EconDevIreland

The Hidden Costs of Clicks

2006-03-03T04:28:00.000-08:00

by Tim Laseter, Elliot Rabinovich, and Angela Huang

02/28/06Internet retailers are finally learning why books and luggage make money online — while shoes and toys don’t.

eBags.com ranks as one of the more notable successes among Internet retailers. The leading online purveyor of luggage, eBags generates more than $38 million in revenue a year and has been consistently profitable since its founding in 1998, in the heyday of the Internet bubble. Operating with minimal inventory thanks to direct “drop shipments” from manufacturers to end customers, eBags could be the model for the future of commerce.

But that model is still developing. EBags continues to expand and adapt its business. In 2004, the online retailer, which is based in Greenwood Village, Colo., acquired Shoedini.com, a seller of dress shoes for men and women, and renamed it 6pm.com. Having expanded from its original focus on luggage into backpacks, handbags, and other accessories, eBags considered shoes the next logical category for marketing synergies. Yet, despite the clear marketing logic, selling shoes online turned out to be more complicated than selling the other product lines.

The issue, as eBags discovered and as many online vendors have yet to understand, highlights the fundamental operational challenges of Internet retailing. It centers on a concept common in the business-to-business realm but rarely employed in a business-to-consumer context: cost-to-serve. Defined as the total supply chain cost from origin to destination, cost-to-serve incorporates such factors as inventory stocking, packaging, shipping, and returns processing. This metric also helps to explain why some of the early high-flying “e-tailers,” such as eToys and Webvan, failed miserably.

In the eBags example, the cost of serving shoe customers is far higher than the cost of serving luggage customers. The Shoedini acquisition more than doubled the number of SKUs that eBags handled, and the complexity of managing the inventory exploded. Most bags come in two variations — usually different colors. But a shoe style comes in several colors and many sizes; there can be 30 or more variations of a single model.

Bags, furthermore, come in boxes that manufacturers use for shipping via small-package delivery to a fragmented base of mostly mom-and-pop retail customers. But shoes ship to retailers in bulk packaging rather than in individual boxes. When 6pm.com sells a pair of dress loafers direct to a consumer, the manufacturer thus has to incur extra shipping and handling costs to repackage and ship the shoes.

Most important, shoes have a short product life cycle — typically three to six months — and suffer from a high return rate. (Some customers order two pairs at a time, planning to return the pair that doesn’t fit.) Luggage life cycles can last six years, and return rates are minimal. For eBags, this means that although shoes and luggage command similar gross margins, shoes carry a much higher cost-to-serve, and selling them online thus requires a different business model.

Understanding the cost-to-serve dynamics is more important than ever as online retailing continues its growth spurt. More than a third of U.S. households now shop online, according to a September 2005 report from Forrester Research, and annual sales of physical goods are expected to hit $100 billion for the year.

Over the second decade of online retailing, the companies that truly grasp the drivers of cost-to-serve at the level of individual items and individual customers will unlock the full value-creating potential of online retailing as an alternative to — and complement of — traditional retailing.

Trial and ErrorBack at the dawn of online retailing, highflyers like Value America (an online “department store”) and Webvan (an Internet-based delivery service that focused its offerings on grocery items) did not comprehend the operational cost implications of their business models. Value America started with a virtual inventory model supposedly applicable to any branded product. Although its initial offering, computer hardware, sold well, shipping and handling costs for lower-value goods proved prohibitive, and an unmanageable flood of returns ultimately sank the company in August 2000. Less than a year later, in July 2001, Webvan declared bankruptcy after concluding that it would never turn a profit, despite its state-of-the-art supply chain with a hub-and-spoke network of delivery cross-docks and highly automated distribution centers. (The flaws in its economic model were highlighted in a Booz Allen Hamilton study more than a year before its collapse. See “The Last Mile to Nowhere: Flaws & Fallacies in Internet Home-Delivery Schemes,” by Tim Laseter, Pat Houston, Anne Chung, Silas Byrne, Martha Turner, and Anand Devendran, s+b, Third Quarter 2000.)

Even Amazon.com did not fully appreciate all the factors driving its cost-to-serve. When Jeff Bezos opened his Internet store in 1995, he started with books, reasoning that it would be easier to offer the millions of titles in print online than through a traditional mail-order catalog. Although Mr. Bezos may not have fully grasped all of the inefficiencies inherent in the book industry, he saw that his model could minimize inventory risk — a significant problem in book retailing. Unlike other manufacturers, publishers take back all unsold copies of their product. Up to 30 percent of trade books ship back to the publisher at enormous cost to everyone: to the publisher, who refunds the payment to the retailer; to the retailer, who pays for shipping and restocking; and indirectly to the consumer. Amazon’s online model minimizes the inherent inefficiency of placing potentially unsellable titles on thousands of retail bookshelves by relying instead on a relatively small inventory to support a “virtual bookshelf.” If Amazon returns fewer books than a bricks-and-mortar retailer, it should be able to negotiate lower prices from the publishers (reflecting its lower cost-to-serve as a customer of the publisher). Amazon can then pass along those savings through lower prices to the consumer.

Although books worked for Amazon, toys were a different matter. As Jeff Bezos learned, the toy supply chain comes with a much higher cost-to-serve. Toys are more seasonal than books and demand for them is far less predictable. Magnifying those challenges, most toys are made in Asia, and the replenishment cycle can easily outlast the actual selling season. That means merchandisers must accurately predict which toys will be hits and then buy enough inventory for the whole season; Amazon therefore gained no benefit from its “virtual shelves.” Guessing too conservatively results in missed sales, and guessing too optimistically leads to write-offs because toy manufacturers do not typically accept returns of unsold goods. Without any toy merchandising expertise, Amazon guessed wrong for the 1999 holiday season and wrote off $39 million in excess toy inventory in early 2000, having sold only $95 million worth of toys.

Furthermore, conventional toy retailers enjoy advantages that traditional booksellers don’t. Unlike Barnes & Noble, Wal-Mart and Toys “R” Us ship multiple truckloads of goods to each store weekly, which puts their transportation costs far below the cost of shipping individual toys to consumers. Recognizing these differences, Amazon gladly partnered with Toys “R” Us in 2000, shifting the inventory risk to the experts but leveraging the additional product lines to lower its own shipping cost for multi-item orders.

Nonetheless, the two partners had a falling-out in 2004, with dueling lawsuits in the New Jersey court system. This denouement suggests that the cost-to-serve for online toy retailing produced a financial model that would not support the two parties’ aspirations adequately.

Channels and BrandsAlthough successful online retailing depends on a variety of factors, the cost-to-serve of a particular product category can explain much of the variance in the penetration rates of Internet sales. For example, according to the United States Census Bureau, in 2002 (the latest data available), 44 percent of retail sales of computer hardware and software took place via the Internet. Certainly tech-savvy computer buyers are more likely than the general population to shop online. But equally important, the high value-to-weight ratio of computers — especially as laptops become more popular — minimizes the importance of transportation cost and makes the category a low-cost-to-serve option over the Internet.

Cost-to-serve factors like inventory, packaging, shipping, and returns help explain why online sales of books outstrip online sales of other kinds of merchandise. E-commerce accounts for nearly 13 percent of the total bookstore and newsstand sales in the United States — $15 billion in 2002 (the latest year available from the U.S. Census Bureau) — and the same portion of the $21 billion market for office equipment and supplies. By contrast, the Internet accounted for just 2.7 percent of the $92 billion in U.S. sales of furniture and home furnishings. Or consider the largest retail category, food and beverages. Online sales accounted for only two-tenths of 1 percent of the $450 billion U.S. food and beverage retail sales total in 2002. As Webvan (and many investors) learned, targeting a huge market does not guarantee success if the cost-to-serve economics don’t work.

Future growth in e-commerce will likely come from continued modification of existing supply chains rather than wholesale replacement. For example, despite the generally low level of Internet sales in furniture and housewares, Williams-Sonoma has achieved great success online. The company, which operates a mix of retail, catalog, and Internet channels under its eponymous store brand as well as the Pottery Barn and Hold Everything brands (among others), sold $3.1 billion in fiscal 2005 — 52 percent through its traditional retail stores and 48 percent through its two direct-to-consumer channels. At $3.3 million in annual sales for its average kitchenware store, Williams-Sonoma doesn’t gain any significant transportation economies in shipping to its stores rather than directly to its customers. Ultimately, the company can maximize profits by assigning items to channels and brands to reach consumers at the lowest cost-to-serve.

Circuit City’s OpportunityRather than minimizing the cost-to-serve across channels, traditional retailers often put their most popular items on their Web site. Although such an approach sounds logical, the reverse would typically work better. Traditional store-based retailing requires turning inventory quickly to justify expensive floor space. Slow-moving inventory — especially products with a high risk of obsolescence — can benefit from the centralized inventory pooling of online retailing. And if the product commands a high value-to-weight ratio, the cost penalty from direct-to-consumer shipping is minimal.

Circuit City, the “big box” consumer electronics and small appliances retailer, has an opportunity to minimize its cost-to-serve by making smart use of its many service options: in-store shopping, in-store or online ordering with delivery from the store, online ordering with store pickup, and online ordering with direct home delivery. Consumer electronics is a category currently underexploited by e-commerce. In 2002, only 2.5 percent of electronics and appliances sales went through online channels despite the fact that many electronic goods share the high value-to-weight ratio of computer hardware and software. Finding the optimal cost-to-serve for each product and customer category would give Circuit City a competitive advantage over pure-play online retailers or less aggressive traditional competitors.

Circuit City operates a network of nine regional distribution centers to serve its 621 domestic stores. With average weekly sales of more than $300,000 per store, Circuit City generates overall cost savings from its transportation network scale. But the relative importance of this bulk shipping network varies by product.

Consider the Hitachi 65" HDTV Display recently offered at $1,299. It weighs 324 pounds and measures 5-feet-by-5-feet with a 28-inch depth. Shipment of such a bulky item through the company’s full-truckload distribution network offers significant savings over a small-package shipment directly to a consumer’s home via UPS. But, with relatively low unit sales and a short product life cycle, inventory held at the store represents a high cost and big risk. Circuit City might benefit from keeping a minimum inventory of this item at the store — even just a display model — and having customers order it online for in-store pickup after the next delivery from the regional distribution network.

A pure online offering might work best for the Sony HDV camcorder. Priced at around $1,999, it is the most expensive model among the 60-plus camcorders that Circuit City sells, and it costs three to five times the price of the most popular models. As with the Hitachi HDTV, low unit sales of the Sony HDV camcorder may not justify stocking the item at the store because of the high inventory-carrying cost and risk of obsolescence. But unlike the Hitachi HDTV, the camcorder weighs very little — less than two pounds — and, accordingly, Circuit City’s distribution network provides little transportation cost savings. Rather than stocking it at each of the nine regional distribution centers, Circuit City could gain further savings by pooling the inventory in a single national distribution center and shipping directly to customers’ homes, minimizing the cost-to-serve for Circuit City as well as for the customer.

For each combination of customer and merchandise, there is an optimal cost-to-serve option among the different delivery choices: store inventory, store delivery, in-store pickup, and direct delivery. For customers living far from a store, for example, even for bulky products like the HDTV, the benefits of routing the goods through a regional distribution center (such as that maintained by Circuit City) may be offset by the extra costs of a two-step distribution cycle, compared to the simplicity of direct home delivery. Finding the optimal cost-to-serve at the levels of customer and item may be challenging, but it will be rewarding.

Even pure-play online retailers should consider the cost-to-serve in their pricing. Despite having the ability to customize Web pages to each individual, few companies fully leverage the potential to price products to reflect the different underlying costs. For example, eBags offers special pricing for bulk purchases for corporate sales, but it does not attempt to adjust shipping costs on the basis of a customer’s geographic location. Such fine-tuned pricing could potentially increase the company’s profitability. That’s the kind of detail that retailers will have to consider as they grow their online businesses.

Accounting for IntangiblesCost-to-serve in online retailing includes such factors as the expenses associated with inventory, transportation, and replication of the existing offerings of traditional retailers. But to get a truer sense of cost-to-serve, it should also take into account intangible costs to the customer. Consider the current approach to furniture retailing, one of the least customer-friendly supply chains in retailing.

Because there are so many manufacturers offering so many styles in so many woods, finishes, and fabrics, most furniture retailers display a limited selection of goods. Customers place their orders and then wait for the couch, table, or chair to be manufactured, shipped to the retailer, and finally delivered to their homes. The whole process regularly takes 12 or more weeks — a cost in “pain and suffering” that falls squarely on the customers.

Early attempts to improve on the furniture retailing process via the Internet proved daunting. Living.com and Furniture.com, two failed Web retailers, focused on the “consumer experience” by investing in technology to allow shoppers to visualize the furniture in virtual mockups of their home. These companies’ supply chains — which, like Amazon’s, depended on outside delivery services — proved untenable. The challenge of scheduling precisely timed home deliveries, something Amazon’s products typically do not demand, proved to be beyond the ability of these nascent furniture retailers. Moreover, products often arrived damaged or unacceptable for some other reason, resulting in return rates of up to 35 percent of sales. Despite good efforts, the “virtual” model failed in the furniture category.

The Amazon online model doesn’t work for furniture sellers. It would be better for them to emulate the automotive industry. The big opportunity online for furniture retailers may lie not in eliminating storefronts, but in dramatically reducing the lead times in the order-to-delivery cycle. Car dealers resolve the choice challenge by sharing inventory information among dealerships and exchanging vehicles to better meet a particular customer’s desires. Roughly half of the vehicles sold by a typical dealership come from such an exchange; the other half come from the dealer’s own inventory on the lot. Similarly, with furniture, customers could check the “look and feel” of a display model, and the retailer would then locate the desired inventory at another store or at a centralized stock pool with delivery in days, not weeks. Such a business model would leverage the Internet’s information-sharing power to lower the “cost” of long lead times without incurring an undue level of inventory investment.

In the end, future success for retailers of furniture, electronics, luggage — any sort of retailers — won’t be a matter of expanding standard offerings to the burgeoning Internet channel or replicating existing online models. Despite the obvious marketing synergies, toys present different challenges from books, and shoes different challenges from luggage. Smart retailers will take a closer look at the costs of bringing each item to each consumer — the cost-to-serve — to decide how to merchandise their offerings and ultimately grow their business by applying the right retail model at the right time.(image placeholder)

Author Profiles:

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Tim Laseter (lasetert@darden.virginia.edu) serves on the faculty of the Darden Graduate School of Business at the University of Virginia. Author of Balanced Sourcing: Cooperation and Competition in Supplier Relationships (Jossey-Bass, 1998) and formerly a vice president with Booz Allen Hamilton, he has more than 20 years of experience in operations strategy and supply chain management.

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Elliot Rabinovich (elliot.rabinovich@asu.edu), a faculty member at the W.P. Carey School of Business at Arizona State University, is an expert on Internet retailing and supply chain management. He is the coauthor of Logistics and the Extended Enterprise: Benchmarks and Best Practices for the Manufacturing Professional (John Wiley & Sons, 1999).

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Angela Huang (huang_angela@bah.com), formerly a financial analyst at the Reserve Bank of New Zealand, is an associate in Booz Allen Hamilton’s Cleveland office. She works with clients on operational challenges, including retail supply chain issues.

Google Earth for Econ Dev

2006-02-09T05:31:00.000-08:00

Google Earth Industries – a new and exciting resource for Econ Dev practitioners
How often have you wished you could take a look at a site to see what the surrounding land looks like – how far is it from the coast – are there houses nearby - … the list goes on.
Have a look at Google Earth and think ‘Virtual Helicopter Trip’ over the site
http://earth.google.com/commercial.html

Guidelines for Developing a customised suite of Innovation Metrics

2006-01-16T04:11:00.000-08:00

Innovation is becoming more of a mainstream topic in Econ Dev - how do we measure it?

the old system was to count R&D spend and Patents.. this does give some indication of direction(in the same way that moss grows on the north side of trees in the Northern Hemisphere) but if there are in the city centre and the sun is not shining you still need a compass - or better still these days a GPS..
The following article give a useful perspective on measuing 'Innovation Metrics' as they are known..

http://www.strategos.com/articles/InnovationMetrics/InnovationMetrics.pdf

Practical Roadmap for developing a strategy

2005-12-01T07:15:00.000-08:00

http://www.northdown.gov.uk/edstrategy

City Certification as a economic development tool

2005-06-08T05:12:00.000-07:00

Cameron Mulder posted the following useful thought ...
-----------------------------------------------------------------------------------------
I currently work for an economic development corporation in California.
My job is to work with rural cities on various economic development projects. This can include business workshops, city council planning session, or basically anything a city wants and we think somehow fits into the rubric of economic development.
I have an idea and I am curious if anyone has done something like this before.
We have a hard time getting everyone on the same page as far as economic development and future planning for the community. Many of the towns we deal with are in dire straights and need a serious plan for the future, but have such serious day to day issues to deal with that it is almost impossible for them to conduct long range planning that is essential for serious economic development and sustainable growth.
What I want to do is make an "Open for Business" city certification. This certification would mean that the city has (or is currently trying to create) -Long term infrastructure goals and funding -A chamber of commerce -Long-term livability goals -Reviewed permitting process in last 5 year -Does a yearly mail/online survey of businesses -Has development plan for face-to-face interviews with business -Has current info on all lots and buildings for sale in city -Has yearly goal planning and education for elected officials -Performs survey of citizens yearly
This is just a basic list to give you an idea. The city would not have to have done all these things, just have plans in the works to get these things done. The certificate would be given out by the economic development corporation (EDC) board of directors on recommendation from the staff of the EDC.
Has anyone heard of a program like this, and what do you think?
cameron.mulder@gmail.com

Online Location Quotient calculator for US

2005-05-20T03:25:00.000-07:00

A Handy New Tool from the Bureau of Labor Statistics
One of the most frequently used measures of industrial specialization or clustering is the location quotient. Up until now, computing location quotients has been a tedious and time consuming task. A new tool produced by the Bureau of Labor Statistics--the Location Quotient calculator--makes exploring LQs easy. The location quotient indicates whether a particular industry represents a larger (or smaller) proportion of a particular local economy than it does the national economy. A location quotient of one means an industry makes up the same share of a regional economy as it does of the larger (usually national economy). High location quotients (much greater than one) indicate that a region is relatively specialized in a particular industry.

The tool lets you compute location quotients for states, counties or metropolitan areas (hint: scroll to the bottom of the geographic area drop- down list for metro areas). The tool lets you compute location quotients for selected industries, or all available industries at once. You can specify up to three different areas for comparison, for example, to compare the location quotients for transportation equipment manufacturing in three different metropolitan areas. The site includes data from 2001to 2003; you can theoretically compute location quotients down to the level of NAICS six-digit industries, but as a practical matter you'll encounter data suppressions for sub-state areas for anything less than 3-digit industry sub-sectors.

http://data.bls.gov/LOCATION_QUOTIENT/servlet/lqc.ControllerServlet

Understanding your Regional Economy

2005-05-20T03:21:00.000-07:00

This 100-page guide to finding and using socioeconomic data to analyze local and regional economies is now available in print and on the Web. Written in an easy-to-read, informal style, the User's Guide offers practical advice on a wide range of data topics, drawn from the experience of analysts nationwide.
Contents

Part One: The Basics
Tools of the Trade
Data Sources: Where the Numbers Come From
Statistics for Analyzing Your Economy
Data Intermediaries: Guides in the Statistical Jungle
Part Two: Lessons of Practice

Ten Habits of Highly Effective Data Analysts
Bookshelf Basics for Economic Analysts
The Web's Twelve Best Sources for Regional Data
Seven Pitfalls of Data Analysis
Advanced Analysis: Power Tools for Data

Available for free download 98 pages (270k) at http://www.econdata.net/content_usersguide.html

Supporting the role of Further Education in Econ Dev

2005-01-12T03:48:00.000-08:00

The following site provides (free of charge) sector specific tutorials to those in Further Education on the use of the Internet for research and development
http://www.vts.rdn.ac.uk/

A great guide to developing an LED Strategy

2004-11-27T14:41:00.001-08:00

This world bank site give a great guide to developing a LED Strategy

http://www.worldbank.org/urban/led/step_two.html

To develop a LED strategy, the community must be fully informed about their own town or city, their own region and their national economy. Conducting a local economy assessment involves collecting strategically important information and then analyzing it strategically. Some useful types of information are:
* Demographic information, i.e., information about the people in the community, what they need and what they are capable of.
* Economic information. This information will provide an understanding of the local economy.
* Investment climate information. This will inform on how the local government treats its business community.
* Hard Infrastructure information. This will inform about the status of water, electricity and wastewater provision. The focus should be on economic areas.
* Regional and National information, to gather information on what is happening in other areas that impact on the community.

One of the best Econ Dev Feeds

2004-11-26T01:23:00.000-08:00

One of the best Economic Development Feeds I have seen is at
www.don-iannone.com/edfutures
don has done a great job and was one of the first to offer an RSS feed

May I recommend you to his site..

The Targeting Social Need & Gross Value Added? a Paradox – poles apart?

2004-11-25T01:41:00.000-08:00

A presentation to the Policy Innovation Unit of DETINI
Wed 24th Nov. 2004
Nick Rogers MSc. North Down BC. nick.rogers@northdown.gov.uk
The policy paradox described
• The dilemma of Targeting Social Need and in yet also achieving above average growth in Gross Value Added to help catch up with the rest of GB
• Could a policy encouraging the direct involvement of the local knowledge based (KB) sectors within the supply chain of the public sector investment stream help retain significant GVA in the local economy?
• Could the same policy generate new enterprise spin off and accelerate enterprise growth?

A critical appraisal of the proposal
• Would the local KB sector respond to the opportunity?
• Would it be a ‘one time’ benefit - or could the partners use the knowledge to create new knowledge based tradable services?
• Would the policy ‘muddy’ the procurement process? i.e. split responsibilities – added costs etc. hence be politically unacceptable..

An analogy in Great Britain
• OGC & DTI are considering how projects based on innovative speculative proposals could be procured via single sourcing whilst still retaining best value and value for money
• Possible emphasis on ‘most economically advantageous terms’ as a criteria for local involvement (EU procurement rules permitting)

Atkinson Review – Measurement of Government Output and Productivity
• …government output represents a sizeable part of Gross Domestic Product (GDP). In broad terms, a one per cent per year faster growth rate of government output raises the overall GDP growth rate by some 0.2 per cent.
Source: Atkinson Review-Interim Report July 2004

So what might we do now?
• Are the potential benefits a mirage in economic terms? – lets check it out!
• Identify any international examples of a similar approach – Europe & further afield
• Develop a pilot project proposal – who with and how funded? DENI?

I would welcome any comments on this topic.. in particular has anyone has tried it?

Industrial and Regional Clusters: Concepts and Comparative Applications

2004-11-24T07:07:00.000-08:00

If you ever wondered about Clusters and how they work have a look at this site

http://www.rri.wvu.edu/WebBook/Bergman-Feser/contents.htm

Mapping of Census Workplace Population

2004-11-17T03:15:00.000-08:00

The 2001 Census Tables for Workforce Population provide a valuable insight into the actual local workforce without being skewed by where people live.. this is the true 'gold standard' baseline data for development planning.. however it is only available every ten years..

The tables and the ability to map them may be found at http://www.nicensus2001.gov.uk/nica/thematicmapping/thematicmap.jsp

Plan To Profit From An Economic Crisis

2004-10-08T05:44:00.000-07:00

Source: The Boston Consulting Group
All companies should make sure that their crisis management plan is in place, whenever a crisis strikes. However, crisis management plan is not simply a pre-requisite for protecting a company’s cash flow, which is the lifeblood of every business. Crisis management plan also enables an organization to capitalize on its competitor’s weaknesses and generate additional long-tem value. The paper examines how to devise an effective crisis management plan in order maximize profits during crisis.
Format: PDF, requires Acrobat Rdr 5
Date: January 2003
Pages: 5
Size: 124.30
Access Details: Direct Access
Topics: Developing Action Plans

2004-09-30T12:25:00.000-07:00

npj@play

Innovative business links via local govt

2004-09-29T09:33:00.000-07:00

I have just discovered that I can build up new contacts for my business clients by approaching my opposite number in the economic development communities of target locations.. the network operates at a municipality to county level.. referrals work and business seems to grow - fostered by the trust engendered through both local government officers knowing their clients and trying to help them..
real simple but maybe that is why it works..

Why a Blog on Econ Dev

2004-09-03T05:29:00.000-07:00

In our profession we dont have time to read lots of books.. we need to know what works ..
If you wonder how others get through their day then this blog will be for you.. I will try and share practical and timely info about how and what we are doing..

The big issue at the moment is Performance Improvement and the Balanced Scorecard Approach.. how are we going to implement this approch in Economic Development when the rest of the organisation just regards the process as more bureacracy....
more tomorrow..