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2 March 2012

The Threats and Opportunities of the Internet

Tag(s): Technology, Future

It is a well-established but little understood fact that when new technologies emerge the impact on society is usually exaggerated in the short term and underestimated in the long term. The internet is such a technology. From 1995 to 2000 dotcom venture capitalists enjoyed skyrocketing gains in their share prices leading them to act faster and with less caution than normal. Losses were almost seen as good as they indicated attempts to build share. As has happened on numerous occasions before unsophisticated investors piled in to buy highly speculative dotcom shares. On 10 March 2000 the NASDAQ index closed at a peak of 5048.62, more than double its value at the start of 1999. By October 2002 $5 trillion was lost in the market value of such dotcom companies. Many went to the wall having burnt through their venture capital without ever making a profit.

For me all this was clear. I could see that the Internet was a force for change but that it would not happen as quickly as all these dotcom entrepreneurs and their investors hoped. If I had known how to make money out of such a view I could have made a fortune but that would have required deeper pockets and perhaps greater nerves than I possessed. Nevertheless I did go on the record to this effect. I wrote an opinion piece in the Marketing Society’s excellent journal Market Leader which was published in autumn 1999. Here is that article in full:

The Threats and Opportunities of the Internet   

“Just as the US space programme led to the invention of Velcro and the development of mobile phones, so the US defence programme led to the creation of the Internet. The Pentagon wanted an alternative communications system in the event of direct strikes on the telephone network. The academic community then realised the potential of this storage and communication. Its potential for commercial application has been recognised only recently.

However, much of this is vastly exaggerated. In the Tulipmania that surrounds the Internet, we are asked to believe that a business with little trading history, negligible sales and start-up losses of millions is worth over £2 billion. Excited prophets forecast that e-tailing will take over next week, even though less than 0.1% of total retail sales are so far made through the Net.

These forecasts have been with us for some time. I remember in my time at Sony that colleagues would quote a consultancy who forecast that by 1999 X or Y billion pounds worth of goods would be sold over the Net. That certainly has not happened.

Let us suppose that these forecasts will come true, if somewhat later than originally stated. Suppose that even 20% of retail sales were converted to the Internet. This would trigger huge threats to the established order.

Brand owners would find their brands under enormous threat, as their carefully nurtured selective distribution policies would lie in tatters. Obviously, if they choose to sell direct, they put at risk relationships with their customers, retailers and end users, the consumers, as they have no experience of selling direct.

The retailers would be in huge danger, because their main assets are their property. If 20% of their turnover moved from the high street to cyberspace, not only would their profits slump, but the value of their property would plummet. The barriers to entry for new e-tailers would be very low if this property base were no longer required.

But our pensions are heavily invested in these property portfolios. A major social consequence would be a serious dislocation in pension funds. This would be exacerbated if they reacted by diving into the South Sea bubble of Internet stocks.

Media owners would lose massive revenue as brand owners and retailers sought to establish alternative Internet strategies.

Surely the government would have to act. Much of the internet revenue would flow abroad, leading to loss of profits and avoidance of VAT, and so the total tax take would fall.

In my view, there are many countervailing pressures that will prevent, or certainly slow down, the development of so-called e-tailing. Some businesses lend themselves to it, but only if the direct model is already established. Dell computers is quoted as transacting 30% of its sales over the Net, but the Dell model has always been direct-to-home and, in this sense, the Net is only a logical extension of an already successful model. A leading credit card issuer now sees 1% of turnover going through the Net, but this accounts for 47% of fraud and returns. This company, at least, could not afford to allow much more growth. Instead there are two much more probable and positive economic developments of the Internet.

First, it should be harnessed as a way to implement dramatic improvements in the management of the supply chain. The real development of e-commerce in the US is in this arena not direct selling.  Business-to-business transactions are being transformed. In the supply chain time is money and in my industry it takes us an hour to make a shoe but a year to bring it to market.

Second, the Internet provides a powerful tool to manage direct relationships with consumers. Too much relationship marketing in the past has simply been aimed at selling more. Great brands in the future really will have a relationship with their consumers in which the consumers are informed, enlightened, entertained and even consulted by their favourite brands. The consumers will take charge, and the brands that understand and embrace this will enjoy the fruits of the relationship.

It may be that these are seen by some as the musings of a dinosaur. To that I would say that the dinosaurs roamed and ruled the world for millions of years, while so far mankind has only managed a few thousand.”

So how did I do? Well, though I say it myself I think I got most of it right. Ecommerce has become established but my main point that e-tailing would not take off as quickly as forecast was correct. Online retailing was invented as far back as 1979. By the time of my article 20 years later it had only penetrated to 0.1%. In 2000 came the dotcom crash and Amazon did not make a profit until 2003. In the US online retailing is now estimated to have reached 9% of total sales. That is exceeded in the UK which is interestingly the most developed in the world at just over 10%. This is well below my hypothetical figure of 20% but already we can see some of the dangers I foresaw.

·         Brand owners. Some have chosen to sell direct while continuing to sell through traditional channels causing confusion and other problems in relationships.  Consumers are using retailers to learn about different products, particularly big ticket items and then going home to buy online. That is clearly not sustainable and in the long run we all lose because if the retailer goes under there will be nowhere to see the products before buying them.

·         Retailers. I said they would be in danger and they are. Many have already gone to the wall particularly those who only sell items like books and DVDs that are so well sold by Amazon and the like. But interestingly not all the business transfers online. When Woolworth closed much of its DVD sales were lost and so the studios have learnt belatedly that they need to nurture the remaining outlets like HMV because not all customers will buy online.

·         Property. The High St is struggling and 1 in 7 shops on the High St is empty. Many of the rest are charity shops; the country’s second largest bookseller is Oxfam. Yesterday’s footfall is today’s Google search. David Cameron has appointed Mary Portas to come up with strategies to save the High St and the Mayor of the relatively prosperous town where I live, himself a lifetime shopkeeper, is working hard locally to maintain the High Street as a thriving asset for the town. But all this is too little too late and I fear that the tipping point is not far away. If a retailer loses 20% of his turnover he will probably not survive. You don’t have to lose 50% to be in trouble. Some will be able to compete by making themselves attractive destinations. And of course the High Street has no God-given right to survive. A quarter of the 40 million visitors last year to the newly refurbished St Pancras International railway station didn’t go there to catch a train but to enjoy the shops and restaurants.

·         Media owners have lost revenue. Google in the UK attracts more advertising revenue than ITV.

·         Tax take. This is clearly under pressure. Google runs its European operation from Ireland and pays very little UK tax. Many of the bookmakers have gone offshore to Gibraltar from where they run online betting “shops”. And HMRC have only recently closed a loophole whereby online retailers distributed DVDs etc through Jersey to avoid VAT.

And I think my forecasts of more positive trends were pretty accurate. First, ecommerce in the B2B sector has developed very strongly and with positive benefits to the economy. There has been considerable innovation in such technologies as electronic funds transfer, supply chain management, internet marketing, online transaction processing, electronic data interchange, inventory management systems and automated data collection systems.

Second, brands are building direct relationships with consumers through social media sites like Facebook.

In 1999 I was working for Pentland as Managing Director of its International Brands including Speedo, Ellesse, Berghaus and Lacoste Footwear. Shortly after I wrote the article I went to a trade fair in Munich where I met some of the directors of Boo.com. They wanted to distribute our brands through their online site. I questioned them about their business model, how they would manage returns etc. It was clear that they had little understanding of the fashion apparel market even though that was their chosen category. I declined to supply them. One of their directors said that maybe they would buy us instead. The following May Boo.com was placed into receivership and liquidated. The company had spent more than £80 million of venture capital in just 18 months.

By contrast Amazon does understand its business and much of it is to do with traditional retailing. Last year I had dinner with Brian McBride after he had retired as CEO of Amazon in the UK. Brian has worked in the technology and telecom sector for 30 years with high level roles in Xerox, IBM, Dell and T-Mobile. Amazon starts with the customer and works backwards. It concentrates on selection, pricing and availability. One of its advantages over a High St retailer is its ability to service the long tail. While 35% of CDs sold and 40% of DVDs are from the top 50 that any High St store or supermarket could sell it makes its money on the back catalogue.

And Brian’s forecasts?

·         The High St can survive but only if the retailer works out what its role is. Some will survive by combining forces with pure online retailers like eBay. Others will offer those things you can’t buy online like haircuts and manicures.

·         Moore’s law will continue to work and you can now buy 16 GB for £12 when ½ GB cost £62K when he started out.

·         Mobile will take over from the PC. In 2008 only 1/6 were connected to the web through their mobile. By 2014 it will crossover vs. the PC.
 

Copyright David C Pearson 2012 All rights reserved

 




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