What is e-commerce? The structural differences between online and traditional retail.

On the surface, e-commerce is a straightforward idea. If traditional retail is when you buy a good or service from a store, e-commerce is when you buy a good or service on the internet. Underneath the surface is where things get complicated. This article looks to further define e-commerce, with an eye towards the business structure of the industry.

How big is e-commerce in America?

According to the U.S. Census Bureau, in 2018 total e-commerce sales in America were approximately $520 billion. As the chart below shows, that’s barely 10 percent of overall US retail sales.

E-commerce as a proportion of retail
Data via the US Census

However, e-commerce is one of the fastest-growing segments of retail. This includes before COVID shifted millions of consumers online.

Annual Growth: E-commerce vs Retail
Data via the US Census

Who are the major players in e-commerce?

The major players are all household names. While their total market share is unknown, Amazon is by far the largest player in the space. What’s interesting is the subtle differences between leaders in overall retail (via NRF) and e-commerce.

RankAll RetailE-Commerce
1WalmartAmazon
2AmazonWalmart
3The Kroger CoeBay
4CostcoApple
5Walgreens Boots AllianceHome Depot
6The Home DepotWayfair
7CVS Health CorporationBest Buy
8TargetTarget
9Lowe’s CompaniesCostco
10Albertsons CompaniesMacy’s

What channels are there in e-commerce?

Retailers were forced to specialize in specific channels because of the physical limitations of real estate. No physical store has room to stock a wide selection of furniture and a wide selection of baseball gloves. Looking at the above charts, the major retailers are in fairly straight forward channels: Consumer Staples (Walmart, Kroger, Walgreens), Multi-sector (Target, Costco) and e-commerce (Amazon).

Drilling into e-commerce is a bit more complicated. It’s best to look not at what e-commerce sites sell, but how they sell it. The major channels in this view are: Marketplaces and Direct-to-Consumer (DTC).

Marketplaces

From an outside perspective, e-commerce marketplaces function like traditional retail. Companies buy a variety of brands and products, store them in warehouses, sell them online to consumers, and ship them out. Examples include Amazon.com, Wayfair.com, and Crutchfield.

Direct-to-Consumer

When a manufacturer sells directly to consumers through a website. Traditionally, this was the domain of big-ticket items, like apparel (Nike) but has recently moved into smaller and cheaper fast-moving consumer goods (Clif Bar, Pepsi).

What’s the e-commerce business model?

This is where things get interesting. E-commerce often functions as both a retailer and a platform. It allows them to make money in a variety of ways. Here are a few.

Direct-to-consumer

Here, consumers are buying a good, directly from a manufacturer’s website. In theory, the direct-to-consumer model is incredibly appealing for all manufacturers. It allows companies to capture more margin or offer lower prices by bypassing retailers, and the wholesalers who service them, and selling directly to consumers. In practice however, it doesn’t always work that way. That’s because manufacturers must manage existing retailer relationships and direct-to-consumer website shoulder all the customer acquisition costs.

Traditional Wholesale Mark-Up

A company buys a good from a manufacturer, stores it in a warehouse, and sells it to a consumer at a higher price through a website. Example: Crutchfield, NewEgg, Amazon

Third-Party Market Place

A company never takes physical ownership of a good, rather, it offers a platform for independent sellers who shoulder the inventory and storage costs. In exchange for access to the network, independent sellers pay the e-commerce site a percentage of the final sales price. Example: Ebay and Amazon.

Logistic Services

For traditional retail, getting the goods to a physical store is a significant cost center for both manufacturers and retailers. In e-commerce, merchants like Amazon have shifted that cost to third-party sellers and internalized the profit. In Fulfillment by Amazon, third-party sellers store their goods in Amazon’s warehouses. Amazon handles all fulfillment processes and distributes the item to buyers. In exchange, third-party sellers pay Amazon a portion of the sale.

Membership

Like Sam’s Club and Costco, some e-commerce requires a paid membership in order to purchase. The membership is both a significant revenue driver and “lock-in” device—driving loyalty and increasing the long-term value of the consumer to the company.

Sales and Marketing Expenses

In traditional brick-and-mortar retail, this is commonly referred to as “trade.” It is mostly promotional expenses that help drive volume for both retailers and manufacturers. Think price reductions, coupons and buy-one-get one deals. The function is still evolving in e-commerce, but sales and marketing expenses typically relate to better product placement within a store’s search returns. The Congressional Investigation on Digital Markets explains:

Amazon generates a significant amount of revenue from the fees that it charges third-party sellers. According to a recent SEC filing, net sales for services provided to third-party sellers increased from $23 billion in the first six months of 2019 to $32 billion over the same period in 2020—an increase of 39%. For the ability to sell a product on the platform, a seller might pay the company a monthly subscription fee, a high-volume listing fee, a referral fee on each item sold, and a closing fee on each item sold. Amazon charges additional fees for fulfillment and delivery services, as well as for advertising.

If a website is suggesting that you buy something, there’s a good chance someone paid for that suggestion.

Where does Amazon fit into e-commerce?

Amazon is the dominant force in American e-commerce. A recent Congressional report estimates the company controls 50% of online retail. In fact, 60 percent of all online purchases start on Amazon.

The Competition in Digital Markets report provided a useful graphic to understand Amazon’s structure.

Image via the Competition in Digital Markets Report

As you can see, Amazon’s business model is a hybrid of all six outlined above. In fact, third party sellers on Amazon are both customers and suppliers.

In conclusion, what is e-commerce?

At a high level, e-commerce is when a good or service is sold through the internet. It’s a small segment of the overall retail market but is growing in both size and impact. Since e-commerce is unrestricted by shelf space, online stores can offer nearly limitless products—meaning the best way to view them from a channel perspective is if they are vertically integrated (direct-to-consumer) or serve as a platform for commerce. E-commerce makes money in traditional and untraditional ways, with the most successful companies functioning as hybrid platforms.

Photo by 🇨🇭 Claudio Schwarz | @purzlbaum on Unsplash

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