ELECTRONIC COMMERCE

ELECTRONIC COMMERCE Potential roles of e-commerce ● Economics of online sales ● Collaborative Filtering ● Search Engine Optimization ● Micro Payments ● “Bricks-and-Clicks” ● Social Media

Learning Objectives • Understanding • Opportunities to use e-commerce • Circumstances when e-commerce is more appropriate • Product level factors • Firm level factors • Collaborative filtering • Influences on a site’s rank on major search engines

Two Types of Online Sellers MANUFACTURERS SELLING THEIR OWN PRODUCTS DIRECTLY TO CUSTOMERS (e.g., Dell, Geico) Typically offer more limited assortment ONLINE SELLERS ONLINE RETAILERS COMBINING MERCHANDISE FROM MULTIPLE MANUFACTURERS (e.g., Amazon, Staples) Larger assortment Typically more frequent purchases Note that manufacturers and retailers may each use more than one channel path—e.g., Dell sells directly and also through retailers; Staples sells both in stores and online

Basic Internet Economics • In most markets, online merchants tend to have HIGHER costs than do conventional retailers • Much more of the work is done by the merchant rather than by the customer. • Intermediaries usually add value through specialization of labor and consolidation of tasks. Eliminating intermediaries usually results in higher costs. • Customers do a lot of the work when they select, aggregate, bring for check-out, and carry away their products. Employees of e-commerce companies and their transportation services have to be paid to do this work!

In a Supermarket or Discount Store: • The customer walks around the store and assembles his or her purchases • The customer takes the purchases up to the checkout stand and puts the items on the conveyor belt • If the customer does not use self-check-out, the clerk rings up the purchase • Either a clerk or the customer bags the items • The customer hauls away the purchases

Yes, when you sell online, you may not need as many store locations—which will save money—but you may face other costs (e.g., labor to assemble and deliver orders) which may more than cancel out the savings from having fewer store outlets. Online merchants often have higher overall costs. The actual cost effectiveness of online selling depends on the specific product, customer practices, and firm characteristics.

Value-to-bulk ratio. High value, low weight/volume items can be more readily handled and shipped. Absolute margin. Even if the percentage margin on a high price item is low (e.g., 15%), the absolute margin can cover considerable expenses (e.g., 0.15x$1,000=$150) Ability of consumer to evaluate quality and fit through online description. Standard branded items from a trusted source can be more easily evaluated than items that need to be examined up close. Convenience to the customer and willingness to pay for this convenience. Some consumers may be willing to pay more for door-to-door delivery. It is usually more expensive to buy groceries online. Customer sensitivity to delayed delivery. Extent of customization needed. Highly customized items—e.g., insurance, plane tickets, personalization—allow the customer to do much of the work (i.e., data entry). Geographic dispersal of consumers. Even if direct-to-consumer sales are not efficient, this may be the only cost effective way to reach customers who are widely dispersed (e.g., bee keepers, Civil War buffs, tall people). Extent of inventory value decline over time.A computer can be distributed to consumers at a lower price through retailers, but the process takes longer and computer parts lose value fast. Considerations in Evaluating E-Commerce Potential

Value-to-Bulk Ratio • Value generally refers to market price • Bulk involves anything making it difficult and/or costly to ship: • Large volume • Heavy object • Oddly shaped object • Perishable object • Fragile object • Hazardous object

Poor Value/Bulk Ratio $27.00 product, shipping included

Absolute Margins When the term “margin” is used without further specification, this usually refers to a percentage figure. For example, if you buy a book for $5 at wholesale and sell it for $10, you have a 100% markup and a gross margin of (10-5)/10) =50%. The 50% gross margin may sound impressive, but it only amounts to an absolute amount of $5.00, a figure for which you can only do a limited amount of work. It may not cover the cost of retrieving the item, packing it, and shipping. Absolute margins refer to dollar amounts. In the above case, the absolute margin is $5.00. Note that if there is a 15% gross margin (a much smaller percentage) on a $1,000 notebook computer, that amounts to $150—a figure that can cover much greater costs even though the percentage margin is less.

Ability of Customers to Evaluate Product Without Seeing it in Person • Does the customer have to see the product to determine fit and/or quality? • Clothing sizes do not tell the whole story • Texture and other difficult to describe qualities are important for certain “experiential” products • Customers are less likely to need to see a standard product—e.g., an iPhone 5—sold by a reputable online dealer • Lesser known brands may require more inspection

Willingness for Customers to Pay for Convenience • Customers may be willing to pay a premium to avoid having to pick up an item • Specialty items with limited distribution that would require • Travel for considerable distance • Uncomfortable travel (e.g., in highly congested area) • Items that require frequent replenishment and/or critical time delivery (e.g., grocery and restaurant meal delivery) • Items that are difficult to transport

Customer Sensitivity to Delayed Delivery • Certain products may be needed with short notice (e.g., replacement for Blu-Ray player that broke down)—overnight delivery may not be sufficient • Amazon is now trying to provide same day delivery in some areas • Hybrid formats—ordering online for pickup in store

Extent of Customization Needed • Customization can come in multiple forms • An airline ticket should be for a specific name for travel to a specific destination from a specific origin at a specific time • Efficiency is introduced when the customer can enter the relevant data • Clothing may now be customized taking into account many more measurement points

Geographic Dispersal of Customers • For specialty products, customers may be scattered over large areas—e.g., • Bee keeping equipment • Specialty collector items • Big and tall clothing • Both brick-and-mortar and online distribution will be costly, but, by default, online sales may be less so

Inventory Value Decline Over Time • Because of rapid innovation and resultant product obsolescence, computer products may lose 1.5% of value per week • Distributing through individual delivery may cost more than distributing through retail stores, but shipping to individual customers may be faster, thus resulting in a product that is more valuable at the time of purchase

Comparing Brick-and-Mortar and Online Sales Costs Please see more elaborate separate handout

The Case of Dell Computer • Customizing computers for each customer probably does NOT save money. It is probably cheaper to provide a limited number of computers that offer each consumer a little bit MORE than what he or she would have wanted in a customized unit. • Prices for “upgrades” to default models tend to be very high—e.g., additional RAM often costs more than twice as much as the “street” price for the components. “Base” models usually have low prices, but the final prices paid tend to be high. • Although the percentage margins on computers tends to be low due to competition (e.g., 10-25%), absolute margins can be significant—e.g., 10% of $1,500=$150. That margin can pay for a lot of work. • It would probably be cheaper to ship directly to an efficient retailer—e.g., Wal-Mart may take in hundreds of computers and a number of other materials at one time. These items are put out on floors using fork lifts and other efficient transportation methods. The customer does much of the work. • However, because computer parts may lose as much as 1.5% in value per week. Thus, reducing distribution lag time by five weeks may “rescue” 7.5%. • If Dell claims to have an inventory turnover time of 48 hours, someone else—probably a supplier—has to carry the needed “buffer” inventory to accommodate fluctuations in demand.

The Value of Customization at Dell • For the vast majority of customers, customization really does not add value. Since computer parts are relatively cheap, it is generally possible to provide, say, choices of some half dozen computers. A computer that offers a bit more than what the customer wanted will probably be cheaper to make than a customized one. There is not much to be gained from eliminating inexpensive parts that the customer does not need. • For customers who seek a very specific combination of parts—e.g., a specialized graphics card and a very specific hard drive--Dell may offer a benefit in allowing that specific combination. The benefit here is not so much cost saving as the ability to get exactly what you want. In other words, the computer will be relatively expensive, but it may match the customer’s exact wishes.

Firm Level Issues Affecting Online Sales Potential, Part I • Firm reputation/credibility • Volumes sufficient for • Economies of scale in automation (e.g., automatic conveyor belts to assemble orders) • Volume discounts on shipping • Ability to sell multiple items together • Synergy with traditional retail store operations (“bricks-and-clicks”)

Firm Level Issues Affecting Online Sales Potential, Part II • Location for minimization of sales taxes • Location for low labor and land costs • Potential for repeat sales to the same customer • Increased business volume • Application of collaborative filtering (ability to recommend additional products of possible interest based on a customer’s overlap with purchases of another

Collaborative Filtering NOTE: This is a simplified chart. The actual algorithms used are somewhat more complex but work off this general idea. Such actual algorithms, for example, will assess how similar two customers are to each other and weigh accordingly. Other factors—such as how products may have been rated by different people and how recently purchases were made—may also be reflected. These details are not needed for the exam.

How Suitable For Internet Commerce? Are There Differences Among Segments?

Estimated Margins—Costco Pearl Earrings

Books, Part I Major marketplace changes from prior semesters! 40%+ discount required to be competitive in this market

Books, Part II Less pressure to discount; thus, greater gross margin

Collaborative Filtering • Comparing purchases by a customer to others who have made “similar” purchases to identify additional products of potential interest • Largely a matter of “brute force” computer analysis • Often a more effective way to identify additional items of interest if it is difficult to conceptually compare items to identify others like them • E.g., favorite songs: What drives the preference? Sound, lyrics, singer characteristics? • E.g., books: Which authors are “similar?” • “Win-win” deal: Merchant has the opportunity to sell more items; the customer finds value that he or she would otherwise have been less likely to find

How Suitable For Internet Commerce? Are There Differences Among Segments?

Reality of Online Competition • Intense competition for large market products (large quantity demanded attracts many sellers) • Use of large demand products as loss leaders (e.g., Amazon.com bestsellers) • Competition will force reduced costs—if any—to be passed on to customers. Even if there is a cost advantage to selling online in a particular market, you will NOT be competing just against “brick-and-mortar” stores but also against those who have the same cost advantage in selling to customers. In the long run, you can probably make NORMAL profits but not above market level profits. • Competition makes charging for shipping and handling difficult. This is usually more expensive than traditional distribution because of • Lesser economies of scale • Lower likelihood that the customer will be home to take delivery the first time around • Less competition on specialty products  greater margins

“Bricks-and-Clicks” • Traditional retail chains and online presence tend to have synergy • Online access to store information—hours, locations, directions • Checking on “in stock” status on local stores • Online orders with store pickup • Online orders with delivery; store return option • Brand equity • Volume purchasing power • Inventory assortment warranted by combined store and online sales

Micro-payments: Opportunities and costs • Considerable online content and services could be made profitably available for a small charge (e.g., 1¢-$2.00). This is usually only viable for electronic content, NOT for tangible goods. • However, collecting small amounts of money can be • Costly—credit card firms or debit processing firms may charge a significant per transaction fee • Inconvenient—the customer may not be willing to enter much information • Mobile technology—with active login—may be helpful for the higher end (e.g., 50¢+)

Micro-payments are generally NOT • For tangible goods. Shipping is too expensive for a small amount (low absolute margin). • For paying over time. The cost of cutting a payment into very small payments is just too high given credit card transaction fees.

SEARCH ENGINE OPTIMIZATION • Search engines • Search engine rankings • Optimizing for rankings • Content • Reciprocal linking

Search Engines • Search engine market dominated by Google • Microsoft’s new BING search engine—the “decision engine” • Deals with Facebook and Twitter for better “real time” access • Results • “Organic” (merit based) • “Paid” or “sponsored”—on top or to the right side on Google

Search engines • Use an algorithm to identify the most optimal links • Algorithms may involve • “Popularity” (number of links pointing inward) • Usage of keywords • “Click-through” rates from the respective search engine (NOT overall traffic volume on the site) • NEW! Location (as determine by IP address) • Other criteria—often proprietary • Historically, key word repetition was the most important factor. Today, on Google, quality links appear to be more important than key words. • Internet consultants will make recommendations for a fee. Many have strong opinions on “what works.” Most are short on evidence that they are correct.

Quality Links to a Site: The Most Important Factor in Ratings • Link quality: Links from other sites ranked highly on a term count heavily; links from low ranked sites count very little • Link quantity: The more links from high rank sites, the greater the impact • Exclusivity of links: The weight of a page is generally divided among the outgoing links—thus, being a single link on a page will have more impact than being one of 50 • Placement: Links early on a page count more

Search Engine Optimization: Reciprocal Linking • If two complementary (non-competing sites) link to each other, rankings of both sites may increase • E.g., Surfer Dude magazine links to Extreme Surfer’s Supply (an online surfing equipment vendor) and to the Association of Pacific Surfers and gets links from those sites in return

Search Engine Optimization: Text • Credible repetition of key words • Frequently greater credit for • Bolded words • Words early in the document • Identification of desirable key words • Analysis of competing sites • Customer interviews • Misspellings

Search Engine Optimization: Other • Domain names • If the domain name features the keyword, more weight is given • Google considers the underscore a space—e.g., Marketing_Tips.com . • Listing in the Open Directory Project (http://www.DMOZ.org) . • Most search engines no longer rely significantly on meta tags—”invisible” information from webmasters about the site—since these can be manipulated. Using meta tags, however, tells your competitors what you are trying to accomplish.

Web Metrics—evaluating sites Details are not needed for the exam! • Some variables • Unique visits • Repeat visits • Average time spent on site

M-commerce: Mobile phone/PDA/ “gadget” access and sales • High growth in mobile technology with Internet access • Access through Internet browsers (.mobi domain is intended for web sites optimized for small screens) • Smart phone “apps” • E.g., banking (for specific bank), information (e.g., Yelp) • Integration with GPS, messaging • Many countries are running ahead of the U.S. • Growth opportunities with “tablet” (e.g., iPad) computers that offer easy portability with larger screens

Some Opportunities in m-Commerce • Location based services (“L-Commerce”) • Identification of offers and services based on GPS location • Mobile banking and micro-payments • Mobile tickets and documentation • Beyond the browser: Mobile apps • Secure transactions on the go (established security protocol with phone carrier) • Mobile entertainment

ELECTRONIC COMMERCE