Ecommerce: the end of an era - and the beginning of a new one

2023-02-08

When ecommerce met Porter…and some found themselves stuck in the middle

We live in difficult and challenging times. But very interesting times too – not least in the world of ecommerce.

So, this is our claim: The ecommerce industry is looking at significant strategic changes. With more than 15 years of experience in digitalization, we  believe the market is about to bring an era to its knees.... then we’ll see the rise of a new one.

Our claim is standing on a solid foundation – and with the Michael Porter framework in hand, we will prove our point.

First. Let us just recap Michael Porter's famous framework:

Either you compete on cost and take a cost leadership position, or you try to differentiate yourself. Otherwise, you end up being stuck in the middle. You can, however, also choose to drive a complete niche strategy, where the big players will not go after our business.

Ecommerce was a booming business for everyone – until it wasn’t

For years Pure Play ecommerce was a booming business. Growth rates were enormous as customers shifted from offline to online. Brands used Pure Player as part of their channel mix. Brands didn't compete with them, and the major marketplaces did not spend heavily on Google.

All this meant that the Pure Players were thriving – not least because of imperfections in the market. They could drive a successful business because:

• The supply chain was immature (few sold online or did a poor job in fulfillment)
• They could carry long tail stock cheaply with low interest rates
• They did not have significant competition on SEO and AdWords.
  
  

Meanwhile, marketplaces continued their march forward at a somewhat different pace. Their significance, however being very different depending on geography and vertical.

Ecommerce business has been great for almost everyone... for years... But now for many the wind has turned into a head on storm.

But what has led to this development?

The short narrative is that the market matured, and the growth rates went down in most ecommerce verticals. And as Warren buffet famously said “only when the tide goes out do you discover who has been swimming naked.” (see also our article ecommerce: Are You Good or Lucky?)

Let’s touch upon the growth rate implication first.

Ecommerce is by nature a ultra-competitive retail industry with cut-throat price competition, dynamic pricing algorithms, and small margins – making it a major challenge to achieve significant profits per se. However, as long as the total market was expanding there was enough growth for everyone – “the rising tide lifts all boats”. But now when general growth has weakened and growth gained at the expense of traditional retailers from customers busy switching online has flattened out, ecommerce market competition is showing its true face. The only market shares left to target, are now predominantly ones already “belonging” to other online players.

And this leads us straight back to Porter and market fundamentals…

In recent years, brands have taken D2C ecommerce more seriously. Many are optimizing loyalty programs to “own” the customers, they implement professional SEO and AdWord strategies and they push hard with a differentiation strategy. As a result of all that combined with the fact that they own their brand and thus have the upper-hand on assortment, they tend to win the Differentiation play in the Porter framework. They still have internal operating issues in terms of handling distribution and D2C channels – but they will all succeed with this - just applying different operational models depending on their size and industry.

At the other side of the framework is Cost Leadership and Cost Competition. And this game is characterized by a scary fact – you need superior scale and cash to win this game. Basically, marketplaces are winning this by miles. Players like Amazon and Alibaba have it all, and they are also doing their utmost to “own” the consumers with their many frictionless services. It’s a bet to own as large a share of spend from customers/households – and it gives them an upper-hand in terms of market power and loyalty as they solve basic/rational everyday household problems. Hence, the major marketplaces are building relevancy and frequency few can compete with. Amazon still takes market share. Retailers like Walmart have created a marketplace. And in one of the most mature verticals – fashion – Pure Player and stock-based European market leader Zalando has added a vertical marketplace to its business as a bet to own the fashion customer and cut capital expenditure tied to stock.

The market changes are leaving pure and omnichannel players stuck in the middle…

So where do these market changes leave the omnichannel retailers and Pure Players of this world? Porter would argue that they are stuck in the middle, and we would argue that they are now at the verge of crashing financially with massive stock volumes required to keep long tail assortment and placed in a margin game that just doesn’t add up to being a profitable business. Selling 3^rd party products that everyone sells through the same channels is tough and not sufficiently differentiated to allow customers to shop across brands and be the umbrella for many brands. In other words - being online distributors with all the associated costs doesn’t seem to fit with the thinking of Porter! But before we come to that conclusion, let’s revisit how they got there.

In recent years, the market imperfections have been removed. Brands have been making significant investments in ecommerce. Thus, the prices for ads are increasing, which harms both profitability and competitive advantage. So continuing to optimize on ads and SEO is a race to the bottom with only few real winners, namely Google and Facebook. One could even say that when Google on top of auction-based bidding also introduced Google Shopping, they actually created their own “de facto” marketplace that requires everyone to apply to a set feed-based format with little or no room for differentiation.

Furthermore, brands are exploring several strategies to achieve better logistics. They either go through marketplaces, or they build their own set-up. Once again this erodes the competitive advantage of a Pure Player or omnichannel players.

So, what is left? All economies of scale are going to the marketplaces or the ad platforms... the Pure Players seem to have lost their competitive advantage.

We should stress that we don’t believe that Pure Players should cope with their situation by buying new technologies like a CDP or a new composable set-up. Why, you might ask? Well, these strategies are also employed by the most modern brands and marketplaces who have more funds to buy the right capabilities and execute on them.

Finally, we will point to the market outlook. The consumers’ buying power has lowered significantly during the last year and, essentially, growth is gone. Also, following the higher interest rates, the cost of stock has gone up – which will carve out the potential small profit that is left in the business.

So Pure Players are stuck in the middle and in the long term will find themselves left with a capital-intensive long tail assortment model offering very little/no differentiation. This also goes for omnichannel players selling third party products, by the way. Riding the wave of “omnichannel” is the future based on the premise that customers interact across channels is obviously correct. But it is by no means a strategy. Your problems are exactly the same as those of your Pure Player competitors. Omnichannel or just calling it all “commerce” is not solving anything business-wise. It’s just semantics.

So, what to do?

Actually, the Michael Porter framework lays the solution out quite brilliantly. You need to differentiate or go niche. This requires some heavy change and innovation for most Pure Players and retailers – but the best ones already began this journey years ago.

Look at some of the best omnichannel retailers. They have worked heavily on their assortment and have built strong Private Label lines. An excellent example is Decathlon retailer who are no longer reliant on large brands such as Adidas and Nike, but have built their own brands & private label, that is highly recognized for quality and performance.

One approach is to adopt a differentiated brand strategy and/or become a community driven business, where you start building brand affinity – though this is definitely a long play. It will not happen over a 3-year period, and for some players in the market it’s frankly too late to pursue this approach if they’ve already established a transactional relationship with customers.

Pure Players could choose to go back and cut their long tail. They need to understand which customer segments drive profitability, and which are only driving “empty” revenue. It is classic category management, but pure players haven't focused sufficiently on this in recent years because their massive growth has blurred this profitability picture.

The Pure Players need to revise and change their marketing mix significantly. It is time to go from ROAS to POAS, understanding that you should only buy ads for profitable product and customers. In a world of recession, the bargain hunters are increasing in numbers, meaning consumers are becoming less loyal. So don't fool yourself into believing that you can buy loyalty – you need to earn it.

The other approach is to go completely niche. While this is an interesting strategy, be aware that many marketplaces continue to expand their assortment and the cost of stock continues to rise. Thus, going niche can be a risky and short-term.

Conclusions and take aways:

We genuinely believe this is an end of an era. But it’s also the beginning of a new one for ecommerce.

This is important because everyone needs to keep an eye out for the worst case scenario for any player in a market – the situation where you did everything right to optimize your business operation short and medium term – but despite this - it was just not be enough to run or own a healthy, sustainable and profitable business in long run.

Pure Players and retailers (incl. omnichannel players) need to revise their GTM and innovate themselves into stronger strategic positions. We’re convinced that this should be the long term focus – and, unfortunately, buying new technology or continuing the race to the bottom will not solve your problems. 

Key take aways:

• Market dynamics has changed

  • Recession is now

  • Cost of stock is growing

  • Marketplaces are taking the cost leadership position

  • Brands are winning the differentiation position, as they invest heavily in Ecommerce and tech stacks

• Michael Porter is still right about the ecommerce industry

• Competition will, or has already, intensified in most ecommerce sectors. Only those that develop a customer relationship beyond product assortment, pricing and functional benefits will survive long term and earn a profit.

• Growth is not enough; only profitable digital growth creates value

• It is time for corrective actions

  • Review your assortment strategy

  • Cut the long tail

  • Develop strong private lines

  • Build brand affinity beyond transactions

  • Create transparency on total cost to serve customers

  • Go from ROAS to POAS

• Honesty and speed of your execution in organization & operations will determine your ability to correct (as always)

 

About the Authors:

Carsten Pingel has been working within digital strategy and business development for the last 15 years. Former experience includes acquiring and scaling high-growth, multi-brand e-commerce businesses, and enabling digital transformation in the largest Nordic media group, Egmont, business development and strategy at Copenhagen Airports, and board positions in high growth e-commerce and SAAS companies. Now Carsten is leading the strategy consulting unit within Valtech, helping companies in their digital transformation, and utilizing data to accelerate growth.

Toke Lund has been working within management consulting, heading up the strategy office and the consumer insights office at the LEGO Group, driving digital transformation at Salling Group, and working as a digital strategy consultant at Novicell. Now Toke has founded Enterspeed, a software company delivering a high-performance product called Speed layer, which can accelerate digital transformation and composable setups.