The Electronic Commerce, or e-commerce, industry is one of the most dynamic sectors of the economy. The industry is still evolving, so data collection and evaluation are particularly difficult. Consequently, one has to rely largely on surveys by both government and private agencies.
According to the U.S. Census Bureau, the manufacturing sector is the largest contributor to e-commerce sales (35% of total shipments), followed by merchant wholesalers (21.2%). These two segments make up the business-to-business category.
While retailers and service providers generated just 3.2% and 1.6% of their revenues online, these are the fastest growing segments. The Bureau categorizes these two segments as business-to-consumer. [2007 figures, as reported in May 2009.]
Retail e-Commerce
Over the five-quarter period ended September 2009, some retailers lost business to online rivals, while others continued to benefit from their online stores. Despite the recession, e-commerce sales outperformed the overall retail sector in each of the last five quarters. According to the Census Bureau, e-commerce accounted for 3.7% of overall retail sales in the third quarter of 2009, a sequential increase of 4.5% and a year-over-year increase of 1.8%. Overall retail sales, on the other hand, grew 1.7% sequentially but declined 7.5% from the year-ago quarter.
Research organization Forrester Research believes that rapid growth in online retail sales in the U.S. will continue to come at the expense of brick-and-mortar outfits. Both Forrester Research and eMarketer publications indicate that this movement is increasingly attributable to the time savings and convenience of online transactions.
Additionally, the advantages of comparison shopping and personal recommendations are adding a new wrinkle. Most of the large retailers offer great variety, as well as evaluations and activities of past users, which help customers make informed decisions. Although in the past the technology required for personalized recommendations was out of bounds for most small retailers, the success of these new features, as well as technology advancements, have made it a priority spend for all.
eMarketer has also found that the most common criterion for a positive recommendation was price, followed by quality and then convenience. This, along with the easy availability of choices from competing online retail sites, could be the reasons for the intense price competition in the online retail market.
According to data provided by ComScore, retail e-commerce (excluding travel) sales were up 6% in 2008. Retail e-commerce sales will grow at a compound annual growth rate (CAGR) of 9% from 2008 to 2013 (eMarketer). According to Forrester Research, around 7% of all retail sales were online in 2009.
Free shipping has become an essential part of retail e-commerce, with 42% of online sales supported by free shipping in the third quarter of 2009, compared to 31% in the first quarter of 2008 (comScore).
Services
Two of the most important categories within Services are travel and banking.
Of these, perhaps the fastest growing is online travel. Travel represented 41% of total e-retail sales in 2008. [derived from comScore estimates]. It is true that 2009 was slower, as most online travel companies used a lot of promotional inventory. However, we expect growth to return in 2010, with both leisure and business seeing modest increases.
International expansion is a common strategy for most of the top players, since a strong international business usually serves to balance out any weakness at home. However, occupancy tax matters remain a headwind for online travel companies in the near term.
Banks are also awakening to the fact that people are now spending more time online. The results of a survey by the American Bankers Association (ABA) show that U.S. consumers are increasingly going online. Around 32% of consumers questioned felt that the Internet method of banking was their most-used, a significant increase from 2008, when 25% felt that the Internet was their most-used method. While telephone and email also showed slight increases, branches and ATMs showed significant declines. This clearly indicates that consumers are visiting branches less often.
A report from the Aite Group, LLC shows that banks are responding to the change in customer priorities. The report is the result of interviews with online channel executives from 20 of the country’s 100 largest banks. Roughly 50% of the banks expect an increase of more than 15% in online channel budgets in 2010, another 35% expect an increase of 5-15%, while the remaining 15% expect no change.
With online transactions expected to boom over the next few years, the top-most concern will be security. While banks will spend significantly on secure payment systems, hackers are expected to have a field day, largely targeting the flood of customers going online.
Alternative payment systems are expected to become more important. While some of these payment systems, such as eBay’s (EBAY) PayPal have been around for awhile, other systems, such as Google’s (GOOG) Checkout are picking up.
Alternative payment systems never really gained momentum in the past because of the low volume of transactions. However, as online transactions continue to increase, many more such systems could suddenly become more available. For example, American Express (AXP) recently purchased Revolution Money for a significant amount of money. Other large banks could follow suit, purchasing alternative payment startups that would keep them in the race.
M-Commerce
M-commerce is a relatively new coinage, indicating the commercial transactions over the Internet currently being carried out by consumers through their mobile phones. Surveys by different private agencies suggest that consumers typically purchase pizza and other fast food, movie and other event tickets, hotel reservations and travelling tickets on their mobile phones, although some users have purchased more expensive items as well.
However, m-commerce sales in North America are expected to gather momentum according to ABI Research. The research firm increased its m-commerce sales estimate for 2009 to $750 million (up from $544 million previously estimated) and currently expects sales to cross the $1 billion mark in 2010.
The sales growth will come from increased user confidence and their adjustment to the new platform.
Online Advertising
While spending on online advertising has been impacted by the recession, it has not suffered as much as other media. Most research firms estimate mid-single-digit growth in 2009, helped by video and mobile advertising. While this may be considered good compared to the low-double-digit decline expected across other media — newspapers, magazines, radio and TV — it is the slowest growth rate in its relatively short history. Despite the weakness in the recent past, online advertising is expected to grow strongly into a $25-30 billion market by 2013.
The main drivers of growth are currently expected to be an increase in the number of users, greater propensity of users to consume, a growing inventory of advertisements that serve to lower advertisement prices and the continued strength in search advertising.
Search advertising is expected to remain the most popular, because results are measurable, and therefore more predictable than other media. This also makes the market more resilient in recessionary conditions, since advertisers are more confident about the results of their spending.
OPPORTUNITIES
The online retail segment comprises a very large number of companies, although one can easily pick out the most important players. We are particularly positive about Amazon.com (AMZN) because of its leading market position in online retail, strong financials and strength in international markets. The company’s e-book reader Kindle continues to do very well, and strength in this business should continue.
Online travel companies, such as Expedia Inc (EXPE) and Priceline.com (PCLN) are in a strong growth market. Consequently, they should continue to benefit from international expansion and customers moving online. While Orbitz Worldwide (OWW) is a much smaller player with more limited resources, it too should benefit from these trends. Although near-term results could suffer from the spillover effects of the recession as well as occupancy tax issues, we remain positive about their prospects over the next couple of years, at least.
The search market is dominated by Google, Inc. (GOOG), which has seen phenomenal growth rates over the last five years. The company is a leading innovator, using its engineering talent to extend its position ion the computing platform to the mobile platform. The company has a huge cash balance that we were concerned was not being put to the best use. However, it is currently on an acquisition spree, which should further round out its product portfolio, build on current strengths and help expansion into new areas.
A much smaller provider of Internet advertising solutions and online marketing services, ValueClick Inc. (VCLK) should also benefit from strength in the online advertising market, international expansion, restructuring actions and strong cash flows. However, as firms with larger advertising budgets increase spending on Internet advertising, many of the services performed by ValueClick could be done in-house. This is a risk of investing in the stock.
WEAKNESSES
While eBay Inc. (EBAY) is a leading retailer in its own right, the company has seen difficult times. Management is in the process of turning the company around by increasing focus on the fixed price model, but this could come at the cost of margins and alienation of a few sellers operating under the auction format. The company acquired some cash by selling off 70% of its share in Skype, and its current 30% stake should bring some returns.
Meanwhile, competition continues to intensify for Akamai Technologies, Inc. (AKAM), which provides distributed e-business infrastructure services and solutions. The low barriers to entry are also a concern, since this is a market adjacency that any large Internet or networking company, such as Google, Yahoo!, AT&T, Verizon, Cisco or Lucent could venture into.
Falling bandwidth prices are a pressure on margins, while rising bandwidth costs are attracting new players. However, demand remains strong, with broadband penetration and momentum in online media and entertainment expected to continue in the foreseeable future.
Yahoo, Inc. (YHOO) is second only to Google in the search market, although the company has been losing market share. New management is refocusing the company, selling off non-core assets and improving cash flows. The company has a leading position in email applications, and is building on this position through acquisitions and upgrades, which should ultimately help it turn around.
