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Internet retailers get revved up

By Shashank Rao

Executive Summary
Online retailing is a different world compared to its brick-and-mortar competitors. So it would make sense that managing operations and the supply chain for Web-based businesses would entail different processes. A summary of recent research offers Internet retailers clues on how to survive and thrive.

As the reach of the Internet has expanded rapidly over the past few years, so too have the potential business opportunities that the Internet supports. Foremost among these is the sale and distribution of goods. Online retailing has increased from just 3 percent of total U.S. retail sales in 2002 to more than 6 percent by 2008, and it is expected to account for more than 8 percent of all sales by 2014.

While many online retailers were swift to embrace the Internet for its marketing reach a decade ago, others were slow to recognize the range of challenges associated with fulfilling the grand promises of timely and efficient delivery. Clearly, managing operations in order to support online retailing presents challenges distinct from those of brick-and-mortar retailing, where the only three rules that matter are still “location, location, location.”

This article discusses some key operational issues associated with the online retailing channel. The focus is not on the back-end aspects of the business but on the upstream (customer facing) aspects. In addition, this article investigates the issue from an operations and supply chain management perspective.

A different supply chain world

Despite the overall health of Internet sales, individual retailers struggle to find their identities in the burgeoning marketplace. Among the top 500 online retailers, annual growth rates have varied from between negative 30.5 percent to a whopping 1,150 percent. Questions arise, then, as to what can explain such a variance in online retailer growth and how operations management can contribute to the success of such retailers.

Recognizing how operations management differs in online retailing from its brick-and-mortar brethren can provide important insights. Some insights are well-established. For example, the online retailer is afforded the chance to ring up sales on items held at central stock-keeping locations that may be a considerable distance from the consumer. The retailer can sell merchandise it does not even possess by way of drop-shipping arrangements, where the retailer serves as a broker between the consumer and the inventory’s holder.

In either arrangement, once the order is collected the retailer assumes the responsibility of delivering the merchandise to the consumer’s door. These shipments usually are quite small, generally consisting of only one or a few items. This makes the economics of transportation in the online realm different from conventional retailing, where full truckloads are shipped to retail locations and consumers select items and assume the burden of home delivery.

Yet another difference is the manner in which the retailer makes promises to the consumer. It is estimated that conventional retail stores achieve in-stock availability at the item level in the 80 percent range, leaving the consumers to select a substitute item on the shelf or to walk away disappointed when they cannot find what they want in the store. In online environments, by virtue of updating virtual catalogs in real time based on item availability, the retailer can direct the consumer toward in-stock items and away from out-of-stocks, preventing the extension of a sales promise it cannot keep.

With that said, online consumers are proving to be an unforgiving sort when online retailers fail to deliver on their promises, leaving customers unsatisfied. Via the Internet, customers have the ability to switch retailers with minimal effort. Thus, online retailers continue to face several unique challenges with respect to order fulfillment as it relates to customer retention.

Learning lessons

Over the past half dozen years, a number of research projects have highlighted key operations and supply chain management issues and implications for online retailers. The following synthesizes the findings from four such research papers that involved the author. Learning and applying key lessons can make the difference between survival and doom in Internet retailing.

Study 1: How do online retailers differ from conventional retailers? This research project went beyond measuring the obvious differences between conventional and online retailers (“The Marketing and Logistics Efficacy of Online Sales Channels,” International Journal of Physical Distribution and Logistics Management). The study investigated several operational differences between online and conventional retailers. The sample size was 260, and 149 of them were online retailers.

The study revealed several interesting insights about how online retail operations differed from traditional retail operations. To start with, it appears that, in general, online retailers are more successful at selling lower value items than conventional retailers. Conventional retailers still continue to dominate in the higher value categories. It thus appears that the haptic element of being able to touch, see and possibly try out the product does have value after all.

In order to counter this apparent apprehension of customers, it also appears that online retailers usually offer more liberal return policies than conventional retailers. This is indicated by the number of days online retailers allow for returning products and the speed of issuing the refund. Additionally, Web-only retailers use substantially more drop-outsourced operations management functions than retailers. Retailers often treat the Web as just another sales channel, despite the fact that they usually carry fewer stock-keeping units with lower overheads than conventional retailers. Finally, online retailers have higher conversion rates than conventional retailers, which indicate the likelihood that a casual browser will end up buying.

Study 2: What makes customers buy online, and what keeps getting them back? There is some consensus that a combination of five factors really leads people to shop at online retailers: merchandise, services, promotion, navigation and user interface. Yet, what makes people come back to repurchase at an online retailer is a question that has not had a very clear answer. This question was addressed by the article, “Electronic Logistics Service Quality: Impact on Purchase Satisfaction and Retention,” in the Journal of Business Logistics.

The study investigated the issue of customer retention measured as the extent of repeat purchase behavior at a retailer across a sample of 260 different online retailers. Using detailed archival data analysis, the researchers determined that rather than product satisfaction, it was satisfaction
with a timely order fulfillment for a good price that affected customer retention most strongly. In fact, the effect of order fulfillment on customer retention was strong, even after accounting for the effect of prior customer satisfaction with the retailer.

Surprisingly, however, the relationship between the cost of getting the product delivered (order fulfillment) and customer retention was stronger than that between order fulfillment and customer retention. This indicates that online shoppers want faster product delivery – something that retailers have known all along – but are willing to pay higher prices for the same – something that retailers have not known quite as well.

Study 3: Why do customers abandon an online retailer? Given that competing online retailers are just a few mouse clicks away, it comes as no surprise that customer loyalty to online retailers is fairly weak to start with. A recent study by the National Retail Federation showed that more than 55 percent of responding online retailers had lower customer retention than expected, despite recognizing that customer retention is a critical avenue for sales growth.

Indeed, there is a lot of value that online retailers can gain by retaining customers. According to the research firm A.C. Nielsen, more than 50 percent of online shoppers indicate that they shop at least once a month from online stores. This translates to more than 12 transactions per year. Thus, online retailers have a substantial amount of lifetime value to gain by retaining customers over the long term.

A first step in this direction comes from understanding why loyal customers abandon an online retailer. The study “Linking Online Order Fulfillment Glitches with Future Purchase Behavior” in the Journal of Operations Management addresses this issue in some detail. According to this study, a top reason that customers abandon a retailer (after product price) is a glitch in order fulfillment. Using a sample of 237 online shoppers, it demonstrated that an order that gets delayed from its estimated delivery date decreases customer spending by more than 16 percent in the next year. In addition, the larger the delivery glitch, which indicates a larger delay in order delivery, the larger the decrease in subsequent customer spending. Most interestingly, prior customer loyalty does not seem to matter much in negating the effect of delayed deliveries. Stated differently, in the aftermath of a delayed delivery, previously loyal customers are just as likely to abandon an online retailer as are customers who were not as loyal.

Study 4: How can online retailers prevent customers from abandoning them? The article “The Customer Consequences of Returns in Online Retailing” in a recent edition of the Journal of Operations Management demonstrated how online retailers can prevent customer defection through effective returns management. Returns management is defined as the process by which activities associated with returns, gatekeeping and avoidance are managed within the company and across key members of the supply chain.

Long considered the forgotten stepchild of operations and logistics managers, returns become increasingly important as companies seek to maximize the value they create for themselves and for customers. In a recent industry survey of supply chain managers, 87 percent of the respondents mentioned that effective management of returns was either important or very important to their organization’s operational and financial success. Returns management is an extremely important issue that reduces profits by 3.8 percent per year. It has been argued that returns are even more relevant in online retailing than offline retailing given that consumers often do not have the opportunity to examine the product physically.

Working closely with a reputed online retailer, the researchers observed that subsequent to a product return, customer loyalty increases. In fact, after a product return, customers spent almost 55 percent more at an online retailer than they did previously. In addition, the magnitude of increase in this spending was related directly to the original expenditure – customers who spent a lot of money earlier spent even more after a successful product return.

Operationally speaking, this means that not only should online retailers encourage returns, but when they are confronted with a bin full of returns they should consider implementing an ABC priority system. This would assign the high relationship value customers the highest priority. The remaining customers would be assigned appropriate classifications based upon their value to the retailer. Building upon this, retailers can facilitate returns operations during their outbound distribution process, potentially indicating the priority of a returning delivery and how it should be managed in the data embedded within the preprinted return label or return authorization.

Research implications

So what does all this imply? These studies, while outwardly different from each other, do have a common thread running through them. The key takeaways from this research stream for online retailers are:

• Commit oneself to the Internet. The Internet does not necessarily pose a threat to the normal working of the retail business, and neither is it a useless expense for the conventional retailer. Although the introduction of the online channel brings with it an investment and an initial learning cost, it allows the retailer to offer services to a substantial amount of customers previously familiar with the product and tied to the company by way of conventional environments. Furthermore, it widens and improves the total value proposition of the retailer, which is suitably valued by the consumers tied to the company, independently of whether they end up making the purchase in the online channel or explore another alternative.

• Have a separate online and offline product strategy. As we have seen, the lower value products are faster movers on the Internet as compared to the higher value product categories. Conventional retailers still trying to sort out their online and offline product synergies need to realize this and change their retail priorities accordingly. Online retailers may be well-advised to adopt an appropriate product strategy as well. Based on these investigations, it appears that success is harder to achieve for someone selling Gucci shoes online as compared to someone selling the cheaper look-alike.

• Invest in the long-term relationship with the customer via efficient order fulfillment. To take advantage of the benefits of the online channel, a special effort is needed with respect to the management of the order fulfillment function. As we have seen, while this may not be the reason customers initially shop at a particular retailer, it is certainly a reason they return to the retailer again and again. It is also the biggest reason that customers abandon a particular online retailer.

• Exploit the advantage of convenience to overcome the disadvantage of distance. Online retailers should cultivate the aspects of their value proposition relative to the greater convenience offered by an online structure. Indeed, used correctly, the convenience of online retail can constitute a key competitive advantage for online retailers over their offline counterparts. The promise and experience of easy returns can and do seem to overcome, at least to some extent, the disadvantages of online retail, such as the fact that customers cannot experience the product directly.

Online retailing is growing, with online sales increasingly taking shares from conventional sales channels this past holiday season. The supply chain management implications of this transition are many.

While pure online retailers now compete with conventional retailers, each enjoys distinct advantages and suffers from certain disadvantages. Online retailers are challenged by several things, including the lack of a physical presence for direct experience of the product, typically smaller market footprints, and lower customer loyalty levels. But the research shows several ways in which such retailers can compete in the marketplace and win.

Shashank Rao is an assistant professor of supply chain management at Auburn University. He holds a B.S. in environmental engineering, an MBA in marketing and a Ph.D. in decision science from the University of Kentucky. Rao previously was a manager in the banking industry. He has served as a consultant to manufacturers, retailers and logistics service providers.

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