What's Wrong With The Net?

When I give talks about e-business lately--during times of dot-com winter when sentiments of some have turned against e-business--I often hear about supposedly inherent limitations of the Net. And those, they say, are the reasons that e-business will always have problems. I disagree and would like to discuss a few of those "inherent limitations."

The high cost of customer acquisition

One widely circulated report stated that the cost of online customer acquisition, the amount of marketing money spent for each new customer purchase, was $71 per customer in late 1999. That's high. Worse yet, the average purchase size at that time was about $50. You're not going to make that up on volume! Those figures are still remembered. Some people point to them as evidence that the Net is therefore a bad place to do business. Customer acquisition costs are just too high.

The critics fail to recognize that those high customer acquisition costs have nothing to do with the Net. Those costs were driven by the frenzied drive for market share that was pursued by many startup companies with almost no regard for cost. Hoards of online companies were in an irrational and uneconomic bidding war for customers. Customers got some good deals, but the companies couldn't sustain the frenzy and now many of them have disappeared. Rationality is returning. And customer acquisition costs are coming down. For example, Amazon's cost of customer acquisition in late 2000 was $7, only 10% of the average cost a year before.

The Net offers inherent advantages for cutting customer acquisition costs. Three benefits of the Net that are used for cutting customer acquisition costs are free file transfers, free e-mail and viral marketing. For example, the fact that files can be distributed for free means that trial copies of software can be distributed online at virtually no cost. Demand can grow through direct experience with the product and word of mouth recommendations from others who have used it. Another example, new products can be announced to interested parties through online mailing lists. The best way to get these lists is to collect addresses on your Web site of people who have asked to be informed about new products and new releases of existing products. The cost of sending promotional e-mails to a list of people who have asked to receive them is zero. Buy a list from a broker and you'll pay for each name and run the risk of being accused of spamming. But mailing to your own list of people who have asked to be notified of new developments is essentially free and tends to have a high return rate. A final example of an online marketing bargain is viral marketing. Viral marketing occurs when a seller notifies one prospect of an opportunity who then notifies several others who then notify several others. Word spreads to a set of prospects that grows exponentially. You've seen it happen with jokes being passed through e-mail. It happens as friends tell friends about cool sites. And it happens as friends tell friends about great online offers. What does it cost? When it happens, it happens fast and free.

The Net May Saturate

For nearly a decade the number of people using the Net has roughly doubled every year. In the past year or so that rate of growth has slowed. It's still growing fast but not at the 100% increase per year that we've seen in the past. This leads some critics to say, see, the Net will not be as universal as TV, radio or telephones so it's not really a mass market channel.

I expect it's true that there will be a lot of people who resist getting online. First, it takes a computer and computers are confusing to a lot of people. Second, unlike TV and radio, the Web requires some initiative on the part of the user. One must seek information. Many people will simply not be interested in learning how and where to seek information on the Net. Libraries are wonderful community resources yet many people never set foot in a library. The Net is similar in many ways.

The number of people on the Net will saturate and may do so well before we see full participation across the country. Let's say it saturates at 75% of the population. How bad is that?

Those who criticize the Net as not being the same kind of mass market medium as TV are missing one of the most important aspects of the Net. It's not a mass market medium. TV is suited for beaming the same content to nearly everyone in the country (or world for that matter). In contrast, the Net excels at its ability to provide everyone with different content simultaneously. Not only are there hundreds of millions of Web sites to choose from but many sites offer personalized pages and pages generated on demand. The Net is a medium for mass customization.

Let's say that the number of US users of the Net levels off at 75% of the population. I don't think it will, but let's say it did. The business question would simply be, can profitable businesses be built addressing only that fraction of the population? If so, what about the off-line fraction of the population? The answer to that is simple: consider an off-line channel to market. Amazon, for example, may be content to sell to online customers and simply let off-line customers shop at Barnes and Noble or Wal-Mart.

Falling Demand for Banner Ads

The Net is a marvelous medium for giving away information. Put up a Web site and fill it with great content and you may see thousands or even millions of people flocking to it each day for the free information. In the off-line world, the ability to draw a crowd like this generally means there is an opportunity to sell products to the assembled or at least sell advertising. Banner ads were one of the first ways that online businesses started generating revenues.

Selling banner ads was a pretty good business as the Internet Bubble grew. More and more online companies were competing for the attention of Web surfers and they had big budgets to spend. Banner ads were a natural place to invest. But the bubble burst in the spring of 2000 so the demand for banner ads quickly fell. What's worse, experience was showing that banner ads are often not effective. The demand for banner ads has fallen rapidly throughout the year 2000 putting many businesses that depend on banner ad revenues in jeopardy.

The good news for advertisers is that banner ads offer the possibility of immediate and detailed information on their effectiveness. Put up a banner ad directing people to your site and you can see in real time whether your traffic is increasing, where it's coming from, whether those new visitors are buying products and lots more. Using this information, offers can be tuned in real time. Not only that but ads can be exposed to people selectively on the Net. It's commonplace at search engines to show ads based on what a user is searching for. Online stores suggest products based on what that individual has already bought. The world of advertising hasn't been this sensitive to the market since advertising was done by a live barker extolling the benefits of patent medicines in front of a crowd of potential customers.

Immediate and detailed feedback improves advertising. But maybe Web surfers are immune to banner ads. Maybe we've trained ourselves to tune out those annoying animated strips at the top of the page. What then? The answer may be unpleasant but at least it's clear: don't base your business model on something that's not working! Change or die.

Abandoned Shopping Carts

The large majority of shopping carts in online stores are abandoned without completing a transaction. It shows a probable willingness to buy, then a change of heart. Some critics cite this as an indication of inherent deficiencies of e-commerce. That's nonsense.

Let's say 80% of online shopping carts are abandoned without a sale. One certainly doesn't see 80% of the shopping carts at the local supermarket abandoned without a sale. They'd be clogging the aisles. Why so many on the Net? The first culprit is certainly the implementation of online stores. When it takes a minute for a page to come up at an online store, I'm out of there and lots of other customers are, too. And if I have to go through a seemingly interminable checkout process, I may give up and shop somewhere else. Luckily for online shop owners, these factors are nearly completely under their control. They can use fast servers, they can improve the flow of their sites. Not only that, but there is a potential wealth of information in those abandoned shopping carts to use for improvements--certainly much more information are far more accessible than what's available to a physical shopkeeper who sees customers come in, browse, then leave without a purchase.

Another explanation of abandoned shopping carts rests with benefits of the Web. What does it cost to go to the local grocery store? You need to drive there, walk around gathering items, purchase, then drive home. Online, you go directly to the store without driving (or even getting dressed), select items with a few clicks, check out, then you're done. Since there is so little investment in time to get to an online store, there is little to be lost by changing one's mind. And since it's so easy to jump from one store to another, there is little incentive to complete a transaction just because you've gone to the trouble to come to the store.

The business question behind abandoned shopping carts is simply, are enough purchases completed to have a profitable store? If the answer is yes, then reducing the rate of abandoned shopping carts is not a problem but an opportunity for greater profits.

Fulfillment Horror Stories

During the holiday season of 1999 and to a lesser extent, the holiday season of 2000, there were many horror stories in the news about online orders that did not arrive in time for Christmas. Sometimes these stories implied that there was something about the Net that made this happen. And there was. It's called success.

Businesses rarely plan to disappoint their customers. It is not a sustainable strategy. Fulfillment horror stories are generally due to unexpectedly high demand. In many cases the demand was so high and the online stores were so swamped that they were unable to properly inform their customers that they would be unable to fulfill purchases in the time promised. This is obviously bad. It shouldn't happen. Not only does the reputation of the retailer suffer but in some cases, such as ToysRUs.com in 1999, the FTC can impose fines for failing to notify customers of delays.

Is the Net somehow at fault? No, unless you want to say that the Net can lead to unexpectedly large numbers of customers and purchases. In fact, online stores have one great advantage over off-line stores for unexpected demand: they can update inventory in real time, so selling items only if they are available to ship. In addition, real time data can flag unexpected demand as it starts to build. Eliminating time delays gives retailers more time to respond. And retail sales information can be fed back to suppliers in real time giving them more time to respond. Finally, real time data allows retailers to adjust pricing in real time. It's rare to see retailers raise prices above suggested retail prices in times of high demand but it's common to see discounts manipulated based on supply and demand.

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