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The evolving world of e-tailing

If you had asked an Internet retailing expert three years ago who was most likely to suffer from the rise of e-commerce, many would have pointed to distributors. However, distributors are not only "not going away" but are, in fact, thriving by embracing what is possible on the Net instead of running scared.

If you had asked an Internet retailing expert three years ago who was most likely to suffer from the rise of e-commerce, many would have pointed to distributors. These disrespected behemoths that deal in the dirty world of moving physical inventory were presumably breathing their last breath. As leading e-commerce vendors gained steam, they would simply order products directly from manufacturers, and the distributor would be rendered, for lack of a better word, unnecessary.

The interesting fact is that some distributors are not only "not going away" but are, in fact, thriving by embracing what is possible on the Net instead of running scared. The tectonic plates of online retailing are still shifting, and the end result may look far different than it does today.

Before looking forward, let's examine the world of e-commerce today. Consumers shop at online stores. Many times, they are directed to these stores by portals, such as Yahoo, or affiliates. Affiliates are small Web sites (more than 1,000,000 of them) that perform niche merchandising and get a commission for sending leads to e-tailers. As a result of the hefty marketing budgets of e-tailers, large portions of customers are brought in through such programs. When consumers purchase products, many e-tailers fulfill these requests through distributors. These distributors perform as they always have, sourcing products from the end manufacturers.

The interesting thing about this value chain--manufacturer, distributor, e-tailer, portal/affiliate, consumer--is that it hardly resembles the lean economic model promised in the early days of the Internet. With five parties and four transfer points, there are many mouths to feed. So how will this model evolve? Which points are likely to be truly disintermediated?

As mentioned, many people believed that the resultant model would be manufacturer, e-tailer, consumer--a philosophy that considered the distributor of marginal value and failed to recognize the emerging importance of portals and affiliates in the e-commerce game.

Ironically, in certain cases an equally likely model may be the following: manufacturer, distributor, affiliate, customer--where the e-tailer is the one disintermediated. I suspect this sounds a bit heretical in Silicon Valley circles, but give me a chance to explain.

Ingram Micro in Orange County, California, is the largest single distributor of computer hardware and software on the planet. Traditionally, Ingram aggregates physical products from manufacturers and delivers them in bulk to storefronts and systems integrators that resell the product to the customer.

However, in response to the rise of e-commerce, Ingram has changed its colors. Rather than focus simply on bulk distribution, this savvy distributor can now drop-ship a "unit of one" directly to the end consumer. What's more, it can make it look like the order came from someone else, complete with customized packing slip.

If this weren't enough, Ingram also has developed programs to help more "virtual resellers" get in the game, increasing their power position in the value chain. The company has created an extranet that shares merchandising information--product descriptions, photos, spec sheets--with anyone who wants to create a virtual Web storefront for computer products.

The interesting thing here is that as Ingram hones its model, there is no reason why its customers can't include the affiliates that are currently driving sales to e-commerce sites. And why can't a company like Yahoo or America Online simply connect to Ingram and send orders directly to them as opposed to routing them through an e-tailer?

Ingram is not the only Web-savvy distributor. If you look at books, music, toys, and office supplies, you will see more and more distributors building expertise in "unit of one" drop shipping. As these skills continue to improve at the distributor level, we could see some fundamental shifts in the overall e-commerce environment.

The first shift to expect is a bifurcation in the e-tailing community. We will increasingly need to delineate between e-tailers that handle inventory and physical distribution (physical e-tailers) and those that don't (virtual e-tailers). Many people believed that virtual e-tailing was the optimal way to go because of the lack of investment in true physical assets (both products and warehouse infrastructure). Return on investment would be higher if you were simply a bit-based business. However, because of the evolution outlined above, the virtual e-tailer may be in the most tenuous position. The barriers to entry in order taking are simply too low.

Virtual e-tailers are likely to be faced with several unfortunate realties. First, their value-add is limited to demand aggregation and order taking. As back-end ordering networks evolve, the task of processing an order will be of marginal value. As the virtual e-tailer is merely an order aggregator, its economics should begin to mimic those of an affiliate. The gross margin of an e-tailer and the commissions paid to an affiliate (typically 5 percent to 10 percent) will undoubtedly converge (if they haven't already). Moreover, virtual e-tailers are likely to be disloyal with regard to who they enable; as a result, these companies will see increased competition in the future.