The Economics of e-Commerce and the Internet
Edward J. Deak, Ph.D.
Chapter 15 – Answers to Discussion and Review Questions.
1. Identify and discuss some of the key aspects of grocery retailing that made the product a natural target for Web sellers. Is physical grocery shopping a pleasurable and value added experience or a bothersome experience lacking in any redeeming feature?
For many consumers grocery shopping is a boring and time consuming experience that requires a diversion of time from and already busy day. But everyone has to eat, so there it is a large retailing industry with hundreds of billions of dollars spent annually. If e-tailers could capture even a small portion of this market they would be able to thrive. The grocery shopping experience is tedious to some and enjoyable to others depending upon the attributes and attitudes of the consumer. Grocery e-tailers are looking to capture the segment of the market that finds the experience a waste of time with a very high opportunity cost.
2. Explain how rival Internet grocery sellers Webvan and WebHouse targeted different segments of Internet food buyers. How did each grocery-buying segment relate to the trade-off between time and money?
Webvan looked to attract relatively high-income consumers who were willing to spend a bit more to save them the time associated with physical grocery shopping. WebHouse looked to attract the segment of the market that was looking for the lowest possible product prices. These people would be willing to spend a considerable amount of time bidding and haggling over individual product prices. In the end while each correctly identified a legitimate market segment, neither was able to convert that segment into a profitable flow of customers.
3. Distinguish graphically and explain the difference in microeconomic theory between the loss minimization and shutdown cases in the short run. If fixed costs must be paid, why don’t they play a role in the decision to produce or not to produce in the short run?
In the loss minimization case, the firm will continue to produce in the short run as long as average revenue exceeds average variable cost. As shown in Figure 15-1, all the costs associated with the short run decision to produce are being covered with some contribution being made to cover a portion of the fixed costs and normal profit. In the shutdown case, the firm ceases to produce in the short run because the average revenue falls short of average variable costs. The firm cannot cover all of the costs incurred because of its decision to produce in the short run. Therefore, it will minimize its losses by shutting down and holding them to the size of the fixed costs only. Despite the fact that fixed costs must ultimately be paid, they play no role in the short run decision to produce or not because they are unaffected by the decision. Fixed costs neither rise nor fall in the short run.
4. Can a firm go out of business in the short run? Why?
A firm cannot go out of business in the short run because by definition it retains its fixed assets, which cannot be disposed of in the short run.
5. Use the concept of discounting to explain why the investors and entrepreneurs at Webvan may have decided to close the firm for good even though the number of customers was growing and the firm looked to be profitable within the next seven years. Would the application of sensitivity analysis have changed their decision? Why?
Discounting is a process of valuing money earned at different points in time in terms of its current value. It places a greater value on funds earned today as opposed to funds received in the future. Given the estimates of potential losses from now to the breakeven point in seven year and the amount of future revenues that might be earned from 2006 to 2020, the combination of limited funds plus future risks and uncertainty made it advisable for investor to pull the plug on the Webvan operation. Sensitivity analysis involves changing key assumptions to see the impact on the final conclusion. Most of the changes in underlying assumptions would have made it even clearer that closing Webvan was the correct decision.
6. Pick a topic from Time Miller’s list of specific failure observations and match it up with an e-commerce firm known to you or some firm already mentioned in this book. Where did the failed dot-com go wrong? Why?
For example, “Nothing changes overnight.” This applied to Webvan as the scale of the operation proved to be excessive in fact as it tried to match the anticipated volume of consumer usage. Getting big fast may be a valid strategy designed to use the fixed capacity, but it depends upon how quickly and how many consumers are willing to change their current buying patterns. Not enough buyers responded fast enough to make Webvan successful at its scale of operation. A smaller scale would have had a greater probability of success.
7. Look at Miller’s failure list along with the set of internal and external forces causing business failure and identify which of these applied to Boo.com. Were any other failure forces unique to this firm? Explain.
Most of the problems faced by Boo.com were of the internal variety. First, the creators of Boo.com lacked a reasonable business plan. They were experts at selling the sizzle, but the steak was vastly underdone. Second, despite some previous business and Internet success, the creators of Boo.com lacked the technical skill to monitor and understand the programming problems being faced by the start-up. They could envision a unique Web site and spend money lavishly, but they couldn’t implement the plan. Third, they couldn’t appreciate the need to rework the plan as it began to unravel. They kept trying to create a level of fashion sophistication that was beyond the technical ability of the programmers to deliver. From Miller’s list, “Too early, too bad” could be identified as a failure cause that afflicted Boo.com. They were on line with a broadband Web site that worked poorly in a dial up environment.
8. Perform the same analytical postmortem for AdCritic.com and Kozmo.com. What might these firms have done in order to become profitable and survive?
For AdCritic.com the “Free is folly” obstacle helped to lead to the firm’s downfall. It was enormously successful as a site of interest to the public, but without a source of income it was doomed to failure. A two-part tariff or at least a modest subscription fee might have provided the cash to keep this popular site alive. Kozmo.com opened the business in too many cities at once with an “un-Internet” startup. The addition of a daytime service might have helped better use the product services and helped the firm appreciate that it was mostly a traditional delivery service with an Internet channel as only one way to link to customers
9. How did the physical characteristics of urban/suburban customer density contribute to the problems faced by Webvan?
Webvan needed a dense location of customers so that it could quickly and efficiently deliver groceries to a high volume of customers. Density and efficiency are the same types of problems faced by resident waste haulers as the carry away the remnants of the groceries that were previously delivered. To be efficient, waste haulers want to stop at every single home along the route. In urban areas, Webvan had potential customer density, but traffic congestion limited the speed of movement from one site to another. In the suburbs, Webvan had relative ease of movement but less customer density.
10. Identify and discuss some of the flaws inherent in the Webvan model of customer behavior for those who are pressed for time. Who was the typical Webvan customer? Why did the original target buyers often fail to return as repeat customers?
Webvan originally thought that it would be serving urban professional workers or “dinks,” household with “dual incomes and no kids.” While some of their customers fit this profile, many fit the profile of homemakers with kids and without the ability to organize as well as devote time to grocery shopping. High income, repeat shoppers were limited by the fact that what they wanted was freedom from food preparation not necessarily freedom from shopping. Homemakers found that it took time and preparation to site at the computer and order groceries. Therefore, while both groups expressed general satisfaction with the Webvan service, repeat customers were hard to attract and hold.
11. What was the nature of Tesco’s store-based distribution model for online grocery sales? How did it offer a strong organizational and technology challenge to Webvan’s high-tech central distribution model? Which proved to be more efficient and why?
Tesco is an English grocery store chain that has introduced a low-tech store based Internet grocery model. Electronic orders are filled from products on the shelves of the local Tesco supermarket and delivered locally within the neighborhood. This limits the congestion problem of trucks from a centralized distribution site having to cover the entire city. This is very much and “un-Internet” business with electronic orders being the sole Web link. As long as Tesco charged a fee for the service above the price of the groceries, it became an efficient and surviving alternative to the Webvan high-tech, centralized system.
12. In general, how did consumers react to the Internet sales of groceries by Webvan and WebHouse? How and why was the issue of scale so important to each firm? Explain.
In general, the two different consumer segments reacted favorably to both Webvan and WebHouse. Initial volume was good but the failure to attract repeat customers was a problem that hurt Webvan volume and limited its ability to achieve an optimal scale of operations. For WebHouse, volume was strong, but the firm subsidized a portion of many sales creating losses or very low profit margins. The survival of WebHouse depended upon them being able to demonstrate their ability to attract and hold a high volume of buyers. Buying scale was crucial to attracting stores and product distributors as participants in the system. The burn rate or dollar amount of monthly loss was so large in order to attract these customers that investors quickly pulled the plug on the e-commerce enterprise.
13. Identify the forces that led to the failure of WebHouse. Were these forces present in the case of Webvan? Why?
The geographic scope of both WebHouse and Webvan was too large to begin with before the bugs in the system had been worked out. A smaller scale of operation would have had a greater chance of success. For WebHouse and its supplier participants, the economies of the system didn’t appear during its brief life. Grocery stores and product suppliers saw WebHouse customers buying additional full price items along with the discount items when they were picked up at the store. This never really happened. Also, they saw the potential for WebHouse to be a substitute for the relatively expensive discount coupons that are used to attract new customers. This didn’t happen either. The typical WebHouse buyer was a frugal customer who enjoyed saving money and enjoyed the psychological experience of using their time and skill to get products at below market cost. This is not likely to be a consumer segment holding many synergies or spin off benefits to the supplier participants.
14. Identify and discuss the lessons that e-tailers in general can draw from examining the results of the Webvan and WebHouse experiences. What two essential questions were never answered by the experience of either Webvan or WebHouse? Why are these important questions for all e-tailers to answer?
Looking at the experiences of Webvan and WebHouse e-tailers can see that there are segments of the market that are attracted to the attributes offered by a variety of e-sellers. E-commerce provides value added services to a portion of the buying public. The two questions that neither firm answered were; first, is there a sufficiently large segment of the market that is willing to pay a price that will cover the full cost of the service? And second, will that segment be large enough to allow the firm to earn a competitive profit on the transactions? Regardless of whether an e-tailer is selling content, a service or a tangible product, they must find their own answers to these questions in order to gain long run survival.
15. As a general summary of the material in this chapter, identify and discuss a number of the forces that support the tension between the success and failure of e-commerce firms. Which of these forces are unique to the world of e-commerce and which affect all businesses both physical and virtual? Can these forces be generalized from the world of online grocery shopping to any type of B2C e-commerce activity? Why?
It is a fact of business life that many start-ups fail and leave the market. Most of these firms fail because of problems or timing or planning. Having the right product at the right time to be marketed with the correct plan along with executing that plan effectively are crucial elements for any business be it physical or virtual. Both Webvan and WebHouse may have been on the scene too early and at too large a scale to effectively capture their target market. These lessons would appear to be capable of being generalized to other e-commerce operations with the caution that other pitfalls, unique to each business, should also be expected and successfully overcome.