Why E-Tailers Are Poised for Disruption

Corporates Strike Back

Pure-play e-tailers like Amazon made great strides in the 2000s getting customers to buy online, but the 2010s are becoming the decade that retail chain empires strike back with Big Data playing an important role.

The corporate pushback is taking the form of a strategy called omnichannel retailing that includes both defensive and offensive components. In the second part of this post, we will explain how retailers can and are using omni-channel and Big Data to prevent e-tailers from poaching their customers and make existing customer relationships more profitable.

But first, we must address the imminent change in the retail playing field that will disrupt the current business model of most e-tailers.

Impact of Marketplace Fairness Act

Congress is now debating closing a legal loophole that created a significant competitive advantage for e-tailers that helped accelerate their growth until now. Under current U.S. law, retailers without a physical presence in a jurisdiction are exempted from the requirement to collect sales taxes from out-of-state customers because the logistical and technological complexity involved.

Technically, until now, online customers were supposed to submit at the end of each year to appropriate tax authority whatever sales tax they owed due to online purchases. In practice, few if any online shoppers do so, without any consequences. As a result, online customers will pay on average between 7 percent and 8 percent less when they buy a product from an e-tailer online than if they bought the same product from a retailer with an in-state presence. To see exactly how much residents of each state save thanks to this loophole, take a look at the sales tax map created by the non-partisan think-tank the Tax Foundation.

The current rules date back to a 1967 Supreme Court ruling regarding mail-order catalogue retailers, well-before anything like the modern web existed. However, the government’s attitude toward sales tax collection has changed with the times as e-commerce has grown and accounting technology has improved. According to the Census Bureau, retail e-commerce sales reached an estimated $305 billion and 6.5 percent of total U.S. retail sales in 2014.

Today, there are software solutions capable of levying and keeping track of varying sales tax rates on a large, geographically diverse customer base exist. Six of these software packages, including Enterprise TaxTools and Avatax, are already certified service providers for sales tax compliance (for more information see here).

As a result, Congress wants to close the loophole with a piece of legislation known as the Marketplace Fairness Act (MFA), which will obligate e-commerce businesses with over $1 million in annual turnover to start collecting sales taxes from all U.S.-based customers.  The first Marketplace Fairness Act was passed by the U.S. Senate in 2013 but did not make it to a vote in the House of Representatives before Congress adjourned in January 2015. However, in March this year a group of Republican and Democratic senators introduced the MFA of 2015 for consideration and many observers believe it is only a matter of time before it is passed. For more details on the act, read this Deloitte summary here.

Unsurprisingly, major brick-and-mortar chains have already come out in support of the legislation, including J.C. Penney, Sears, Macy’s and Target.

Low Profit E-Commerce Vulnerable

Taken out of context, some of you may think that a 7 percent or 8 percent discount on prices doesn’t sound like a lot. Actually, it is several times the size of most e-tailers profit margin.

It may surprise people who follow all the hype surrounding high-flying stocks but e-commerce giant Amazon registered a zero percent profit margin the last three years in a row. To phrase it a bit differently, Amazon barely makes money anymore. It basically transfers goods to customers and money to suppliers while keeping its employees paid.

Don’t believe me? Take a look at Amazon’s financial statements. You will see that last year, Amazon declared a net loss of $241 million on revenue of $89 billion. That wasn’t fluke either, the year before it made a slight profit of $274 million on $74.5 billion in net sales. In fact the last time Amazon had a profit margin that exceeded 1 percent of net sales was 2011.

In contrast, in 2014 retail giant WalMart had a 3.5 percent profit margin on $482.2 billion in net sales.

The relative ease in which potential e-commerce players can launch competing services in different Amazon product categories is partly to blame. Amazon has to keep its prices, and hence profits, low or risking losing sales entirely. But specialty e-tailers selling products that require specific expertise are not faring much better.

Blue Nile, an online jeweler that primarily sells diamond jewelry, recorded a net profit last year of just 2 percent on net sales of $474 million. On the other hand, Signet Jewelers, the owner of several major jewelry store chains including Zales, Kay Jewelers and Jared: The Galleria of Jewelry, registered a 6.6 percent profit last year on net sales of $5.7 billion.

Take a look at the table below and you will get an idea of where the real money is being made. You would probably find the same is true for all product category e-tailers but since most are privately-held it is impossible to review their financial statements without being an investor.

Some consumers currently shopping with e-tailers like buying online because it provides them a wider variety of selection and allows them to order from the comfort of their own homes. But 56 percent of consumers like to shop online to find lower prices for the same product they would be at a brick-and-mortar store, according to consulting firm PwC’s 2015 Global Total Retail Consumer Survey. Price was the primary reason listed by the survey’s respondents, ahead convenience or wider selection.

So, when you factor in that e-tailers are primarily competing with brick-and-mortar businesses on price, a 7-8 percent difference has the potential to disrupt their entire business model.

Enter Omnichannel

For e-tailers focused on low-profit growth through competitive pricing this may throw a real monkey wrench into the works. Even more so, now that it’s possible for consumers to order products from some major retails brands online and pick them up the same day at a nearby store. This seriously erodes the convenience factor of ordering a product from an e-tailer that can deliver products to customers only within 2-5 business days. But that already ties into omnichannel retail, which we will discuss in greater depth in part 2 of this post.

So you may be wondering: What is dragging down the profitability of e-commerce?  Or, how is Big Data helping major retail chains steal e-tailers’ thunder?

To find the answers to these questions view part 2 of this post.