Web Commerce: Not ready for prime time

This past holiday season proved that Internet retailing is here to stay. But are the cyberstores really ready to handle the distribution end of the business?

By James A Cooke -- Logistics Management, 3/1/1999

America caught its first glimpse of a virtual Santa Claus last Christmas. The December holidays turned out to be a season that will go down in retailing history for the record amount of shopping done via the Internet. A study conducted by the Boston Consulting Group of Toronto for shop.org--a Silver Spring, Md.-based trade association of online retailers--found that Internet revenues for the 1998 holiday season tripled in comparison to those recorded the previous year. When year-end totals are tallied, the group predicted, online retail revenues for 1998 would exceed $13 billion.

In fact, Web sales have exceeded even the rosiest forecast. "The growth rates are staggering," says John Jordan, director of electronic commerce research in consulting firm Ernst & Young's Cambridge, Mass., office. "'Net traffic is doubling every hundred days and commerce is riding the same growth."

Take Amazon.com Inc. of Seattle, for example. The Web store, which sells books, videos, computer games, and CDs, has become the darling of Wall Street. The four-year-old virtual store announced that its 1998 fourth-quarter sales were about $250 million, more than three and a half times its sales for the same period in 1997. It shipped more than 7.5 million items during the past holiday shopping season.

And Amazon.com is hardly alone in its success. Proflowers.com of La Jolla, Calif., shipped some 10,000 fresh flowers via FedEx during the Christmas season, says its president, Bill Strauss. The Web-based florist ships directly from a network of six West Coast growers to consumers, bypassing the middleman. "That's why we can deliver fresh product at a lower cost," says Strauss.

Back-End Challenge

Despite skyrocketing sales, many cyberstores still haven't given enough thought to the back end or distribution part of the business--the filling and shipping of orders. Rumors are rife that despite their booming sales, Web retailers are not rolling in profits because their distribution costs are too high. "Online retailing is a great opportunity," says Beth Enslow, an analyst at The GartnerGroup, a market research firm based in Stamford, Conn. "But you can get into some dangerous territory if you don't have the right back-end fulfillment. My guess is that a pretty high percentage of online transactions are not profitable."

In many cases, the cyberstores have masked their backroom inadequacies by relying heavily on established express and package carriers for distribution. A survey of Internet shoppers by Zona Research Inc. of Redwood City, Calif., found that Atlanta-based United Parcel Service shipped 55 percent of the estimated $3 billion goods ordered online during the 1998 holiday season.

Other express carriers have reported a surge in business due to Web sales as well. "We definitely see growth [in this area]," says Alan Boehme, director of business planning at DHL Worldwide Express in Redwood City, Calif. Federal Express Corp. of Memphis also has seen an increase in business that can be traced to Web retailing, according to representative Sally Davenport.

But there's more to distribution than simply turning over a package to an express carrier for delivery. Orders must be filled promptly and correctly and inventory optimized to control costs. For companies used to shipping palletloads or truckloads of product, in particular, a Web site promising overnight delivery of individual orders brings a host of new challenges. "Onesies is a whole different way of picking and packing," says Enslow. "If you have a highly seasonal product and you have a real influx of online orders, things can get messed up."

To manage the distribution part of the process successfully, Web stores also must interface with order management and warehouse management systems. If companies can integrate their operations so that they can fill orders without any additional keypunching, they eliminate a major source of human error.

Web stores will have to master more than just the delivery of merchandise, however. To maintain customer goodwill, they have to learn to process returned merchandise as well. "You still have to have a channel for returns," says Jordan. "That's where the people doing catalog understand distribution and should have a jump on the Amazons of the world."

In fact, companies such as Recreational Equipment Inc. that have experience in catalog operations have a huge headstart in the cyber marketplace because they bring valuable distribution expertise to the Web sales arena (see the accompanying sidebar). "Mail-order companies have a great advantage," says Enslow. "They've mastered the back-end process of shipping to individual customers and processing payments."

Logistics in the Limelight

Although conventional wisdom holds that Web retailers can take advantage of centralized distribution--because a virtual store, in theory, can hold its stock anywhere--at least one consultant argues the reverse. Steve Biciocchi, a partner at CSC Consulting in Cleveland, predicts the advent of Web retailing will reverse the trend toward centralized retailing, forcing companies to bring stocks closer to consumers to reduce distribution costs and improve customer service.

"As the world moves toward a direct path of supply from source to consumer, which is what electronic commerce is doing, it leads us to place a very high emphasis on price and service," says Biciocchi. "That world means we want inventory to be close to us and be relatively inexpensive for us to get. People will want the product faster and will be willing to pay less. The smart Internet companies--and logistics professionals--understand that."

Just as the Internet holds out new promise for retailing, it also has implications for logistics managers. Professionals who have mastered the challenge of fulfillment and delivery for online retailing will become extremely valuable to corporations in the next century. Notes GartnerGroup research director Alyse Terhune, "You really have a whole new career path in a whole new industry for logistics professionals."

Webward ho!

In the world of online retailing, Recreational Equipment Inc. (REI) stands out. The 60-year-old Seattle-based retailer of outdoor sports products has managed to keep pace with order fulfillment on sales made via the Internet. That's an impressive feat in view of its cyber sales volume. Almost 19 percent of its total sales resulted from the Internet last year, says Clark Koch, order-fulfillment manager at REI. That figure represents a whopping 241-percent increase over 1997 Web sales.

REI, whose companywide sales totaled $536 million in 1997, operates two cyberstores. Its main store (www.REI.com) was launched in 1996. Last year, it opened a companion site (www.rei-outlet.com) that offers closeout goods and last year's models of recreational equipment.

REI has an advantage over many Web retailers in that it has years of experience handling individual customers' mail orders. In 1938, a group of Pacific Northwest mountaineers seeking quality climbing equipment founded REI as a cooperative--a status it maintains today. (Anyone may shop at REI, but co-op members share in the company's profits through an annual patronage refund.) Although REI operates retail outlets, the company has handled mail-order sales throughout most of its history.

To serve retail, mail, and online customers, REI relies on a 469,000-square foot distribution center in Sumner, Wash. The warehouse employs somewhere between 35 and 40 workers during the non-peak season. During the past Christmas holiday, it added about 110 employees for a three- to four-week period. The building itself stores around 13,000 active stock-keeping units (SKUs) of recreational equipment.

The company hasn't changed its order-picking procedure despite the increase in volume from Web sales. "When we get an order, we don't know if it's a phone, Internet, or mail order," explains Koch. Yet the company has managed to maintain a high level of order-fulfillment accuracy and speed. Some 93 percent of all orders placed in 1998 went out the door in 24 hours, Koch says.

When a customer places an order on REI's Web site, it's processed automatically unless there's a problem. "If there's a discrepancy like a wrong bank card number, we have a staff of Internet people who can resolve the problems," says Koch. "If there's nothing wrong with the order, it goes right through electronically."

The company uses the same batch picking system for filling all individual customers' orders regardless of origin. Its computer systems process the orders and then group them into batches for picking. After the orders are selected, they are checked and then packed.

Interestingly, the company picks and packs individual orders without any automation, although it does use bar codes for internal product tracking. "Our operation is very manual," says Koch. "We're not tied to automation. A lot of processes are the same processes that were in place when we started."

When it comes to shipping those orders, REI does business with a variety of carriers. The company uses UPS and the U.S. Postal Service for a majority of its ground domestic orders. It ships air domestic packages via FedEx. International shipments are split between DHL and the post office. Koch says REI does so much volume that FedEx and DHL both have personnel on-site in the retailer's warehouse. If products are shipped via FedEx or UPS, a customer can track an order online over those carriers' Web sites.

Koch says that Internet sales will be his company's largest source of growth over the next few years. As a result, REI is busy determining how it's going to handle that surge in volume, whether through automation, increased work-area capacity, or more work shifts.

REI's experience demonstrates that companies with experience filling individual orders are well positioned to take on cyber sales. "We do have a clear advantage over other e-commerce businesses that don't have the back end established," Koch says.