Christopher Grosso, John McPherson, and Christiana Shi
2005 Number 3
Online retailing has come a long way since the go-go years of the 1990s: it generated $90 billion in revenues for US retailers in 2004, compared with just $8 billion in 1998. To study how the online strategies of today's successful retailers reflect this maturation, McKinsey analyzed the 100 largest direct retailers in North America.1 We found that direct retailers with physical stores captured 52 percent of Internet sales in 2003, while those without stores garnered just 31 percent.2 For each group, two broad strategies appear to be most successful. Together, the four models we identified (exhibit) have lessons for all retailers.
Retailers without stores do well as either "efficiency machines" or "niche leaders." The first approach is best for sellers of relatively low-margin products like CDs, books, or computers, because the Web provides the global reach these companies need to gain scale. Efficiency machines—such as Amazon and Dell—invest heavily in brand marketing, innovative Web sites, and highly efficient sourcing and fulfillment processes. These investments create massive fixed costs, often running into the hundreds of millions of dollars, so efficiency machines must generate annual revenues of at least $750 million to be profitable. Such retailers, once successful, tend to generate strong cash flows, however. Amazon invested more than $400 million in marketing and technology in 2004, for example, while generating $477 million in free cash. The largest efficiency machines drive repeat business by offering deals to customers (for example, Amazon's $79 annual membership, which includes unlimited two-day shipping). Of the top 100 direct retailers, only 7 are efficiency machines, yet they account for a quarter of total online revenues.
Niche leaders, such as L. L. Bean3 and Ross-Simons, sell higher-priced, higher-margin products (like apparel or jewelry) primarily through catalogs and over the Internet. Niche leaders build a loyal customer base by offering quality merchandise, exceptional service, or both. The ability to acquire and retain customers is crucial, since most niche leaders are too small to afford expensive brand marketing and must rely instead on targeted online or direct-mail campaigns. The most innovative niche leaders coordinate their channels by making products from their catalogs easy to order online, for example, or by using their Web site to display a wider selection of products than a print catalog could accommodate profitably. The 28 niche leaders we studied generated nearly $15 billion in revenues—17 percent of which came from the Internet—and account for 6 percent of total online revenues.
Store-based retailers do well as either "traffic drivers" or "triple plays," depending on their scale and profit margins. Retailers with relatively low margins and large scale succeed most often as traffic drivers. These companies use the Internet both to draw customers to their physical stores and to offer shoppers a wider selection of goods and greater convenience. Traffic drivers, such as Target, The Home Depot, and Wal-Mart Stores, attract shoppers using a variety of techniques—gift cards, rich-media advertisements, online circulars, and e-mail notification. Since traffic drivers tend to sell low-margin products at many price points, understanding the economics of different channels and how fulfillment costs can eat into profits is critical. Traffic drivers promote their highest-margin products (such as bedding and apparel) online, for instance, while displaying just enough other merchandise to reflect the broad range of products available in stores. Although stores generate most of the sales for traffic drivers, these retailers—with nearly $35 billion in annual revenues, on average—are so big that their Web-based sales are still impressive, accounting for 35 percent of total online revenues.
"Triple-play" retailers, such as J. C. Penney and Williams-Sonoma, use stores, catalogs, and the Internet to maximize their share of customer spending. These merchants sell relatively high-margin products (home goods or apparel, for instance) while striving to tailor their channels to complement one another fully. Catalogs attract new customers, drive repeat business, and coordinate product lines; the Web offers convenience, product information, and quick updates for pricing or promotions; stores, by contrast, allow shoppers to handle and test goods before they buy them. The challenge for triple plays is to understand how customers use each channel, to match products to that channel's economics, and to create a consistent customer experience across all of them. Triple-play retailers generated nearly $6 billion in 2003, some 17 percent of total online revenues.
As these models indicate, retailers that analyze all their channels and make thoughtful, strategic choices can enjoy exceptional results. Today's top Internet retailers understand the need for complementary on- and offline strategies, coordinated marketing, and balanced investment. Without an integrated strategy, store-based retailers seeking to boost sales through the Web or catalogs risk simply shifting sales volume to these direct channels and destroying profitability because of the added costs of fulfillment and overhead. To succeed, multichannel retailers must coordinate their online, catalog, and store activities to convert customers and encourage them to spend more. Such retailers must also develop efficient processes for capturing and fulfilling orders and ensure that consumer insights are shared across all parts of the organization.
About the Authors
Chris Grosso is a consultant in McKinsey's New York office, John McPherson is a principal in the Dallas office, and Christiana Shi is a director in the Orange County office.
Notes
1Direct retailers sell products through catalogs, stores, television, or the Internet.
2Manufacturers such as Sony (whose products are sold by multiple retailers) and person-to-person retailers, such as Alticor, accounted for the remainder. While such companies are included among the 100 retailers we studied, they are excluded from the models discussed in this article. Unless otherwise noted, all figures are from 2003, the last year for which comprehensive data are available.
3L. L. Bean has several physical stores, but the majority of its revenues come from catalog and Web orders.
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