January 01, 2012

What Happens When the Showrooms Go Away?

by Alan Beatts

In the aftermath of the holiday shopping season the consumer trends have turned out to be pretty much what anyone would have expected, other than people seeming to be willing to spend more money that was expected.  Barnes and Nobel, along with many independent booksellers, had a nice boost in sales due to Borders Books closing.  Even more stuff was bought on-line.  A little bit of a surprise was Amazon's offer to pay customers up to $5 to go into a local store, scan an item, walk out, and buy the same item on Amazon (a move that was decried by even some of the biggest tech and Amazon fans http://gawker.com/5865612/amazon-launches-christmas-attack-on-local-shops).

That recent offer from Amazon got me thinking about where that phenomenon (i.e. consumers shopping at physical stores and then buying online) might take us.  The obvious conclusion is that eventually the physical stores will vanish since they won't make enough sales to stay open.  But what happens then?

Obviously, people will have to get used to buying things without being able to take a look at them first, which is actually fine for most sort of product but may be troubling for people shopping for things like furniture, clothing, and so forth.  But even then, simple, friendly, no-questions-asked return policies will reassure consumers enough that it shouldn't be a big hurdle for on-line merchants.

Impulse purchasing will probably decrease since the number of products that you can "suggest" on a web page is much smaller than the number of things that someone will look at during a trip to a retail store.  But there as well, technical advantages may even it out.  Unlike a retail store, an online retailer can gear the products that get suggested specifically to the individual shopper based on their login to the site and cookies planted in their browser.  So, though less products are put in the consumer's face, the one that are presented are much more likely to result in a sale.

But I think that the most interesting change may come from a change in the covenant between manufacturers and retailers.  Retailers, in essence, supply manufacturers with advertising, showroom space, and customer service for free.  In return manufacturers don't undercut retailer's prices and don't try to poach the customer from the retailer.  For a very long time that system has worked pretty well.  There have always been some manufactures who either choose to sell direct to consumers (some very successfully, like Snap-On Tools) or who maintain their own retail stores, either in parallel to non-affiliated retailers or exclusively, but in general that retail / manufacturer split has been dominant.  But what happens when retailers can't stay in business because of ecommerce?

Before I take my guesses at that, I should touch on some of the things that are influencing my answer.

One of the lessons that came out of the collapse of Borders was that it's important for merchants to have a direct relationship with their customers rather than allowing an intermediary in the middle.  It's also important that retailers pursue new sales channels themselves, rather than farming those channels out to another business.  Borders made a mistake in both those departments when it contracted with Amazon to provide ecommerce services to Borders customers.

Apple has demonstrated how successful a company can be by controlling the entire relationship with the customer.  Apple Stores are some of the most profitable retail spaces in the world, on a per-square-foot basis and have cemented the direct relationship between Apple and its customers.

Manufacturers have found themselves in "golden handcuffs" to a number of retailers, often to their regret.  Publishers took a huge financial hit when Borders started to have money problems and then were hit again when Borders closed down.  Many suppliers to Walmart have ended up having draconian terms dictated to them, often after they have made investments to increase output to keep up with Walmart's demand.  As a result, when Walmart tells them what retail price they need to achieve or set penalties when their deliveries are late by as little as 15 minutes, the manufacturer has no choice but to dance to Walmart's tune.

All those factors plus some of the basic realities of ecommerce are going to keep shaking up how we buy and sell for years to come.  We might start to see manufacturers in a common industry joining forces and running their own co-op stores.  Consider books -- there are only five or six major publishers in the US.  As bookstores close in major markets like Los Angeles, New York, and Chicago perhaps those publishers will join together and open their own "super-stores".  Just by stocking all the in-print titles from the participating publishers such a store would have an inventory to rival the biggest and best bookstores in the world (and just imagine the author events they could host).  The profit margin would be great since the stock could be purchased at _manufacturer's_ wholesale.  Another fertile field for that would be power tools, another industry dominated by a small group of players (DeWalt, Porter Cable, Milwaukee, Makita, Bosch and a few others).

Or more companies might open their own stand-alone retail stores.  Apple has certainly had a huge amount of success with that model.  Sony has also done alright with that idea and other companies may follow.  Again, in this situation the profit margin should be very good since the companies set retail prices high enough that there is a profit share for both the company and the retailer.  If they cut out the retailer, the excess profit goes to them.  Some companies might even adopt the Snap-On Tools model and have roving sales people with company supplied trucks stocked with a huge range of their products.  Such trucks could set up in public areas on a rotating schedule (posted on the company web site, of course) and deal direct to the public without the headache of large staffs, high rents, and associated overhead.  Anything that wasn't in stock on the truck could be drop-shipped direct to the customer.  In fact, even more of Snap-On's model could be used -- Snap-On drivers own the truck and inventory.  They are, in essence, independent contractors working on a franchise scheme.

Finally, I think we'll see more and more companies create and maintain their own ecommerce sites.  The attraction here is three-fold -- they get to "own" their customers in terms of marketing, promotions and repeat business, they reduce their reliance on a single retailer (i.e. Amazon) for most of their sales, and they, again, benefit from increased margins.  Some premium vendors might even withdraw their products from other sales channels figuring that they're better off getting the entire profit margin in exchange for less exposure and sales.  A decision like that might even become a matter of significant prestige (as in "our products are of such high quality and desirability that we don't _need_ to sell them anywhere else).

You'll notice that all of the preceding ideas are attractive to manufacturers in part because of the increased profit generated by selling products without a retailer in the middle.  That equation might work out differently though.  Perhaps manufacturers will abandon the principle of not undercutting retail prices.  If most commerce is on the internet then the benefit of having retailers maintaining showrooms for products no longer matters.  If selling is merely a matter of setting up an ecommerce site with the associated fulfillment department and customer service, might it not be worthwhile to take that step, cut out _all_ the retailers and make greater profits?  Or, accept a lower profit (though perhaps still greater that in the past) and undercut all the retailers, even Amazon?

If I ran a successful on-line retailer, I would plan on moving very cautiously into the next ten years.  Without good customer service, good relationships with suppliers, and careful thought, the end of small independent retail might be the start of an "extinction event" that could spread to on-line retailers as well when manufacturers start cutting out all the parties between them and the consumer.

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