retail news in context, analysis with attitude

Content Guy's Note: "The Innovation Conversation" is designed to be a new regular MNB feature, prompted by the positive reactions that Tom Furphy and I have gotten after having done live and customized versions at a number of industry and corporate events. Our goal in each edition is to explore some facet of the fast-changing, technology-driven retail landscape and how it affects businesses and consumers. It is, we think, fertile territory ... and I'm thrilled to have Tom Furphy engaged in the effort.

In case you don't know Tom, I can tell you that he brings unique credentials to everything he does. Tom Furphy is CEO and Managing Director of Consumer Equity Partners (CEP), a venture capital and venture development firm in Seattle, WA, that works with many top retailers and manufacturers, who make CEP a regular stop during their Seattle visits. Prior to CEP, Tom was at as Vice President, Consumables and AmazonFresh, where he was responsible for building and running the company’s Grocery and Health & Beauty businesses on the platform, and was also responsible for launching and rolling out the AmazonFresh business. And before that, he held a variety of senior roles at Wegmans.

So, let the conversation begin...

KC: Let's talk about Jet, the e-commerce site launched with $225 million in funding last July by Marc Lore, the Quidsi founder who sold that company to Amazon for $545 million in 2010. My sense is that by making Jet a pure price-play ... that is, hinging everything on providing a lower price and providing levers through which consumers can lower their prices ... they are playing a dangerous game.  There's an old saying in retail that you can always be undercut on price;  is jet potentially putting itself in a situation where, if it is undercut on price, it has no other differential advantage on which to rely?

Tom Furphy:
It seems to me that Jet is “all in” on the lowest-price positioning. Their model is to break even on transactions, with the company realizing its profits only on the $50 annual membership fee, similar to the club model.

Shoppers love to save money. Allowing them to control how much they save and how they save it may take root and be defensible for some period of time. But it will be a costly fight. To offer the lowest prices, you need to be a low cost operator. I understand that Jet is losing anywhere from a few points to upwards of 30 points on transactions today to establish their low price image. That is costing their investors a lot of money.

Amazon has a more mature and extensive infrastructure of fulfillment centers which provides for lower logistics costs and allows them to sustainably offer lower prices. They will not give up their price image easily and they are sufficiently capitalized to fight for a long time. Also, I don’t see anything that would prevent Amazon offering a similar model if it wanted to. No company better tracks and optimizes the cost levers that underlie e-commerce transactions. It would not be a stretch for them to expose those levers to customers to offer an Amazon Prime version of the Jet model. And as they open more fulfillment centers closer to more homes, their cost lead just widens, which enables them to continue to lower their prices, either in the lead or in defense of competition. I don’t see how Jet can keep up with that long term and I don’t see what else is differentiating in the model.

KC: Jet was forced to remove links to more than a hundred retailers and brands when they complained that Jet was using those links to drive traffic and sales on its own site through a kind of loyalty marketing program.  You dealt with a lot of suppliers and retailers when you were at Amazon;  is it your sense that these are long-standing competitive concerns that Jet just ignored at its own peril, or is this a reflection of how much more competitive the e-commerce world has gotten?

Retailers all want to “own” the customer. They love to work with affiliates that send them volume, and they are willing to share revenue and sometimes even customer information with their affiliates as long as both are benefitting. But most affiliate agreements explicitly state that referral commissions are not to be used as a customer discount or rebate to offer a better deal than published on the retailer’s site. That is, affiliates are precluded from using the commissions to compete against the site. For many of the sites that booted them, Jet was offering prices below the retailers’ price and was funding the discount with the affiliate revenue, which appears to have been in violation of the agreements.

That said, the e-commerce world has gotten very competitive. By offering products across a range of most retail categories for sale via third party sellers and itself, Amazon is a big driver of that competition. Being a marketplace for sellers while also competing against those sellers is a bit of a balancing act. You want to create an environment that attracts sellers and brings more products to customers. But you also want to offer the best prices, and often that means offering the product directly in competition with those sellers, especially when your scale allows you to procure it at a lower cost. This can create some discomfort between the parties. Ultimately, all parties need to engage in e-commerce with their eyes wide open and make sure they are going to market through as many paths as possible, including marketplaces.

KC: I tend to think that even if Jet does not have a sustainable business model - and I believe that the jury is out on this - the fact that it is spending so much money right now on marketing means that it has the potential of changing the game for everybody else, simply because it will change perceptions and expectations.  Would you agree?

Yes, I would agree. Jet will require everyone to be on their game. Shoppers continue to have more and more options available to them, and the data shows that they are willing to try new things. As new entrants and options emerge, it is important for retailers to deliver compelling value to their customers that clearly sets them apart from competition.

KC: In the end, how big a threat do you think Jet is to traditional brick-and-mortar retailer?

I don’t think that Jet on its own is a significant competitive threat to existing retailers. I do think they stand a chance of taking share from center-store grocery, mass, sporting goods, office supply, apparel, electronics and other hardline categories. But the slice from each will likely not be significant. However, each of these formats has been getting sliced from the outside for years. A little share erosion here, a little there, and it adds up. For many of these categories, it is their bread and butter that is getting eroded. In Grocery, it’s the center store well ahead of the fresh areas.

Amazon continues to double down on programs to make it even easier to buy center store items – Prime, Prime Pantry, Fresh, Subscribe-and-Save, Dash buttons and the Echo are all squarely positioned to keep shoppers out of stores. This battle will be fierce. Jet will take their piece of it, but I don’t see them as a significant threat on their own.

KC: And do you think Jet has a sustainable business model?

As I get older, I am particularly sensitive not to become the curmudgeon that scoffs at new ways to do business. That certainly would not be in the spirit of the Innovation Conversation! However, based on what I’ve seen from Jet and what I know about e-commerce profitability, I don’t think Jet has a sustainable business model. Fulfillment costs are what make or break a model.

To be able to maintain the lowest prices online, Jet will have to have an extensive fulfillment and partner network as well as a robust technology platform to enable transactions to be easily configured by customers. They have a fulfillment and partner network that is only a small fraction of the size of Amazon’s (and Wal-Mart’s, Target’s, Kroger’s and others for that matter). They have a technology platform that is not as robust as Amazon’s. And their value proposition based only upon price, which Amazon can crush at will. Wal-Mart, Target, Kroger and many other existing retailers are in a better position to succeed, and they can all do so without acquiring Jet. Maybe someone would give in and purchase them, but I can’t see who or why at this point.

But this is a team that knows how to turn lemons into lemonade. In my opinion, the team’s prior win, (along with Quidsi, their parent company), wasn’t sustainable either. It was drafting behind Amazon’s lead into the diaper space with a more consumer-friendly experience, but with an inferior cost structure. The company was in need of further capital or facing death as a result of a price war with Amazon. Amazon overpaid to take it out and keep it away from competition, which was a great outcome for the investors and founders. Jet’s CEO has come out publicly and stated that Jet will break even in roughly five years, at $20B in annual sales. Even if that happens, how much will Jet lose along the way to $20B in annual sales? From the outside, it seems like the investors and founders are betting big to get acquired along the way.

Maybe it’ll happen, but it’s a risky bet.

"The Innovation Conversation" will return in a couple of weeks. If there are subjects you'd like us to chat about in the future, let us know.

KC's View: