Consumers and merchants agree — the Internet is good for business. Their enthusiasm has not only propelled the growth of the Internet as a legitimate retail channel, it has created a self-feeding growth spiral. Consumer acceptance and retailer ambitions are combining to fuel a rapid growth cycle that will drive 3.6 million Canadian households to shop online by 2003.
Online retailing is no longer a question mark. At Forrester Research, our interviews with 100 online merchants reveal that sales are at least double what merchants projected a year ago — 31% of retailers that disclosed profitability are in the black. Executives who lived through this extraordinary growth spurt say the increased number of online shoppers and the executives’ own early learning are the key factors for growth and profitability.
From our conversations we’ve concluded that online consumers want more of everything. Retailers report that Web shoppers arrive by the tens of thousands, and those who buy spend more money on more products with each visit. Though pleased with increased spending, merchants say that online consumers are demanding: Web buyers expect deep product information, real-time order confirmation and status, and around-the-clock customer service.
To meet these demands, retailers are rapidly gaining sophistication. Runaway growth has forced merchants to refine their business practices. When we interviewed 75 retailers in April of 1998, only 56% knew their look-to-buy conversion rates. Just seven months later, 84% measured this vital statistic along with other key metrics like ‘average order size’ and ‘units per order’.
Computer-related products, books, and travel are no longer the sole beneficiaries of the surge in E-commerce. Merchants have added thousands of SKUs: department stores sell a wide variety of products, including not so obvious lines like garden supplies and household goods, while niche players find success by focusing on one product category like cigars or family-friendly videos.
NETWORK EFFECT TRIGGERS GROWTH SPIRAL
As we move into ‘the commerce threshold’, a market’s 12- to 18-month momentum-building period prior to explosive growth, Web retail will expand rapidly due to the network effect — the fact that new consumers and merchants who adopt E-commerce increase the value of Web shopping for everyone else. This phenomenon sets off a self-perpetuating spiral wherein:
More people shop. Despite continued concerns about security and privacy, consumers who overcome these barriers quickly embrace Web shopping’s convenience and ease of research. As these converts tell their friends and family, the E-commerce gap — the time between when users go online for the first time and when they shop online — closes.
More retailers sell. With millions of online shoppers, merchants can no longer ignore the Web as a niche marketplace. Between September and November 1998, Costco, Kmart, Nordstrom, and Starbucks all opened full-service online stores.
More categories become available. Retailers quickly realize that a broad category assortment and deep product selection increase their chance of interesting customers and showing profits. This intense competition leads retailers to offer promotions and incentives that give consumers a compelling reason to shop online. The growth spiral feeds on itself, drawing in additional consumers and merchants with each turn.
WEB SHOPPERS WILL SHIFT FROM ELITE TO MAINSTREAM
As overall online demographics diversify, millions of mainstream households will enter the shopping fray. During the next five years, the affluent will form the core of the Web-shopping universe. The purchasing power of upscale households makes them disproportionately important to Net shopping. In the U.S., households earning more than $50,000 (all figures in U.S. dollars) a year make up 36% of the total population today yet account for 47% of total consumer spending and 74% of spending online. In 2003, this group will still generate 66% of Web revenues.
But low-income households will adopt online shopping and narrow the gap. Today, households earning less than $25,000 make up 34% of the U.S. population but generate only 6% of Web dollars. By 2003, this overlooked segment will use sub-$500 PCs and shop online to save money, nearly doubling their share of online spending to 11%.
CANADA POISED FOR GROWTH
Canada will benefit from the retail momentum generated in the States. We project that Canadians will spend $246 million online in 1998. But two factors will drive this nascent market to $7.8 billion by 2003, or 7% of the $115 billion in total North American online sales: better access and big players.
Canadian government involvement provides citizens with Net access through schools, libraries, and other public terminals. As a result, 32% of Canadians have Internet access, compared to 28% of U.S. households. By 2003, 56% of Canadian households will be online.
The online retail market is finally real in Canada. Recently launched ChaptersGLOBE.com wants to be the Canadian Amazon.com, while prominent retailers Hudson’s Bay Company, Eaton’s, and Sears Canada are all committed to building and expanding online retail operations in 1999. Their entries make the water safe for other merchants, drawing them into the spiral.
ANALYZING RETAIL CATEGORIES
As the Canadian market tends to reflect its U.S. counterpart, the following online retail projections should provide a fair indication of trends that can be expected in Canada. To create our market model, we combined 11 prominent retail categories into three groups: convenience items, researched purchases, and replenishment goods. We modeled purchasing trends for each group separately by evaluating Technographics data for consumer demand and U.S. Census Bureau expenditure figures for retail-buying behavior.
CONVENIENCE ITEMS LEAD THE WAY
Low-risk, low-cost discretionary purchases such as books, apparel, and flowers lead today’s market, generating $2.8 billion this year. Deep product selection, easy shipping, and powerful promotions will keep convenience items a favorite with consumers, leading to sales of more than $32 billion by 2003.
Competition accelerates this group. Amazon leads the pack, but specialists and general merchandisers will expand the media category to $10 billion in 2003. In apparel, cataloguers, together with aggressive retailers, will lead manufacturers into direct selling. Also, department stores will make apparel their most natural online category, resulting in a total of about $13.5 billion in sales by 2003.
Technology innovation starts here. The need to drive high volumes and create ultrafast environments around low-margin goods forces pioneers to launch affiliate networks, one-click buying, personalization, and multimedia presentation. For example, Lands’ End will allow shoppers to use a body measurement system to virtually try on clothing.
RESEARCHED PURCHASES COME ON STRONG
High-information, big-ticket planned purchases like travel tickets and computers drive this group, currently accounting for 56% of total online revenues. By 2003, consumers will spend more than $56 billion on these costly items. Retailers who sell researched products will experience steady dollar growth.
Led by air and hotel bookings, travel represents the single largest category today and will reach nearly $30 billion in sales by 2003. Household goods such as small appliances and kitchenware will gradually build momentum. However, large appliances will lag until 2001 when they will be distributed through the wide reach of major department stores or via networks of local appliance dealers.
The high cost of these items will lead merchants to recreate the personal relationships consumers have with travel agents, appliances dealers, and electronics gurus. Homegrown product configurators like Ace Hardware’s paint estimator will proliferate.
REPLENISHMENT GOODS TAKE THE LONGEST
Moderate-cost, high-frequency purchases like groceries and personal care products could build significant volume, but they lack a feasible distribution model. With the exception of specialty foods and prescription refills, this group’s huge potential will remain largely untapped by the year 2003.
Merchants in these categories will realize that there’s a long road ahead. Some retailers will struggle as millions of households experiment with replenishables, only to drop out after one or two tries. One bright spot will be the health and beauty category, where refills on prescription drugs will keep customers coming back. This Trojan horse opens the consumer’s door to many other replenishment items, pushing the overall category from a mere $703 million in 1998 to more than $19 billion by 2003.
EVOLVING CONSUMER BEHAVIOR PRESENTS NEW OPPORTUNITIES
Dividing retail categories into three groups exposes two dynamics of consumer behavior that impact revenue growth: 1) People progress from one level of online buying to the next, and 2) the time that it takes them to progress will shorten over time. Merchants that anticipate and respond to these changing dynamics will dominate the market, while laggards will see their business erode.
Consumers shop one category at a time. People who buy online advance from one group of categories to the next over a period of time. First-time buyers go for convenience items. This year, 43% of first-year shoppers bought software online, 38% ordered books, and 20% purchased apparel. Experienced Net shoppers diversify into researched purchases. In 1998, second-year shoppers spent 2.5 times more than average first-year shoppers. Four-fifths of the additional spending went to airline tickets and computer hardware. Only veterans buy replenishment goods. Third-year shoppers were 60% more likely than first-year shoppers to buy groceries online. Nearly two-thirds of these buyers use the Web every day.
The consumer E-commerce lag, defined as how quickly shoppers advance from buying one group of categories to the next, also affects spending patterns. We estimate that the average online shopper currently takes a year to progress from one level to the next, but this lag time will shorten dramatically in five years as Web merchants iron out the kinks. During the next 12 to 24 months, retailers will improve merchandising and begin to deliver a guided selling experience, integrating one-click buying, intelligent product recommendations, and real-time customer service. Better conversion rates for first-time visitors will boost look-to-buy ratios from today’s 2% to between 5% and 10%.
Also shortening the lag will be the fact that so many people are doing it. The yearly addition of an average of 6.3 million online shoppers for the next five years produces a mass market. By 2003, buying online will seem commonplace. In this environment, new shoppers won’t need E-commerce training wheels for long — they will buy from many categories, spending more money along the way.
HOW TO CAPITALIZE ON CHANGING DYNAMICS
Merchants that respond to these E-commerce changes will grow the fastest. To succeed in this competitive channel, merchants must use convenience to get in the door. Convenience goods will become retail’s new loss leaders. Merchants will sell books and CDs to build relationships with customers, upselling buyers into more expensive categories like travel or home electronics over time. Department stores have the advantage of already selling across these categories; by moving online before their customers and developing database expertise, they will be poised to walk millions of current customers through the stages of E-commerce.
Discount stores like Wal-Mart and Costco are perfectly positioned to grow with the spiral. Costco counts more than 27 million North American shoppers who buy convenience, researched, and replenishment goods at a discount on a regular basis. This makes warehouse stores the only retailers able to cross-promote all three categories of Web commerce. To take advantage of this potential, these titans must reformat stores with drive-through pickup windows and strike parcel delivery deals with shipping companies.
THE IMPACT OF RETAIL’S GROWTH SPIRAL
Online retail growth will alter the domestic and worldwide retail landscapes. We foresee the following impacts:
Alternative Net devices will become salespeople. Everywhere the consumer goes, Net-connected devices will sell something. Calendar-based PalmPilot shopping agents will push anniversary flowers and birthday gifts, WebTV ads will churn out impulse-oriented “buy now” buttons, and digital phones will let shoppers place orders for groceries and show tickets through voice commerce servers.
Media companies will buy into commerce. In 2003, marketers will spend $10 billion on Internet advertising. Media players must move now to grab a piece of the 10-times-larger commerce pie. Traditional media companies must get over the church and state editorial debate and invest in E-commerce ventures with affinity networks like Home Depot and AutoZone.
Shippers will scale up. To handle the surge of convenience items, shippers will scurry to expand capacity. Researched goods will trigger a new shipping model: the Automobile Association will pioneer a service-based approach, where today the company services your vehicle and tomorrow it will install and service your digital TV and appliances.
Manufacturers will change their model. Schooled in the art of shipping crates by the truckload, manufacturers will adapt to a world where up to 10% of their products ship to individuals.
Internationals will take a cue from North America. The U.S. and Canadian markets will lead the rest of the world into the retail growth spiral. Faced with threats like Amazon.co.uk, European retailers will expand their shipping models and category offerings to avoid losing market share to Web-based internationals.
WEB-SAVVY COMPANIES TO WATCH FOR
We visited with Michael LeBlanc, manager for Hudson’s Bay Company’s Internet initiatives, and learned that Canada’s largest retailer is working feverishly to launch several Web stores. Mainstream retail unit Zellers just opened a toy store, and for the 1998 Christmas holidays Hudson’s Bay Outfitters ramped up to sell more than just its well-known wool blankets. We think 1999 will be the baptismal year for Canadian E-commerce. Why? ChaptersGLOBE.com bookstore recently launched with two million titles, and giants Sears Canada and Canadian Tire are awakening. This is great news for Canada’s 11 million households.
And here’s an interesting U.S.-based story: not only did the $5 billion specialty fashion retailer Nordstrom open its own Web store in October, it also invested $23 million in Streamline, a full-service online grocer based in Massachusetts. Fur coats and toilet paper? It’s a strange combination . . . well, not really. The connection is customer service. Both Nordstrom and Streamline pride themselves in offering the best. Little-known Streamline bills itself as a lifestyle management company. Grocery delivery gives Streamline a chance to whittle its way into the daily management of life’s chores by taking care of groceries, video rentals, dry cleaning, and firewood delivery. And that’s the attraction: Nordstrom wants to learn how to best serve its core customers — high-income families — on the Web.
Finally, executives from Bertlesmann’s BooksOnline shared this scoop with us. The German media giant has a new goal: 45% of all revenues will come from multimedia operations by 2002. That’s huge — from nothing to more than $6 billion in four years. How will the company do it? By using more than 50 warehouses across the globe and launching localized extensions of www.bol.com from Europe to Latin America, Australia, New Zealand, China, and eventually Japan.
This article is based on a report entitled Retail’s Growth Spiral, released in November 1998 by Forrester Research, Inc., Cambridge, Mass. It is published with permission. Forrester’s Web address is www.forrester.com
