The E-Tailing Hangover

Now that the season has passed, it’s time to deal with the hangover.

For Internet retailers, or e-tailers, the party was an orgy of ad buys that sent prices for all kinds of ad space skyrocketing. The hangover is the red ink of sales that disappointed or couldn’t be fulfilled.

The major media are calling this a “shakeout” and “consolidation,” claiming we don’t need more than three players in any niche. As usual, they’re missing the point.

The first shot in this “shakeout” or “consolidation” was fired last week, when Value America laid off nearly half its staff. What we’re really seeing is a process that Frederic Schumpeter called “creative destruction.” It’s what Joseph Heller’s Milo Minderbinder meant in “Catch-22” when he said, “Think of it as evolution in action.”

Business is like war, but – unlike in war – nothing really dies, it just gets recycled. That’s really what’s going to happen here, a vast recycling of money, talent, and market share.

The fact is many e-tailers (and their venture capital backers) put the cart before the horse last year. They thought it was more important to get someone in the door and have them press the “buy” button than to back up the promise of that button with service.

Now we know better. Those who didn’t learn the lesson are going to merge for pennies on the dollar or just fade away. Those who did learn their lessons will prosper over the long run.

In retrospect, two of the most important e-tailing stories passed almost unnoticed. First was Amazon.com’s decision to build a network of fulfillment warehouses across the country, which forced it beyond its original niche of books and turned it into the first web department store. Second was eBay’s alliance with MailBoxes Etc. and iShip.com, which gave it the ground presence its buyers and sellers needed to succeed.

That’s not to say that you should buy Amazon and eBay stock right now. The whole consumer Internet sector is going to be punished along with the bad boys, and its manic boom time has definitely passed. (The mania has moved on to Linux and b2b web companies.) Instead, consumer Internet e-tailers will have to start showing a profit, and the VC windows will slam down on e-tailing business plans.

This does not mean that the boom in e-tailing is over, or that you shouldn’t get into the business. It does mean, however, that we now know how to measure e-tailing, we know what it takes to succeed, and we know what to expect in terms of a business process and rational growth.

So those who think there will just be three toy stores or three bookstores in the online world at this time next year are wrong. There will be tons of both. We’ll just see more niche players, and more plays backed by retail-savvy capital, than we did last year.

The lesson of all this should also be clear. Before you enter the arena, make sure you have all the weapons you need to succeed on the customer’s terms, not just the stock market’s.

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