Amid E-tail Shakeout, New Study Highlights Viable E-tail Business Model; Future Dot.com Winners Must Sell Through Multiple Channels, According to McKinsey/Salomon Smith Barney Study.

Retail & Internet Writers

NEW YORK--(BUSINESS WIRE)--June 19, 2000

E-tailers who sell to their customers across multiple channels--through stores, catalogs and on-line--significantly increase their chances of generating impressive returns and emerging victorious amid the growing e-tail shakeout, according to a new study by McKinsey & Company and Salomon Smith Barney.

In their race to gain market share of customers, most major online retailers lose money every time they sell anything, according to the McKinsey/Salomon Smith Barney E-tail Economic Study. However, online retailers can profit on every sale if they drive up their average order size, hold the line on discounting and sell higher-margin products, according to the McKinsey/Salomon Smith Barney analysis.

"The notion of a 'pure play' is turning out to be the wrong play," said Joanna Barsh, a director at McKinsey & Company and a leader of the firm's e-tail practice. "To be successful, online retailers need to exploit other marketing channels simultaneously, such as in-store and catalog sales, as well as private labels. A number of apparel e-tailers are already doing this successfully. Our study shows that multi-channel players can increase their share of wallet, as many consumers are already browsing on the Web before buying in the store."

The McKinsey/Salomon Smith Barney E-tail Economic Study found that first-quarter sales for orders taken by online retailers were below the cost of acquiring and distributing goods sold to customers. Resulting per-order losses before marketing, overhead and Web site development costs ranged from $2 to as much as $12.

The study pointed to difficulties online retailers face in reaching a break-even point while selling low-margin products over the Internet. For instance, even if an online pure play toy retailer could generate an $11 per-order contribution to gross income--which is extremely ambitious given high fulfillment costs--it would need more than $1.0 billion in revenues (approximately 5 percent of the total toy market) to support the $120 million to $140 million it would have in fixed warehouse, Web site, marketing and overhead costs.

Despite these findings, most online retailers and catalog merchants can generate significant profits. The frequency and size of each order are much more important contributors to an online retailer's profitability than large customer counts, the study found.

For instance, while the average online grocery order generates only $9 in gross income, the typical online customer will buy groceries on the Web up to 30 times a year. Thus, order frequency drives the net present value of an online grocery customer to $909 over a four-year time period, according to study data.

The McKinsey/Salomon Smith Barney E-tail Economic Study analyzed five industries, focusing on specific sectors within those industries. Following groceries, online retail categories showing the highest customer net present values were: prescription drugs ($434--over a seven-year period), specialty apparel ($384), department store apparel ($283), direct mail apparel ($190), pure-play books ($50), off-price apparel ($39), pure-play toys ($9) and pure-play apparel ($9).

"Shrewd e-tailers need to drive up their average order size to at least $50, hold the line on discounting and move to products with margins over 35 percent," said Blair Crawford, a principal at McKinsey & Co. "Together with maintaining high ticket sizes and decent gross margins, driving order frequency is the way to bypass today's costly market-share wars."

"The e-tail shakeout now underway doesn't mean the industry is economically unsound," Barsh added. "Winners will be those who focus on making their current transactions profitable while stopping the suicidal race to acquire unprofitable customers at any cost."

The study of five e-tailing industries involved extensive research of published materials, company statements and public filings. Researchers developed in-depth economic models for best-practice players with a focus on per-order, per-customer and scale economics.

About McKinsey & Co.

McKinsey & Co. is an international management-consulting firm that serves leading corporations and organizations in most industrialized nations and many emerging markets. With nearly 6,000 consultants deployed from 81 offices in 43 countries, McKinsey advises companies on strategic, operational, organizational and technological issues. While currently serving several of the world's largest companies measured by market capitalization as well as the largest companies in virtually all industries, McKinsey is also helping promising start-ups to rapidly launch and grow their operations. The firm will also undertake more than 1,000 e-commerce engagements this year--a threefold increase over 1999.

About Salomon Smith Barney

Salomon Smith Barney is a global, full-service investment banking and securities brokerage firm. The firm's 10,900 financial consultants located in approximately 460 offices across the United States, service over 6.2 million client accounts, representing over $816 billion in client assets. Salomon Smith Barney is a subsidiary of Citigroup.