Retailing, E-Commerce, Direct Marketing, and Wholesaling

Key Terms: store retailing, specialty store, department store, warehouse clubs, superstore, scrambled merchandising, wheel of retailing theory, pyramiding, direct marketing, telemarketing, electronic commerce, asymmetric information, wholesaling, merchant wholesaler, agent and broker, full-service wholesaler, limited-service wholesaler, rack jobber, and manufacturers’ agent.

Store retailers vs. nonstore retailers. Most retailing is done in stores today. Electronic commerce may accelerate the shift from store retailing to nonstore retailing.

Some important types of retailers:

Department Stores – The first one was built in 1852 in Paris. It was a great retailing innovation. If offered both depth and breadth as far as the assortment of merchandise. The old general store (the kind of store you might find in old Western films or TV shows) provided lots of breadth and carried everything from dresses to flour, but there was no depth and they might only carry four dresses and three rifles. Have you noticed how many department stores have gone out of business? (Gimbels, Alexanders, Korvettes, S. Klein, Altmans, Ohrbachs, etc.) There is a reason for this. New retailing institutions have appeared that offer better prices and/or better selection (more depth). Department stores, however, provide many customer services that result in relatively high operating expenses (about 35% of sales). Example of department store: Macys, Jordan Marsh, Bloomingdales. Today, most of the revenue of a department store comes from female apparel. Department stores are using mail order (e.g., catalogs) to expand their business.

Discount Stores —Discount stores date back to post-World War II. They operate on the principle of working with lower markups and try to make it up through greater volume, i.e., fast turnover ("fast pennies, not slow dimes"). One of the early discount stores was Korvettes. At first, prices were quite low and fewer services were offered. Over time, Korvettes starting offering more customer service and prices rose and Korvettes started looking more and more like a department store. Some examples of discount stores: Wal-Mart, K-Mart.

Specialty Stores – They provide a great assortment/selection within a relatively narrow product line. If you want toys, you go to Toys R’ Us and have an entire store dedicated to toys, not just a single department. Other well-known specialty stores: The Gap, Foot Locker, Home Depot, and Staples. A typical shopping mall uses a department store as an anchor and also houses many specialty stores.

Warehouse (Wholesale) Clubs – They offer a wide assortment of goods at wholesale prices (typically, about 8% above cost). There is an annual membership fee. Some examples: Costco, B.J.’s, and Sam’s Wholesale Club.

Off-Price Stores – Most of them are in the clothing business and sell at low markups. Many operate on the principle of "Brand names for less." They are facing stiff competition from the more efficient department stores and outlet stores. Some examples: Marshall’s, Syms, Filene’s Basement, Daffy Dan, and TJ Maxx.

Variety Stores – They offer a wide assortment of inexpensive items such as health and beauty aids, stationary, toys, etc. They used to be called 5 and 10 cent stores because the merchandise in the store cost that much. This retailing institution is dying. In fact, Woolworth’s, which used to be the largest variety store, has been closing stores down and has become mainly a specialty retailer (it owns Foot Locker, Kids Mart, Northern Reflections, etc.).

Supermarkets – the first supermarket (King Kullen) opened in 1930. It was a great retailing innovation and helped destroy many of the mom and pop grocery stores in this business. Supermarkets offered a much better assortment, self-service, and better prices than the small grocery store. They are also in trouble. A typical supermarket makes about one cent per dollar of sales because the markups on food are relatively low. There is a limit on what you can charge for staples since these are items that consumers buy all the time, and they know what would be a fair price. The margins on take-out, gourmet foods, drugs and cosmetics, meat, produce, and nonfood items are much higher than dry grocery foods. This is why virtually no supermarkets are being built today. The trend is to build superstores.

Superstores – (late 1960s) Today, Pathmark and ShopRite are building superstores, not supermarkets. These stores have four times as many items as the typical supermarket. They carry some clothing, flowers, tires, garden products, hardware, prescription drugs, etc. By selling many nonfood items they have better profit margins than supermarkets.

Hypermarkets – Started in France in 1963. They are huge and have 40+ checkouts. They are not doing well in the United States. They are too big and it is very difficult to find things.

Convenience Food Stores – These store are open very long hours, e.g., from 7 to 11 and mainly carry staples at a relatively high price. Best example: 7-Eleven stores.

Dollar Stores – These store are both liquidators (they buy close-outs) and discounters and are opening up all over the country.  Best example: Dollar General, Family Dollar, and Dollar Tree.  Wal-Mart is getting nervous and is introducing dollar-store sections in its stores.

Wheel of Retailing theory – This theory explains why there is constant change in retailing institutions, i.e., a cycle. New retailing institutions emerge offering lower prices and less customer service. Once they become established, customer service increases and so do prices. This then results in the emergence of another new retailing institution. This is what happened with discount stores. They also started as low-margin, low-price, and low-status operations. Some of them (e.g., Korvettes) evolved into higher-priced, higher-service operations and eventually became indistinguishable from department stores.

Scrambled Merchandising – Since the profit margins on food are quite low, many food stores sell untraditional items in their stores. For instance, some supermarkets sell health foods, vitamins, plants, flowers, take-out foods, etc. to improve their profit margins. When a retailer carries untraditional items, we call this scrambled merchandising.

Nonstore retailing: The trend is away from store retailing to nonstore retailing. Direct marketing and electronic commerce (which is also a type of direct marketing) are accelerating this trend.  Many retailers sell online and via stores = click and mortar.  This way they can reach everyone.  Some people prefer shopping in stores, others prefer online shopping, and some people go to stores to see (and try) the actual products and then buy it online.

Other trends:  Supermarkets are facing stiff competition for bulk items such as paper goods and canned foods from Wal-Mart.  Wal-Mart has become an important force in the grocery business and is taking away business from the major supermarket chains.  In 1996, a typical household made 95 shopping trips to a supermarket per year; in 2004, the number of shopping trips was down to 70. Prices at Wal-Mart are up to 20% cheaper (Melanie Warner, "An Identity Crisis for Supermarkets," NY Times Oct. 6, 2005, pp. C1, C6). 

Costco vs. Wal-Mart

Steven Greenhouse (New York Times, July 17, 2005, Section 3, Sunday Business, p. 1) describes the difference between the philosophies of Costco and Wal-Mart.  Both are very successful retailers.  Wal-Mart is the nation's largest retailer whereas Costco is number 5.  However, they have very different philosophies when it comes to compensating employees.  The average pay at Costco is $17 per hour, 42% more than the average pay at Wal-Mart.  Costco does not believe that discount retailers have to pay very poorly.  Costco's CEO (Jim Sinegal) feels that high wages and decent benefits are the reason employee turnover and employee pilferage are low at Costco. A satisfied employee will tend to more productive than one who is not happy.  In addition, Costco's customers tend to be very affluent; customers like to know that low store prices do not come at the expense of employees.  Prices at Costco are kept very low.   One of the major rules is that "no branded item can be marked up by more than 14%, and no private-label item more than 15%"  Please note that markups at supermarkets are usually 25%.  The CEO of Costco says:  "We don't want to be one of the casualties.  We don't want to turn around and say, 'we got so fancy we've raised our prices,' and all of a sudden a new competitor comes in and beats our prices."  [This philosophy reminds one of the wheel of retailing theory].

A Costco store will stock approximately 4,000 items; Wal-Mart carries 100,000 items.  Costco stocks fewer items; this means higher sales for each and this in turn allows the store to get better prices from suppliers.  As you can see from this article, there is very strong price competition in the retailing business. Costco and Wal-Mart are at war.  Let's see who wins. 

Door-to-door retailing is a dying institution. At one time, it was an important channel for selling various products including vacuum cleaners. Some examples of this type of retailer are Amway, Electrolux, Fuller Brush, and Avon. Today, many of these retailers are moving away from door-to-door to selling via catalogs and/or direct response ads on TV.

Many pyramiding / multilevel marketing schemes involve products that supposedly will be sold door-to-door. Remember that if the way you are supposed to make money is by recruiting others to sell, the system falls apart when no one else can be found to be recruited. Check out this FTC site to learn more about pyramiding:

http://www.ftc.gov/bcp/conline/pubs/invest/mlm.htm

Direct Marketing – With direct marketing you use direct response advertising in order to produce a response (a sale, an inquiry, a membership, a contribution, etc.). Responses are tracked and measured and direct marketers maintain a database of customers and prospects. Thus direct marketing is all about a measurable response. Ads that encourage individuals to call an 800 telephone number to order a product or obtain information are using direct marketing.

Go to the Direct Marketing Association Web site to learn more about direct marketing:

http://www.the-dma.org/index.shtml

Included in direct marketing:

(1) Direct mail – also known as "junk mail." For instance, suppose a charity sends out 100,000 letters at a cost of $75,000. If the letters generate 5,000 responses with total contributions of $150,000, the charity has made $150,000 for a $75,000 investment. They can also create a database of contributors.

(2) Catalogs – You have a "measurable response": you know what it costs to send out each catalog and you can observe how much you sell. Also, you can create a database of customers.

(3) Direct response advertisements in newspapers

(4) Direct response advertisements in magazines

(5) Direct response advertisements on television

(6) Direct response advertisements on radio

The above (3 to 6) usually include an 800 telephone number which allows the direct marketer to maintain a database of customers (or individuals making an inquiry). When the prospect calls the 800 number in the ad, the prospect’s name and address are entered into the company’s database. The company knows the cost of the ad and can easily determine the amount of sales (or inquiries) generated by the ad.

(7) Telemarketing – With outbound telemarketing, the company calls the customer, e.g., Daily News calling you at home to convince you to subscribe for home delivery.

With inbound telemarketing, customers call the company (probably a toll-free number) to request brochures or to order products. Usually they are responding to a direct response ad containing the telephone number. When a prospect calls, his/her name goes into the database.

(8) Electronic Commerce – Organizations that buy, sell, barter, or exchange information on the Web are engaging in E-Commerce. Amazon is a major B2C (business-to-consumer) firm; Cisco is a major B2B (business-to-business) firm; eBay is a major C2C (consumer-to-consumer) firm; Respond.com is an important C2B site; and Govworks is a fast-growing C2G (consumer-to-government) site. Selling over the Web, as you know, is becoming a major part of direct marketing.

As you know, electronic commerce has dramatically changed the way people purchase books, music, and travel (and slightly changed education-- think of this course).  There was a fascinating article with the title "E-Biz Strikes Again" in Business Week (May 10, 2004)  that describes six industries that are being transformed by the Internet.  They are:  jewelry, telecom, hotels, real estate, software, and payments.  Let's discuss some of them.

(a)  Jewelry  

The normal markup for a diamond is somewhere between 60% and 100%.  A diamond might go five or more  intermediaries before getting to the retailer (some major retailers that sell via stores are Zale and your neighborhood jewelry store).  E-tailers such as Amazon.com, Blue Nile, eBay, and Diamond.com are able to make a profit with a 15% markup.  Some e-tailers, in order to reassure customers, provide a 30-day money-back guarantee. They also provide a great deal of information about precious stones.  Many jewelry stores are going out of business as consumers learn that they can get a better deal on the Internet.

(b)  Telecom  

Some of you know that phone calls using the Internet are much cheaper than using regular phone service.  The cost of calling foreign countries using Vonage and Net2Phone is considerably less than with Verizon or ATT. 

(c) Hotels   

Online bookers such as Expedia, Orbitz, and Travelocity are doing very well.  Hotels need the revenues that the Internet bookers can provide.  Firms such as Expedia can send a large number of customers to a hotel. Many consumers -- including your professor -- will shop for a hotel room online to see where the cheap rooms are. Even with a substantial discount, hotels can make this up with the increase in the number of customers. 

(d) Real Estate  

According to Business Week, more than 70% of home buyers will use the Internet.  Today, you can see photographs and the layout of homes anywhere in the country.  Some of the big names in zipRealty and Lending Tree.

(e)  Software 

Linux is making Microsoft nervous.   It is an open-source operating system, an alternative to Microsoft operating systems (e.g., XP).  Open-source software can be downloaded from the Web for free or at very low prices.  There are several firms developing open-source software.  They include, according to Business Week, Red Hat, JBoss, and MySQL.  MySQl has an open-source database program that costs about 10% of Oracle's database program.

(f)  Payments

Checks are becoming obsolete.  According to Business Week, online bill payment costs only about 10 cents, a third of the cost of processing a check.  Checks have to be printed, processed, and sent all over the country.  It is much cheaper to use digital processing technologies. Some Wal-Mart stores scan in the customer's check and then return it to the customer.

The Web is becoming more and more important in marketing.  The Internet has four major functions:

(a)  It is used for communication.  This includes e-mail, instant messaging, meeting in chat rooms and/or online communities.  Many companies use electronic bulletin boards as a way of increasing customer satisfaction.  If a customer has a problem or question, s/he e-mails it to the company; the technician will post both the question and answer on a bulletin board.  This enables other customers to search the bulletin board and find answers to questions.  Many firms have a FAQ (frequently asked questions) website. This also saves a company a great deal of money.

(b) It is used for information.  There is a great deal of information on the Internet.  One of the more popular search engines for finding information is Google.  Many newspapers have websites that can be searched for information and articles can be downloaded for a small fee. There are also a large number of websites (e.g., government) that provide free information.  A good one to use to learn about any country is:  http://www.cia.gov/cia/publications/factbook/  -- The World Factbook (CIA).  Distance learning is another way students are learning. 
Check out Angie's List at http://www.angieslist.com/AngiesList/about.asp  This is a website that collects information from homeowners about their "real-life experiences with local service companies."  You can find out, for instance, how happy consumers were with a plumber in Brooklyn.

(c ) It is used for entertainment.    There is a great deal of entertainment on the Internet.  This includes games, music, e-books, gambling, etc.  You can even find entertaining commercials and movies on the Web.  Of course, it is unethical and illegal to download copyrighted software. Some aspiring musicians have websites that allow visitors to download or listen to their music. Check out:  http://games.yahoo.com/  to learn about gaming on the web. Check out: http://www.artistdirect.com/
for free music. Amazon also has some free music downloads. Project Gutenberg is a site that allows you to download free e-books:  http://www.gutenberg.org/

(d)  It is used for E-commerce.  This has become the major function of the Internet.  The Web is not only important for selling goods and services (e.g., books and DVDs);  it is important for many services.  A number of banks use the web--you may have heard of ING Direct (http://www.ingdirect.com).  Many other banks are expanding their online banking. The same is true of brokerage companies.  As noted above, the Internet has had a huge impact on various industries including hotels, real estate, jewelry, software, etc. 

Online Stores and Salesmanship

(Source: "Salesmanship Comes to the Online Stores, but Please Call it a Chat"  NYT 8/7/2006, p. C9,  Bob Tedeschi)

Retail stores always used salesclerks to get a customer to buy something if they saw that s/he was indecisive ("Hello!  Can I help you?" is what is usually said).  Online retailers are doing the same thing now. One way is with "live chat" options.  The goal is to reduce the number of abandoned shopping carts.  Studies show that as many as 75% of shopping carts are abandoned before a purchase is made.  Land's End  is testing a system that features a pop-up window with the face of a woman and the message "A Land's End online shopping assistant is standing by... Would you like assistance completing your order ... Click here to chat with a shopping assistant."  This is done when a shopper appears to be indecisive and has clicked on numerous items.  The purpose is to convince the customer to make the purchase and not abandon his/her shopping cart.  Some consumers need a little push.  Remember what you learned about cognitive dissonance.

One study shows that about 10% of customers who press the "click to chat" button will actually make a purchase; 20% of customers who are solicited for a chat will actually buy something.

The Internet and Asymmetric Information

Asymmetric information occurs when one party has more (or better) information and thus knows considerably more than another party. This can cause problems when two people are interested in conducting business.  A classic case is the used car.  Suppose I purchase a brand new car for $15,000 and need to sell it two months later. I will have to take a big loss since potential buyers will fear that the car is a lemon.  Even if the car is not a lemon and is, in fact, a great car, I will be lucky if I can get $10,000 for it. Note that there is information asymmetry.  The seller knows how good the car is but the buyer does not.  Because of this asymmetry, the seller must sell the car for considerably less than if there was information symmetry (i.e., both buyer and seller possessed equal knowledge). 

The Internet has done a splendid job of providing consumers with information.  The price of term insurance (see Freakonomics by Levitt and Dubner, p. 66) dropped significantly because of the Web.  All consumers had to do was go to a website to price, say, a $2 million, 20-year term insurance policy.   Term insurance, unlike whole life insurance, is a very simple product; you only collect if the policyholder dies.  Consumers interested in purchasing term insurance could go to a several websites that allowed one to compare the price of this policy at firms all over the country. The same happened to the price of caskets. The funeral director knows considerably more about the cost of a coffin than does the family of the deceased.  In the past, the family would be convinced to purchase very costly caskets.  Today, one simply goes to the Web and prices a nice casket and it is delivered immediately.

Before purchasing a book, I check out the price at several websites that allow comparison shopping.  For instance, I will use: http://www.bestwebbuys.com/books/    or  http://www.cheapesttextbooks.com/  or  http://www.chambal.com/  or http://www.mysimon.com/

By the time I have done my research, I have as much information as any bookseller.

A large number of consumers will not purchase a new car before doing extensive research on the Web.  Some websites will provide information as to the dealer's cost.  Once you know the dealer's cost, you can negotiate and get a very good deal on a car.

Check out Amazon at: http://www.amazon.com

Check out eBay at: http://www.ebay.com

Check out Cisco Systems at:  http://www.cisco.com/

Check out Respond.com at: http://www.respond.com (you can see what consumers want to purchase)

Check out GovWorks at: http://www.govWorks.com 


Click here to read a paper that describes how firms might use direct marketing to increase profits.


Wholesaling:

Merchant wholesalers – two types: (a) full-service wholesalers and (b) limited-service wholesalers. Merchant wholesalers take title to the goods which they sell.

Some functions of full-service wholesalers: warehousing, financing/credit, breaking bulk, delivering the goods, supplying market information, and providing advice on such matters as store layout and inventory control systems.

A mail-order wholesaler is an example of a limited-service wholesaler. They are prevalent in the jewelry, stationery, and office furniture industries. Other examples of limited-service wholesalers: cash-and-carry wholesalers and truck wholesalers.

Rack jobbers – mainly nonfoods (e.g., paperbacks, magazines, and cosmetics) in food and drug stores. This is one way a store selling low-margin grocery products can improve profit margins. Rack jobbers bear the full risk since they own the goods being sold and the retailer shares in the profits.

Brokers and agents – Do not take title to the goods. An agent (think of a real estate agent) brings buyers and sellers together and thus facilitates the buying/selling process.

Manufacturers’ agents (or manufacturers’ representatives) serve as a substitute for a sales force. Small manufacturers that cannot afford their own sales force will hire a manufacturers' agent. Suppose a towel manufacturer would like to enter the Miami area, a new territory, and cannot afford a full-time salesperson. The firm might contact a manufacturers’ agent to represent it. Of course, the agent will not only sell the firm’s towels s/he might sell shower curtains for another company and other complementary products as well. Agents fax orders back to the manufacturer and work for commissions. If sales in the Miami area are very high, the manufacturer might replace the agent with a full-time sales staff.

It is important to keep this difference in mind: merchant wholesalers take title to the goods they sell, agents and brokers do not. 

 

 


(c) 2011 H.H. Friedman