The ever changing e-commerce model

E-commerce is expected to expand not only vertically--with more books, music, movies and PCs sold--but also horizontally, into categories such as apparel, consumer electronics and gifts. The expansion could drive this year's holiday e-commerce season to three to four times that of last year's $4 billion market. And this may just scratch the surface of e-commerce's potential.

Despite this rapid growth, the evolution of the underlying model must continue, particularly on the fulfillment side. The latest model is one we can call "localized fulfillment." Recent examples include Barnesandnoble.com's "on the go" service, which uses New York City bike messengers and local stores to rapidly get products to buyers. Another example is consumer-direct services such as Streamline.com and Webvan, which build localized warehouses and trucks to deliver straight to consumers.

Before we delve into this, let's step back and take a quick tour of recent history. Many of the early pure-play e-commerce merchants started with the concept of cutting the middle layer out of the distribution chain--the true "virtual" model, going directly from supplier to consumer.

As e-commerce began to take off, online stores quickly realized that many suppliers didn't have the infrastructure to keep pace with surging volumes. E-merchants learned that they needed to build the fulfillment infrastructure themselves or find outside providers.

And it didn't end there. Many players that built the infrastructure themselves quickly discovered that, as the business grew and products and volume were added, a single distribution center might not be enough. To handle the volume and quickly get products into consumers' hands, a more distributed fulfillment and warehousing infrastructure was required.

Amazon.com's fulfillment model is an example of this. The company is building a warehousing system, geographically distributed close to major shipping hubs for its leading markets to quickly and cost-effectively deliver products.

Let's walk through the long-haul fulfillment model. From the manufacturer, the product ships and gets put on a local truck to be delivered to a local shipping center, which then loads the product onto a truck, ship or plane that delivers it to the e-merchant's warehouse, with perhaps another shipping center and truck ride for good measure.

From there, the consumer orders the product--at an average order size of about $75 to $100--from an office in New York, for example. The product then gets put back on a truck, and then on another truck, ship or plane for long-haul delivery. Exhausted yet? Too bad, because we're not done yet.

It then arrives at the local UPS, FedEx or U.S. Postal Service center, which again puts it on a truck that drives it to the consumer's house. Obviously, the closer the warehouse is to the consumer, the more of these shipment layers can be removed. But in an increasingly tight gross margin environment, there is not a lot of margin for error.

You may not think this is much different from the traditional catalog model, but in fact, there are some key differences. First, the inherent free flow of information on the Internet causes a narrowing of pricing spreads and downward pressure on gross margins--as every competitor is only one click away, and several shopping search and comparison engines have been launched.

Second, many e-tailers are still learning one of the core critical elements of this business: efficient fulfillment. They are reinventing the wheel by building warehousing and fulfillment centers as rapidly as possible. Clearly, the challenges and risks associated are high with so many moving pieces. The big question is, are they building the right model? The one that will be the most efficient over time in a tight margin environment?

E-commerce innovation is far from over, and it will be years before the final chapter is written on which model works best. But what we are seeing is that the model is coming full circle, back to the original "virtual" model. As it turns out, the distributors are far from dinosaurs close to extinction. In fact, they may be the linchpins to successfully competing in an environment that boils down to speed, efficiency and execution.

These businesses, neither exciting nor sexy, could become increasingly more valuable. The Ingram Micros and Hanover Directs of the world that operate at volume and scale can provide the outsourced back end for the e-tailer. That way, the e-tailer can focus its resources and energy on differentiating itself with marketing, customer service, content and so on, instead of dumping billions into infrastructure that may or may not be the right thing to do.

Companies like Buy.com are examples of this model, concentrating their resources on building a great consumer experience and on offering great prices while partners like Ingram Micro do the heavy lifting on the back end.