Many-stop Shopping? How Niche Retailers Are Thriving on Internet 2.0

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A decade after pets.com and a string of other early Internet specialty retailers collapsed, a new wave of start-ups — enabled by the power of cloud computing, advanced delivery systems and deep social relationships with customers — is shaping e-commerce.

From diapers and eyeglasses to pool tables and, yes, pet products, entrepreneurs are developing specialty businesses to compete alongside one-stop shopping giants like Amazon.com and Walmart.com.

“There is a new generation — Internet retail 2.0,” says Wharton marketing professor David Bell, noting that after the 2000 dot-com bust, activity in online specialty retailers dried up as financing became difficult, or impossible, to get and industry executives struggled to evaluate failed business models. Now, engineers have dramatically reduced obstacles to creating web-based businesses, and entrepreneurs have learned more about how to capture online consumers.

Many of these small players are working in affiliation with Amazon or other major online retailers that assist with the marketing platform and/or delivery fulfillment. Others are folding into bigger sites. This month, Seattle-based Amazon paid $545 million to acquire Quidsi, a New Jersey retailer that delivers diapers and baby products under the name diapers.com and recently started selling soap and cosmetics. Last fall, Amazon paid $1.2 billion for Zappos, the specialty shoe retailer.

Online sales continue to outpace overall retail spending growth. In 2010, U.S. e-commerce sales totaled $165.4 billion, up 14.8% from 2009, the U.S. Department of Commerce reported. Looking forward, eMarketer, which tracks the digital marketplace, estimates online sales will rise to $188 billion in 2011 and $269.8 billion in 2015. According to eMarketer, 87.5% of U.S. Internet users over age 14, or 178.5 million people, will browse or research products online this year. Of that group, 83% will make an Internet purchase in 2011.

The Internet lends itself to specialty retailing because it allows companies to offer huge product portfolios without having to stock inventory in bricks-and-mortar shops. Wharton marketing professor Stephen Hoch notes that Amazon itself began in 1994 as a niche player selling books only. Now, the $34 billion company markets everything from fine jewelry to industrial supplies.

According to Hoch, improvements in computer technology and graphics allow consumers to get a better sense of what they are buying online. “People, especially young people, have grown up on this and are more trusting and more confident about buying online.” Zappos, for example, made it easy for consumers to buy shoes — “the one thing that really has to fit right” — online with liberal return policies. And eyewear e-tailer Warby Parker will ship sample frames to customers. The site also has an interactive feature that allows shoppers to upload their photo to see what they would look like in different styles.

In the earlier days of online retailing, Bell notes, companies overestimated the value of “eyeballs,” or the number of visits consumers made to a site. Retailers now understand more about converting visits into sales, often by building relationships through social commerce tools, including blogs, Twitter and Facebook. “Companies are learning how to turn their own customers into their sales force,” says Bell. “The whole social media platform wasn’t around in the first boom.”

Jeffrey Grau, principal analyst at eMarketer in New York City, predicts that social connections will continue to drive growth for Internet retailers as mobile technology expands. “There are a lot of creative business models coming out all the time that involve social commerce or mobile commerce. There’s a lot of innovation going on in e-commerce.”

Pitching to New Parents

But Wharton marketing professor Peter Fader cautions that e-tailers hoping to evolve small niche lines into national mega-brands face difficult, if not impossible, odds. He cites the marketing law of “double jeopardy” and research showing that big brands enjoy higher sales and more brand loyalty than their smaller, more specialized counterparts, which tend to appeal only to the most avid buyers.

He uses the example of a consumer who buys a specialty brand of gentle laundry detergent for people with sensitive skin. That person is probably still buying name brands such as Tide to meet his or her other needs. A business based on the specialty detergent could never scale up enough to capture significant sales from the major brands, Fader says. Online specialty retailers can be successful if they understand their limitations, and construct logistics and marketing operations to suit that size.

“Unfortunately, too many small brands don’t view themselves as a specialty,” Fader points out. “They think they can compete with the big guys.” As a result, the company spends too much on broad-based advertising and other attempts to drive scale. Ultimately, Fader says, they “get crushed…. If you admit that you are a small brand, go after the specialty angle and say, ‘People will buy us only occasionally’ — and you keep costs down and keep the message focused — then you can be okay.” However, he adds, “That [approach is] not sexy and doesn’t sell well to the venture capitalists.”

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