce) emerge. A merchant who can take an order from a customer while she is driving home from work, and have it ready for her to pick up when she arrives at the store a few minutes later, may have a real advantage over a competitor who lacks this lightning-fast response capability.

Crossing the bar Cross-channel fulfillment – allowing customers to pick up and return merchandise across channels – is another key ingredient of success in multichannel operations. A recent survey by Boston Consulting Group found that 34% of online retailers allow customers to return products purchased on the Web to a store or another drop-off location, and that percentage is expected to increase sharply. Circuit City (see sidebar on page 16) and Office Depot are among the growing number of retailers that allow customers who order products online to both pick up and return the items at their stores.

An essential requirement for retailers is to present “one face” to consumers, regardless of which sales channel they use. “Consistency in terms of product assortment and pricing is important,” says Luckert. “You don’t want to be competing with yourself. It’s important not to confuse the customer.” However, some analysts say prices and assortment do not necessarily have to be uniform across all channels. “Customers recognize the convenience of ordering on the Web, and they are willing to pay more for it,” says IBM’s Fry. Indeed, studies have shown that convenience, rather than price, is the driving force for most online shoppers.

Breen says it’s not necessary for a retailer’s product assortment to be the same online as in its other channels. It depends on how a company is positioning itself on the Web. “If you’re a category killer and you have a limited selection online, that’s a disconnect with the customer,” she notes. “But if you’re a niche player, say a baroque music specialist, it’s OK to have limited selection. The point is, the site offering should be consistent with consumers’ expectations. Otherwise, it could cause confusion.”

Even when a retailer’s back-end operations are not totally integrated, it’s important to present a seamless face to the customer. When Brooks Brothers, the venerable men’s clothing merchant, launched its Web site in 1998, its information systems were not fully integrated to handle cross-channel returns. But Brooks Brothers accepted returns in any channel – store, catalog, or Web – regardless of where the merchandise was purchased. To its customers, the retailer had always seemed fully integrated, even though it wasn’t.

Another ingredient of a winning e-commerce strategy is to make the fulfillment process as transparent as possible to consumers. A growing number of retailers are providing access to real-time information about inventory and order tracking through their Web sites. “The more real-time info available on the site, the less opportunity for abandoned shopping carts,” says Breen.

Obviously, merchants migrating to the Web should strive to hire talented personnel with extensive experience. McNealey says BlueLight decided to establish its headquarters in San Francisco, far from Kmart’s headquarters in Troy, MI, because “the best talent in the e-commerce world was in the San Francisco area.”

The 24/7 imperative Needless to say, customer service is a top priority in e-commerce. In the “always on” world of cyber commerce, customers demand immediate gratification. BlueLight, for example, offers 24/7 service by phone and e-mail, instant e-mail order confirmation, guaranteed e-mail response within 24 hours, and the ability to track orders either online or by phone.

“A lot of people thought this whole Internet thing was about technology,” Ampuja says. “What they forget is that they have to have solid support behind the Web site.” Adds Luckert: “You can’t afford to fail one customer at a time – your reputation won’t survive.”

Your Web site must also be easy to navigate, secure, fast, and capable of accommodating surges in traffic during peak periods. “Sites have to be robust and scalable, otherwise they run the risk of getting crushed,” says IBM’s Fry. A Boston Consulting Group study found that purchase failures, security fears, and service frustrations are major concerns for many consumers. “You have to consider the novice as well as the more seasoned Internet shopper,” says Luckert.

To understand what users want, make sure to know your customer base intimately. BlueLight.com, for instance, was built with the Kmart customer in mind, McNealey says. “We knew the site had to embody the characteristics that customers associate with Kmart – value, trust, and convenience. In addition, we wanted to make the site as easy to use as walking down the aisles of your neighborhood Kmart store.”

Money talks One crucial consideration for retailers is to stockpile sufficient funds to afford the steep cost of entry into e-commerce. Analysts say that an e-merchant who expects $3 million to $5 million in annual sales should budget at least $1.8 million to launch a site, plus $1.9 million a year for maintenance. If you forecast sales volume of $20 million or more, plan on spending $10.6 million on start-up, and throw in $14.3 million a year for support fees.

Given the vast cost and complexity of launching an online business, it’s not surprising that some traditional merchants have stumbled in their efforts to add clicks to their bricks. One common mistake is underestimating customer demand; another is taking too long to react to market conditions. “The speed with which you have to react on the Web is orders of magnitude faster than in traditional retailing,” Fry says. An example of a retailer that did react quickly when disaster struck was toysrus.com. During the 1999 holiday season, when the company realized it would not be able to deliver some orders to shoppers in time for Christmas, it quickly issued customers $100 gift certificates – regardless of the size of the order – redeemable at any Toys `R’ Us store.

Retailers can also fail if they launch the online channel prematurely. “You can’t go out there with a slipshod product, ” says Ampuja. “It’s like the Old West. The guy that wins the shootout isn’t necessarily the fastest draw, he’s the one with the most accurate shot.” On the other hand, Ampuja says, some firms sit on the sidelines far too long. “A lot of companies say, `I’m gonna watch and wait to see all the mistakes my competitors make before jumping in.’ It’s like a squirrel sitting in the middle of the road. It doesn’t matter if you run left or right – just do something or you’re gonna get run over.”

Peter Kupfer is an editor at the the San Francisco Chronicle. His articles on technology, science, and culture have appeared in national magazines. He can be reached by phone at (415) 928-8959 or by e-mail at [email protected].