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'Amazon will probably end up scaling back'

Aseem Chhabra

As the new economy goes through a market correction, there is speculation about which companies will survive, while the others go under. Do certain online sites have a competitive advantage over their rivals? Does building a brand name and providing superior customer service give these online services an edge over their competitors?

A recent study conducted by three Indian business school professors shows that out of the several qualities that could define a superior online experience, only two -- building trust and providing high level customer service -- are valued as important long term advantages by the stock market. The market has continued to value these advantages even after the crash of April 2000.

The study also explains why a site like Amazon.com has managed to survive so far, despite its sinking stock value and the attack by click-and-mortar giant Barnes & Noble, and why online toys and grocery stores have had a tough time competing against brick-and-mortar stores like Toys R Us and Safeway.

"Customer confidence -- which can be viewed as the notion of trust related to brand and reputation -- truly stands out," Suresh Kotha, an associate professor of strategy and e-commerce at the University of Washington and one of the three co-authors of the study said. Kotha's collaborators are two assistant professor of accounting -- Shivaram Rajgopal, also of the University of Washington, and Mohan Venkatachalam of Stanford University.

"The second thing valued by the market is the things that online sites do to develop customer relationships," Kotha added. "Our intuition is that these two qualities are very difficult for companies to imitate. It is internal to the firm, not external."

"If your site is at the threshold level of navigability or at the threshold level of selection, you don't want to overinvest any more," Rajgopal said. "If you have scarce money, scarce resources, invest them in creating trust and building customer service."

The three looked at 48 e-commerce companies during the period fourth quarter of 1999 to the third quarter of 2000. The sites studied included Amazon.com, eBay, cdnow, buy.com and Yahoo. Based on a methodology developed by an outside vendor -- Gomez Advisers -- the 48 sites were judged and given scores on five categories of services -- ease of navigation, customer confidence/trust, selection of product, price leadership and virtual community building.

Their study revealed that, on average, for every 1% increase in the online site's score, there was a 1.66% increase in the traffic to that site, resulting in a 0.84% increase in revenue. But to maintain that revenue and the traffic, most sites have to invest heavily, which makes their operating expenses too high. And so a 1% increase in the score also leads to a 2% decrease in net income.

"That is a problem a lot of startups face," Rajgopal said. "You can take away from that that they will never make money. The winners and losers have become clearer and will continue to become clearer as time goes by."

Rajgopal identified the case of Amazon.com. As a reaction to critics who pointed at its declining profits and tough competition from brick-and-mortar stores like Barnes & Noble (the leading bookstore launched its online site -- Barnes&Noble.com -- and hence became a click-and-mortar store), Amazon.com began to invest heavily and expanded into various other lines -- from auctions to selling electronic goods.

"Expanding like crazy and pouring in money was not a sensible strategy," Rajgopal said. "We can comment on this ex-post -- but cross selling is not that easy. They have begun to notice that people who buy books continue to buy books and people who buy electronics don't necessarily buy books. Amazon's model would have made sense if they were able to spread the customer acquisition cost, by pushing the same people to come back and keep buying."

Some analysts have predicted that it is only a matter of months before Amazon.com will shut down its operations. Rajgopal does not agree with this forecast.

"They will probably end up scaling back, focusing on core business -- books, music and video," he said, adding that Amazon.com may enter into alliances with other brick-and-mortar companies (just as it recently did with Toys R Us) and operate on a commission basis.

"Amazon's strength lies in creating customer trust and customer service," he said. "And those things are valuable and the best way for them is to exploit their advantages and get rid of everything else."

A vital part of the research by the three professors focused on the fact that as the extent of the competition increases (especially from brick-and-mortar companies), the relative advantage an online business might have, decreases. The problem is especially acute with products lines like toys and grocery stores.

"Toy R Us is still standing and doing fine, while eToys collapsed," Rajgopal said. "Online grocers had a bizarre business model, where they were trying invest millions of dollars building infrastructure whereas regular grocers already had that advantage. It was never clear how the online grocers would add value."

The one exception to the general rule is the case with Amazon.com, he added. Barnes and Noble's web-based store has made no dent into the market share that Amazon.com still continues to command, he added.

Kotha has conducted a separate study where he compares the strategies and level of on-line success of Amazon.com with Barnes& Nobles.com and cdnow. He pointed to a listing on Interbrand's site (www.interbrand.com) where the top brands of the world are identified (Coca-Cola and Microsoft are the leaders in this list). Amazon.com ranks number 48 on this, while Starbucks is 75th on the list.

"Starbucks been around for 27 years while Amazon has been here for a short while and is already no 48 on the list," he said.

Amazon.com, he said, made a series of strategic and symbolic decisions which have solidified its image as the leading online store.

"They called themselves the world's largest store," Kotha said. "That was symbolic because it related to Amazon -- the world's largest river. They were essentially coming and telling Barnes & Noble -- 'You are not the largest player in the world.' And all of a sudden Barnes & Noble, which is the leader in the field, was facing a small start-up which was claiming that it was larger."

"Those are the kinds of things they (Amazon.com) did that cemented the virtual site to the real site and created in the minds of the people that they are the leaders in the space and that the new technology is going to transform everything."

Further information:
Suresh Kotha
Shivaram Rajgopal
Mohan Venkatachalam

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