After the Gold Rush: New Rules for the Game
Hindsight is easy; all you have to do is look at your backside. Declaring e-commerce a passing fad is also easy; all you have to do is look at the stock market. What is difficult is to use that understanding to avoid repeating the mistakes of the past.
The Internet boom of the 1990s is frequently compared to the California Gold Rush of the 1850s. The land grab that ensued in 1848 as miners staked their claims and the "brand grab" 150 years later share many of the same characteristics of frenzied competition, high stakes, and big rewards. They also raise the same question as the claim of instant riches: what is left after the gold rush?
California grew to become the thirty-first state in 1850. E-commerce is growing as well at a rate of 81%, despite the valuation of so-called dot-com or dot-bomb companies. Continued growth is creating a marketplace in excess of $2.6 trillion dollars with just under one billion Web devices by 2004.1
Commerce Rules
The rules of this marketplace have changed, placing a greater emphasis on building a sustainable business. During the "gold rush," the belief was that profits could wait while the new economy was established. Executives focused their attention on marketing and customer acquisition rather than establishing business fundamentals.
Unfortunately, the new economy has the same demands as the old economy, where the fundamentals of business still apply. The ultimate challenge in e-commerce is not driving visitors to your site, it is converting visits into profitable business. Meeting this challenge involves a new look at e-commerce rules that build on traditional ideas of CRM.
This white paper concentrates on the business dynamics and economics of relationship-based e-commerce as these fundamentals determine the potential viability of an e-commerce design. Executives need to understand the dynamics of e-commerce efficiencies, customer acquisition, process performance, and the move toward services. Executives ignored these factors during the gold rush. Today, these factors form the basis for a sustainable e-commerce business.
E-Commerce Efficiency
E-commerce remains one of the most efficient channels for business interaction. Studies across a variety of industries consistently point to the transaction processing efficiencies associated with e-commerce. Figure 1 shows the process cost superiority of e-commerce relative to other channels of customer interaction.
Figure 1 - Relative efficiencies of customer interaction channels
In some cases, these efficiencies are 100 times greater than current approaches to doing business. The business attraction to these efficiencies is understandable when one considers that companies made investments in business process re-engineering, which promised only 10 times improvement.
The relative efficiencies of e-commerce drive companies to move transactions into this channel through creating a new e-commerce company or augmenting existing channels. The business case associated with channel switching appears easy to calculate as shown in Table 1. These benefits are the result of the raw efficiencies associated with e-commerce technologies.
Table 1 - Sample benefits from channel switching (source: Accenture study [2])
On the surface, a channel switching approach appears similar to fishing in a barrel because gaining benefits requires little new growth, only moving existing transaction volumes from high to low-cost channels.
However, there is a catch. The benefits outlined in Table 1 are based on customers choosing the electronic channel. Customer choice changes the economics of an e-commerce business.
Choice - The Economics of Customers
Customer choice requires companies to invest in customer acquisition ahead of realizing e-commerce benefits. These investments provide education and incentive to choose this channel above others. In the gold rush days, heavy marketing expenditures sought to build the brand and "grab the high ground." Customers still have a choice in making these expenditures necessary; however, a profitable e-commerce channel requires more than the first time visitor or page view.
Customer acquisition investments influence the economics and business case associated with e-commerce. This creates the paradox facing many e-commerce channels where high sales growth rates accompany growing losses. This situation exists when business planners fail to recognize that positive e-commerce economics rest not on the individual transactions in the channel but rather on customer repeat business. Figure 2 illustrates how this paradox is possible.
Figure 2 - E-Commerce economics
Companies operate in the red, where the cost of customer acquisition exceeds customer revenues. This situation exists as the cost of customer acquisition ranges from $13 to $68 for online retailing to more than $250 in financial services.3 These acquisition costs virtually guarantee large negative margins on a customer's initial use of the e-channel. Companies establish positive margins when repeat customer sales exceed the costs of acquisitions. This enables the company to enjoy the efficiencies of e-commerce without the debilitating cost of customer acquisition and retention.
Companies in a customer acquisition mode, without an underlying rationale for repeat business, will lose money on first-time business and operate in the red. Consider a sample retail customer who would have to make $680 in follow-on purchases to overcome their cost of acquisition. The case for online trading, an early killer app in e-commerce, is even more daunting when you consider that an individual will have to execute 16 trades to have gross fees match the cost of customer acquisition.4
Customer choice, not company design, drives the economics and success of the e-commerce channel. Customers must choose your site and the type of relationship you offer. That choice must be free of promotions, coupons and discounts - these are indirect forms of customer acquisition or retention. A one-time use approach simply does not provide the revenue to overcome the cost of customer acquisition. Customers choosing a relationship virtually guarantees repeat business, which is essential for success.
Build Relationships
Relationships provide the means for profitable repeat business. A relationship exists when the customer or trading partner consistently chooses the e-commerce channel because it provides the best way to meet their needs. An e-commerce channel can foster relationships through its design, operational capabilities and services.
Providing customer sales and service capabilities through the Internet is an important step in building a relationship. These capabilities, which provide a powerful set of e-commerce capabilities centered on the customer, have the following characteristics:
o Recurrent - Concentrate on areas of repeated need and interaction rather than a single use.
o Extend operations base - Provide customers the ability to use company facilities and tools to meet their needs.
o Blur the line between products and services - Enhance the basis of the relationship from concentrating on product availability and price to achieving customer outcomes.
These characteristics form a basis for sustainable relationships and an e-commerce channel. Building the foundation that involves reviewing and re-grounding the e-commerce business in the fundamentals of customer choice and repeat business is necessary to unlock e-commerce efficiencies that meets repeat needs, enables customer self-management, and competes on more than price.
Recurrence
Recurrence is the rationale for the relationship, providing the reason for repeated usage of the e-commerce channel. Many e-commerce companies ignored the concept of recurrence and provided facilities that focused on one-time customer purchases. Examples include the sale of furniture, automobiles, moving , and other high-dollar value transactions. Those companies thought that raw efficiencies and the Internet's convenience would drive business. However, consumers made purchases infrequently. The economics of e-commerce defeated these businesses - without recurrence, they have to buy e-commerce transactions through customer acquisition and marketing.
Call Centers
Call centers are a significant source of investment in customer retention. The relatively high cost of handling calls as opposed to providing information over the Internet makes this an early opportunity for e-commerce technologies. Call centers have a large volume of similar calls, leading companies to make the answers to the top 100 questions, such as an airline customer asking if pets are allowed on the plane, available on the Internet. To ensure a more recurrence-sensitive approach, companies should look at the information needs of the top 100 callers rather than the top 100 types of calls.
Recurrence Is Customer-Defined
Customers define recurrence, not the company. The company must define their e-commerce business based on customer values, not company values. This definition should concentrate on areas of repeated need and customer value where the company has the information and facilities to address those needs through an electronic channel. Figure 3 illustrates the opportunities created from this view.
Figure 3 - Customer and company
Customer recurrence does not always equate to strategically important company values. Recurrence exists where customers place a high value on information and capabilities. This means that a company can go a long way toward building customer recurrence without compromising its strategies. Examples of these relationship improvement opportunities frequently center on enabling cash flow processes (inventory, receivables, payables) and other customer or trading partner operations. Finding those opportunities involves asking the following questions:
o What information does the company have that would enable customers and trading partners to operate their business more effectively?
o How could they use this information to improve their cash flow, operations, or logistics?
o What information would the company need from its customers to provide better service or improve efficiency?
The answers to these questions will help identify the areas of customer recurrence. Addressing those areas through e-commerce technologies establishes the basis of a relationship, the first step in supporting repeat business.
Banks provide an example. Consider the value of the information locked inside their transaction systems. Payment history, cash management flows and disbursement information describe the cash flow of a business. Large companies have sophisticated applications that allow them to manage their cash on their own behalf. However, small businesses often lack these systems and make decisions with limited understanding of their cash flow. Banks can build an electronic relationship through providing cash flow information that enables small business leaders to make better decisions.
Enabling Customer Self-Management
Recurrence is more than a content strategy. It defines how the company extends its products and services to customers and trading partners. Extending the operations base reinforces recurrence by creating customer self-management. Customers build a deeper relationship when they are able to use the e-channel to complete their tasks and activities on their own behalf. That is the definition of self-management.
A content strategy without self-management requires customers to navigate multiple channels to complete their transaction, for example, researching a bill online and then contacting the call center for resolution). Extending your operational processes involves looking at customer dynamics through the following questions:
o What information does the customer have in their current context that will enable them to complete the process?
o What is the customer's motivation? Why would they perform these processes on their own behalf rather than leaving them to the company?
o How does the company retain economic control of the transaction even when it is initiated entirely by the customer?
Answering these questions helps identify areas for customer self-management where the company can transfer process execution responsibilities to its customers or trading partners. These opportunities exist when the customer has the information and motivation necessary to complete the process and the company can still maintain control of the transaction. Examples of self-management include: allowing customers to maintain preference and profile information; giving them greater choice in directing shipments or selecting financing plans; and allowing them to view and manage invoices and orders.
Process Performance
Customer self-management places new demands on company internal processes as transactions flow through multiple channels. Customer self-management processes must have a greater degree of process performance than traditional in-house processes. First, customers have higher performance expectations for online processes in terms of information accuracy and processing speed. They expect the correct answer and accurate information in real time through online channels.
The efficiencies of electronic processing can quickly erode from rework, errors, and exceptions handled in a higher cost channel. Table 2 illustrates the case of processing a transaction through a three-step process with a 95% accuracy rate. In this example, processing costs for standard transactions are $0.25 per item per step, while rework charges are at a cost of $4.50 per item per step, the same as the traditional channel.
Table 2 - Process performance for e-commerce channels
In the example, the company experiences a 75% variance between actual cost versus budget as both channels process the e-commerce rework. This variance is dramatic when compared with the 5% experienced when the transactions rework remains in the same channel. Table 2 illustrates the importance of process performance for e-commerce channels.
Raising process performance involves enabling the e-commerce channel through clear business rules embedded in software rather than expressed in the skills of individual people. This is a challenge for many companies as embedded business rules need to be clear and unambiguous, otherwise they will create exceptions and rework. One test for clear rules involves defining a situation and the rule to five people and having them all reach the same conclusion.
Self-Management and Relationships
Enabling self-management builds deeper relationships as customers and trading partners use company facilities to complete processes on their own rather than engaging higher cost channels. Customers using these facilities will gain as they feel greater control and participation in the business as they manage a portion of the process. The company gains as customers repeatedly use the e-commerce channel.
Crafting Products into Services
Companies with solid relationships compete on more than product availability or price. A successful relationship blurs the lines between products and services creating a more sophisticated value proposition. Companies, such as Charles Schwab, are able to use the relationship to sustain premium pricing in the face of commoditization pressures present on the Internet.
Services represent purchased outcomes or results rather than tangible goods they purchase, hold, and transform. Using this mindset, executives can identify service opportunities through assessing the following questions:
o Do customers or trading partners manage an inventory of company products? Would they rather consume the product on a just-in-time basis than in bulk?
o Do customers call with emergency or urgent requests? What is the value to the customer in avoiding these requests?
o Is the product complex to configure, operate, or maintain? Is it part of a broader configuration central to the customer's operations? What are the costs associated with maintaining that configuration?
o What activities do customers perform for themselves even though they lack the skill, or scale, to perform efficiently?
E-commerce technologies are well suited to creating the answers to these questions and enabling new service opportunities for your customers and trading partners. Providing a service involves a significant information and operational integration that was not economical using prior technologies. Using e-commerce technologies, with their superior efficiencies, allows companies to address the customer needs raised in the questions above through a more sophisticated approach.
Vendor Managed Inventory - An Example
Suppliers are moving from selling products to providing services through vendor managed inventory (VMI). This approach changes the supplier relationship as they bear responsibility for managing their customers' inventory levels, making repurchase decisions, and handling receiving and distribution, among other items. VMI requires a close cooperation and sharing of information, placing the supplier at the heart of their customer production processes. This extends the value of the relationship beyond price and product availability. Customers are able to reduce capital investments in inventory, warehouses, and logistics operations, enabling them to use this capital on other higher value-added activities.
Service Economics
Companies looking to craft products into services must recognize different economic factors. Products-based companies concentrate on unit cost and gaining production efficiencies through scale. They conduct business in bulk with a relatively small number of customers. This drives a business model characterized by individual transactions with a high dollar value and low transaction volume. Producers look to their customers to manage their own inventories with incentives for bulk purchases.
Service companies look to leverage their capital investment in as many customers as possible. They concentrate on decreasing the cost for service per customer through maximizing the capacity of their service platform that can include differentiated pricing to manage yields on these assets. This often involves a fundamental shift in the transaction mix for service companies away from large bulk purchases to a higher volume of lower individual value purchases. Figure 4 illustrates this shift.
Figure 4 - Transaction mixes between products and services
An operational analogy illustrates the shift in transaction economics from products to services. "If it costs the same to handle a $100,000 order as it does a $1,000 order - then sell more $100,000 orders." That adage works in a product focus where customers are willing to buy in bulk to get a discount. In the future, as more products become services, that adage will change from "selling more large orders" to "cut the handling cost for every order." This shift is necessary as customers consume services according to their need and not the company's production schedule.
Services and Relationships
Providing services, rather than selling products, creates a deep relationship as customers, trading partners, and the company all share mutual interests and risks. E-commerce technologies support crafting products into service through providing greater information access, sharing, and management capabilities at a lower cost. These characteristics reinforce use of the electronic channels as traditional call centers and other means cannot provide the same level of accuracy and coordination.
Supplier Management - An Example
Consider a large international retailer looking to improve supplier management capabilities. With literally thousands of suppliers and a large volume of supplier-related calls, this retailer was looking to minimize the cost of supplier management. This is a common rational for a channel switching strategy.
At first, the company provided a "tunnel" from the Web into its ERP software. The tunnel enabled suppliers to look up invoices and check status. The business case for the "tunnel" rested on moving supplier support calls from the call center to the Internet. The company initially targeted status checking, one of the most frequent types of supplier calls. This represented an area of high relationship value because suppliers placed great value in knowing when they were going to be paid.
Unfortunately, providing status information actually increased call volumes as suppliers were able to see their invoices move through the payments processes. Suppliers called whenever they felt their invoices were not moving quickly enough through the payment processes or when payments went into suspense. This increased costs in two dimensions. First, the company was supporting two channels (call center and Internet) to handle supplier interaction. Second, supplier calls lengthened and grew more complex as suppliers had better information at the time of the call.
The company addressed the problem through extending the functionality of the tunnel to enable suppliers to correct non-material defects in their invoices. The company defined a non-material defect as something that did not change the financial terms of the invoice (price, amount, item, etc). This move enabled the suppliers to maintain invoice information, correct errors, and manage the invoice payment process on their own behalf. For example, a supplier could correct clerical errors on its own such as an invalid shipping address, product description, or other items.
The company now has a new supplier service that provides a competitive advantage. Extending information and operations to suppliers has enabled this company to establish a deeper relationship with its suppliers at a lower cost of service and a higher level of overall performance. The company gains partial benefits from reduced supplier support costs and supplier calls. The suppliers gain through having better access to cash flow information and the ability to proactively correct errors in a timely manner.
This example illustrates how an e-commerce channel supports repeat business and builds stronger relationships in the following ways:
o It focused on an area of customer recurrence. Payments represented an area of strong customer interest with a sufficient volume of transactions to warrant the investment.
o It provided suppliers with information necessary for them to take action in the form of the invoice status and notes. This information was already within the company's systems and it cost it relatively little to make it available to their suppliers. The suppliers, however, place great value in having better information on when they can expect payment.
o It enabled the trading partner to use the information through extending operational capabilities to the supplier through the Internet.
After the Gold Rush
Today, California represents the world's sixth largest economy5. It reached that status through building a sustained business base that is not dependent on the economics of the gold rush. Electronic commerce will make this same transition as e-business becomes just business. Companies that succeed in this transition will be those that recognize the business fundamentals of sustainable e-commerce.
Blending "new economy" technologies with "old economy" needs for sustainability and profitability requires taking a new look at the fundamentals of e-commerce, how customer choice changed those fundamentals, and the requirements for building a sustainable e-commerce channel. The old-new rules for e-commerce are very similar to the old rules of traditional commerce:
o Seek repeat business
o Recognize the role of customer choice and design for it
o Enable customer self-management through high-performing processes
o Move product offerings toward services
o Make business decisions based on sound economic fundamentals
These rules recognize a path to sustainability based on an understanding of e-commerce efficiencies and how they can be unlocked through relationship-based e-commerce. What is left after the gold rush? Well, nothing more than a growing marketplace.
References
1 Forrester Research. "The Rising Tide of Global E-Commerce: worldwide internet usage and eCommerce," 1999-2004. David Emberly, Carol Glasheen and John Gantz.
2 Accenture Study of channel costs for governmental services provides an illustrative example.
3 Robert Hof. "Amazon + Wal-Mart = Win-win," Business Week, 3/19/01. Page 42.
4 The retail figure assumes a cost of acquisition of $68.00 and a retail profit margin of 10%. The online brokerage figure assumes a cost of acquisition of $150.00 and a trading fee of $8.95.
5 As a note, California gold mining accounted for $126 million in 1997. However, this pales in comparison to the $1,043,669 million dollar state economy. Source: California Department of Finance.
