The Retail Revolution

Management Review
April 1999

By Pierre M. Loewe and Mark Bonchek

An era of unprecedented consumer power is dawning. It will separate the winners from the losers in all types of retail fields. Retailers everywhere are talking about using "data mining" to learn more about consumers¡¯ habits, tastes and buying behavior than ever before. Every credit card transaction, Internet sale and "frequent buyer" purchase leaves behind a trail of information that retailers are exploiting to their advantage. If knowledge is power, then retailers would seem to have the upper hand.

Don't be fooled. We are entering an era of unprecedented consumer power.  Armed with their own databases and tracking technologies, consumers are no longer at the mercy of retailers who set the rules and prices. "What I want, where I want it, when I want it, and how I want it" is the credo of the emerging consumer. If knowledge is power, then consumer knowledge about retailers' products, inventories and profit margins is about to overturn the world of retailing as we know it.

Retailers who continue to use old business models and treat customers in old ways will eventually fail. But those who develop new business models around an informed and empowered consumer will thrive. Many of these business models will involve the Internet, but not all. For those interested in capitalizing on consumer power, the lessons and successes of pioneering companies point the way.

THE NEW CONSUMER

Who is this new consumer, and what does he or she want? It's simple: anything, anytime, anyplace --on his or her terms. Consider:

When you bought stocks in the past, you could choose among several full-service brokers -- as long as you initiated your transaction between 9 a.m. and 5 p.m. and were willing to pay a hefty fee. Today, the array of choices is mind-boggling, with discount brokers like Quick & Reilly, online brokers like E*TRADE and combination brokers like Charles Schwab & Co. You can do it in person, by phone, by fax or online and in the middle of the night if you like. You can choose a full-cost option with advice, a reduced-cost option that involves only a transaction or a bare-bones option where you do all the work.

Not so long ago, there were two ways to get dinner: You could go out to a restaurant or cook at home. Now, you not only have more food choices in your supermarket and in the mix of restaurants in your neighborhood, but you also can order your food online, have your groceries delivered in person or by overnight delivery pick up a prepared meal at the supermarket or a restaurant chain, or order a restaurant-quality meal from Waiters-on-Wheels.

No single trend accounts for the rise of the powerful consumer. A convergence of economic, technological, social and cultural forces has given consumers more information, higher expectations, more choices and better products at lower prices. Still, the individual changes are familiar: Globalization of trade increased the number and quality of competitors in many industries. Deregulation of markets as diverse as trucking, telephony, airlines and financial services unleashed new competitors and lower prices. The quality movement raised the standard for product performance and consumer expectations.

Additionally, technology now allows retailers to manage larger inventories at lower cost and ship any size package anywhere overnight. And the Internet enables consumers to research products, compare prices, check availability and buy or sell merchandise, all without leaving their homes. Forrester Research estimates that 9 million households spent $8 billion on online purchases in 1998. By 2003, more than 50 million households are expected to spend in excess of $100 billion.

Above all, lifestyle changes have made consumers more demanding than ever before. Working couples with little time but plenty of disposable income have created a new dynamic between shoppers and sellers. "Shopping used to be a leisurely activity," says Professor Eugene Fram of the Rochester Institute of Technology in New York. "But we've gone 180 degrees. People are now living time-compressed lifestyles. 'Shop 'til you drop' has gone to 'Drop shopping."' Consumers have little patience for retailers that do not understand them or will not adapt their business practices to today's lifestyles.

Farsighted retailers recognize that the new consumer has markedly different needs. They are migrating to new business models that will allow them to profit from the creation of value for consumers. Their experiences provide a lesson for other retailers making the same transition. But innovation requires more than imitation. Retailers must reexamine their relationships with customers, suppliers, distributors and competitors, and then design new business models around the following five core principles.

HARRIED BUT HUNGRY

"Paper or plastic?" Shoppers of the future may not even know what the phrase means. Imagine that tiny computers are built into your refrigerator, pantry and trash can. They automatically scan the bar codes on items and generate orders when supplies are low. The items are shipped overnight and delivered to a modern-age milk box with a refrigerated space for perishables. This scenario is hardly farfetched. Online grocers are already expanding and creating a competitive industry. Subscribers to Peapod, for example, pay a monthly fee of about $5 plus 5 percent of the bill and can choose from 20,000 items. Orders are filled at local grocery stores such as Safeway and Jewel and delivered within a 90-minute window. The formula seems to work: Customers typically do 70 percent of their shopping through the service, so two-thirds of their grocery dollars go to a single retailer. Peapod plans to remove a link from the distribution chain by building its own food distribution centers, making its partnerships with local grocers unnecessary. NetGrocer offers a similar service to online customers, shipping orders directly to their homes by FedEx. Consumers can keep their grocery lists online and choose from an array of choices. In July 1998, NetGrocer signed a $15 million deal with America Online to be its exclusive Internet supermarket. Little wonder that a supermarket chain executive recently bemoaned the fact that he had 40,000 employees and a million square feet of retail space. "All this will soon be obsolete," he sighed.

1.  EMPOWER YOUR CUSTOMER

Traditional retail business models rely on weak, uninformed consumers who don't know the actual cost, performance or repair record of a product. By contrast, business models based on consumer power help customers learn about products, know their options and make intelligent decisions.

Consider the market for long-distance telephone service. Matt Pokress, co-founder and chief technology officer at MediaCom Co., observes that "with hundreds of telephone carriers it is practically impossible to figure out which carrier is best for different types of calls." most telephone carriers use large advertising budgets to make consumers believe their service is the cheapest. MediaCom, based in Bedford, Massachusetts, has taken a different approach with a business model based on empowering the customer. Its product, PhoneMiser, connects to a personal computer and automatically searches a database of 200 long-distance phone companies to find the cheapest carrier for each number dialed. It routes the call in less than a second, and typical customer savings are more than 50 percent.

Similarly, most auto insurance companies assume that consumers don't know much about insurance and rarely shop their policies around for a better rate. Progressive Insurance assumes no such thing. When a consumer calls its 800 number or links to its Web site to get an Express Quote, Progressive gives its own rate and the current rates of up to three leading competitors. The company, based in Mayfield Village, Ohio, has substituted education and information for presumed ignorance and slick sales pitches. Its approach sends a different signal to consumers, many of whom buy from Progressive even if the rate is higher.

Progressive's migration to a customer-focused business model began in 1988 when California voters passed Proposition 103, freezing insurance rates and mandating good driver discounts. According to Leslie Kolleda, a public relations person at Progressive, "Proposition 103 was our wake-up call. Consumers were mad as hell and not going to take it anymore. We could continue to do things the way we always did or we could create a consumer-friendly experience."

Like Progressive, Charles Schwab also has developed a business model based on empowering the customer. While conventional financial planners often act as prophets or wisemen and sell only proprietary funds, Schwab emphasizes objective information and financial education to help customers identify their financial goals and make decisions that are right for them. Schwab's "One Source" guide covers hundreds of funds that are not offered by the company. It is available to customers and non-customers alike. According to a senior executive at Charles Schwab: "We presume that our customers are really, really smart and we don't think we can fool them."

In the auto industry salespeople used to intimidate customers who had little information by playing a game of hocus-pocus about the actual cost of a vehicle. Today, car buyers walk into dealerships armed with spec sheets downloaded from Internet sites, such as Microsoft's CarPoint or Edmunds.com, that tell them the dealer's own invoice. Jack Gifford, professor of marketing at Miami University in oxford, Ohio, observes that "consumers shopping for cars are negotiating not on price, but on how much profit margin the dealer will make. It's a very different kind of negotiation than in the past."

Retailers that do not empower customers will find that they empower themselves. Web sites such as bottomdollar.com or comparenet.com allow consumers to instantly compare the prices and features of virtually any product. These services dramatically reduce the cost of finding the best deal. By incorporating such services into their business models, retailers build trusting, informed relationships with customers and make their lives easier.

2.  PERSONALIZE YOUR OFFERING

The empowered consumer wants it all: customized products and attentive service without the luxury prices that usually accompany them. In sectors as diverse as computers, clothing and vitamins, manufacturers and retailers are deploying new technologies and business models to provide custom-made products and personalized experiences at competitive prices.

Dell Computer and Gateway 2000, for example, manufacture each computer as orders come in, assembling components according to customers' exact specifications. Customers don't have to choose from a limited, off-the-shelf selection or wait a long time for delivery. Instead, the all-powerful consumer configures his own machine, which is custom-made, shipped and delivered in a matter of days.

TC2, a clothes manufacturing consortium, has begun testing a new sales method that takes the concept of "tailor-made" to a whole new level. A customer walks into a booth located at a demonstration center in North Carolina, and either strips to underwear or puts on tight-fitting stretch clothing. Six cameras take 48 snapshots of his body, which a computer then combines into 300,000-point, three-dimensional map. More than 100 key measurements are extracted from that data and transmitted electronically to a plant. A customer can watch his garment being made a get it in minutes.

TC2 has sold its first two booths (to a jeans manufacturer and a startup company), and Brooks Brothers has announced that it will put one in its New York store in early 1999. Initially, Brooks Brothers will manufacture only shirts and provide express shipments to consumers -- but the expansion to other garments and multiple stores is easy to imagine. As for TC2, it is now refining the "virtual try-on" -- a system where the customer "sees" himself wearing the garment and can adjust the fit accordingly. It expects the technology to be perfected within three years.

Similar fitting technologies are being used by Custom Foot and Digitoe create custom footware at mass-production prices. But personalization doesn't necessarily mean high tech. Vitamin companies such as GNC, Green-Tree and ideal Health are creating customized vita-packs to meet customers' individual nutritional requirements. And a simple system from Colorlab lets customers create custom-blended lipstick in minutes at any cosmetics counter.

BRANDING IN THE INFORMATION AGE

Now that customers have virtually unlimited information about their choices, is brand loyalty on its way out? Will consumers buy on price alone? Not at all.

The information age arms consumers with facts, prices, data, product reviews, advice and how-to guides. But the sheer volume of information can be overwhelming. And in a world where more and more customers are buying products without speaking to a salesperson or even seeing the goods* trust becomes an invaluable benefit. That's why branding strategies, always important in retail, will take on a new urgency.

A trusted brand goes a long way toward meeting the demands of the new consumer. It makes the consumer's life easy because it says that a particular product or service will provide the promised benefits. It also conveys information: the FedEx brand represents reliability, BMW stands for performance ("The Ultimate Driving Machine"), Maytag stands for the reliability implied by the lonely and bored repairman.

A familiar, trusted name that offers a well-established product or service will be particularly important to consumers shopping online, where the "newness" of the technology and the lack of physical contact create some anxiety. Familiarity, in many cases, will be more important than price. But price comparisons also will be easy in cyberspace, increasing the onus on manufacturers to truly differentiate their products and provide added benefits that competitors do not offer. Undifferentiated products will be bought on price alone, and the price premium commanded by branded products will need to be better justified.

That is why, initially, branding on the Internet has benefited well-established businesses whose online service offers customers something more. In 1998, Egghead Software announced its intention to close all its stores and convert the entire company to Internet sales. But unlike so many new ventures competing on the Internet, Egghead began with a trusted brand name. More importantly, the company's Web site offers far more products to its customers than any of its retail stores ever could.

Similarly, the Wall Street Journal Online edition is charging a relatively high subscription rate for online access to its pages, something few print publications have managed to do. The Journal's success is due both to its national reputation and its personalized search and archive features, along with 24- hour instant news alerts for online readers only.

CAR LOTS OF THE FUTURE

Most American consumers have experienced the trauma of buying a new car. They must travel to several showrooms, where their choices often are limited, and employ the skills of a seasoned negotiator to reach an acceptable price. It can be an expensive and frustrating experience.

Traditional car dealerships make little sense in an age of busy consumers. A single location serves as a sales office, service center, demo center, used car lot and parts supplier even though consumers rarely need all five functions at once. Indeed, everything about traditional car sales seems designed for the convenience of the dealer. The system keeps the consumer weak and uninformed. Not surprisingly, the dealer-based distribution and sales system accounts for about 30 percent of the price of a new car.

But the empowered consumer has already started looking for retailers willing to break the rules and provide more information and choice. Online and telephone car sales provide fair and objective information about the going prices, overcoming the biggest handicap facing shoppers when they enter a dealer's showroom. Local, multi-brand demo centers allow them to test cars made by several companies at a single site. "Search time," the burden of every car shopper shuttling from dealer to dealer, will soon be dramatically reduced as "Come on Down to John's Ford" is replaced by "Come on Down to John's Sports Utility Vehicles" or "John's Convertibles."

Consumers won't have to wait long. Auto-by-Tel, the online service for consumers, allows shoppers to describe the make and model of a car they want and receive a range of quotes from dealers who pay to have access to the consumer.

Meanwhile, CarMax is reinventing the used car market for the benefit of the consumer. At its used-car superstores in the mid-Atlantic and Midwest, customers choose from an enormous selection of vehicles at fixed prices. Consumer research and extended warranties are available on all cars. The company has announced plans to expand nationally, virtually assuring the first major challenge to regional and local car dealers.

3. ABANDON ARTIFICIAL BOUNDARIES

Here's a little secret for retailers: Consumers don't care what industry you are in. And they don't care if you are a manufacturer, wholesaler or retailer. They just want you to give them what they want -- which, in a word, is convenience.

As a result, retailers are crossing industry boundaries to help consumers consolidate their shopping trips. in Europe, supermarkets realized years ago that customers wanted the convenience of filling up their cars with gas when they shopped for food. in France, for example, 60 percent of all gasoline is now sold at supermarkets. In Britain, supermarkets will sell more gas than Shell oil this year.

Convenience also means having a single trusted source. Why have four separate companies to finance your car, insure it, issue an extended warranty and provide roadside assistance? Allstate Insurance in Northbrook, Illinois, is developing a complete package for automotive care that covers all of these categories. According to Mary Beth Shea, responsible for brand and product development at Allstate, "We feel our business is protection, not just insurance policies. For example, we can provide a full circle of protection around two of the most important assets our customers own: their home and their car, Our goal is to maximize the use and enjoyment of these assets and minimize the risks."

Since consumers want it all, retailers are blurring industry boundaries to remove trade-offs. In the food business, for example, customers traditionally were forced to choose between the quality of restaurant food and the convenience of prepared foods. EatZi's, a chain based in Dallas, Texas, is a cross between a restaurant and a gourmet fast-food stop. Thirty-five chefs prepare a full variety of high-quality meals for discriminating shoppers who have little time to cook, but no patience for second-rate fare.

Consumers also want shopping to be a rewarding and pleasurable experience. in response, retailers skilled at creating such experiences in a limited product offering are moving into new areas. Nordstrom will soon bring its renowned customer service in clothing to financial services by offering home equity loans and money-market checking. Virgin Group is bringing the adventurous spirit of its airline and media stores to the passenger rail industry through its recent acquisition of British Rail. Disney has extended the wholesome fun of its theme parks and movies to cruise lines, community planning and adult education.

Successful companies are not only expanding "horizontally" into new fields, but also making a mockery of the old "value chain," where the manufacturer sold to a wholesaler, who sold to a retailer, who sold to the consumer. Are Dell Computer and Gateway, which manufacture computers to order and sell directly to consumers, manufacturers or retailers? Are Sam's Club and Costco, which sell to consumers at wholesale prices in warehouse-like stores, retailers or wholesalers? Who will be the retailer in the virtual supermarket of the future, when one company runs the online ordering service, another runs the express delivery service and another the regional warehouse?

Traditional labels are rapidly becoming meaningless, and a company must look for ways to break out of the artificial horizontal and vertical boundaries of "its industry." But do so with an understanding of what you bring to the party. It's not enough to identify a potential market or customer benefit; you will need the necessary core competencies and strategic assets as well. Without them, you will either fail to execute your vision or lose share to imitators. If you don't have the right portfolio of competencies and assets, acquire them or ally with companies, that do.

When moving outside your traditional industry, your best bet is usually to move along your existing value chain or into "adjacent" value chains that share a unique core competence or a rare strategic asset. Prime retail locations were strategic assets that enabled supermarkets to sell gasoline -- and, conversely, for gas stations to open convenience stores. A core competence in complex billing systems is what enabled AT&T to move into the credit card business a few years ago. More recently, it leveraged its national presence (a strategic asset) to create one of the first nationwide cellular phone networks.

Remember: consumers don't care what industry you are in -- as long as you create value and make their lives easier.

4. PROVIDE SOLUTIONS

Access to information is making some consumers almost as knowledgeable about retailers businesses as their accountants. When consumers know the wholesale price of an item products become commodities. The traditional model of offering a broad selection of product and marking up each item doesn't work today.

In their search for new business models, retailers are taking a lesson from the business-to-business market where companies have wrestled with commoditization for years. That lesson is to focus on solutions beyond products and services. Jack Welch, CEO of GE, describes the company as a "global solution service provider," a label that applies to mundane businesses such a locomotives, domestic appliances and jet engines every bit as much as it does to GE Capital.

According to Jeet Singh, CEO of the Art Technology Group, a software company in Boston that develops platforms for personalizing e-commerce sites, "Offerings have become much less commodity-like in the business-to-business market because so much is wrapped around the product -- specialization, services and volume or repeat discounts -- all designed to solve a customer problem."

In response to consumer power, retailers are wrapping commodity products into profitable packages that make customers' lives easier. For example, consumers are increasingly turning to meal solutions rather than meal ingredients. Salad bars, precooked chickens, and prewashed, precut and prepackaged lettuce are now standard items in most supermarkets.

In fact, customer service and execution are critical ways of differentiating products that otherwise are commodities. According to Singh, "A shoe from Neiman-Marcus or Nordstrom's is not the same as from another department store because it can be returned no-questions-asked. And computers purchased from some catalogs or Web sites are different because they can ship the package that very day for next-day delivery. Other sites take two or three days to get the package ready for shipment."

Home Depot is one retailer that has embraced a solutions-oriented business model. The company started by providing do-it-yourselfers with everything they need for home repair at low prices. Recently it began moving to services and solutions. Do-it-yourselfers can now take classes in home repair or have Home Depot arrange complete installation services.

TravelFest is another company packaging products and services into solutions. In fact, Gary Hoover, the founder of TravelFest, has said, "We want to be the Home Depot of travel." At the five Texas-based TravelFest stores, you can do research on a country you want to visit, make plane and hotel reservations to get you there, buy clothes, guide books, maps and luggage ' take foreign language classes, exchange money and get help obtaining a visa.

5.  FIND A NEW ECONOMIC ENGINE

The rise of consumer power means that your economic engine where and how you make money may need an overhaul. Once reliable sources of profit may shrink or disappear. In their place, you will need to find related products or entirely new pricing structures to give consumers control, convenience and rewarding experiences.

THE DANGER OF RETAIL ARROGANCE

In 1992, when Arthur Martinez joined Sears, Roebuck and Co. as head of the Merchandising Group (he became CEO in 1995), he saw the signs of rising consumer power immediately. For more than a century, Sears stores had been a retailing pillar in communities across the country.

But by the end of the 1980s, its financial performance was lagging. The company lost nearly $4 billion in 1992 and seemed to be the classic retailing dinosaur. According to Martinez, one of the chief culprits in this decline was retailing arrogance. Sears had become too confident that it knew how and what to sell. It had started taking its customers for granted, and they had started taking their business elsewhere.

Sears' turnaround, engineered and lead by Martinez, was based primarily on getting every store to focus on the customer. Although Martinez also undertook many of the traditional rationalizing steps -- slashing 50,000 jobs, selling non-performing assets and abandoning the Sears catalog -- he realized that financial engineering was not enough to survive.

His immediate goal was to make Sears a compelling place to shop. He invested $4 billion in making the stores more friendly to female shoppers. One year after Martinez began his "back-to-basics" strategy, the company was well into the black. Its stock price climbed 34 percent in 1996 and then grew another 50 percent until the market correction of 1998. While other department store retailers were folding their tents, Sears bounced back by reinventing its strategy and putting customers at the center of its business.

One route to a new economic engine is to take the well-known concept of a "loss leader" a step further, from the level of the product to the level of the business model. For many years, AMR (the parent company of American Airlines) made far more money from its Sabre reservation system than from flying airplanes. Movie theaters and amusement parks make most of their money on food and beverages, not admission tickets. The majority of profits at insurance companies come from investing the premiums paid by customers, not from the difference between premiums and payouts for claims. Even on the Internet, where most companies measure their age in months, retailers have had to rethink their economic engines. Online services such as America Online initially thought membership fees would drive profits, but have since migrated to business models based on advertising.

Another option is to change to an auction-based pricing structure. Consumers are flocking to online auction sites, drawn by information about demand for a product, control over how much they bid and the excitement of competing for a bargain. Priceline.com uses a reverse auction to let consumers set their own prices for airline seats, hotel rooms and new cars. Consumers tell Priceline.com what they are willing to pay for a specific flight, room or car model. Airlines, hotels and car dealers looking to fill an empty seat or vacant room or make space for a new car shipment can accept the best offers of these consumers. Retailers selling time-sensitive products that disappear, such as airline seats, or that have difficulty judging demand and regularly discount items, such as clothing or cars, should consider reverse auctions in their search for a new business model.

Web sites such as eBay and ONSALE use a traditional auction in which customers bid for products listed online. Although these sites are filled with collectibles such as beanie babies, a growing number of small retailers are selling new products in much the same way. These retailers typically set a minimum bid equal to their cost of goods to make sure they break even. When demand is high, prices are bid up and they make a healthy profit. When demand is low, they don't waste time wondering whether and how much to mark the price down.

Established retailers also are incorporating auction-like pricing in the form of automatic markdowns. L.L. Bean has adapted a business model from Filene's Basement, a discount clothing store, to the world of e-commerce by automatically marking down certain items on its Web site until they sell. Customers can check the Web site anytime they want and don't have to wrestle with traffic (or other customers) for a bargain.

RETHINKING RETAIL

Today's retailers must bring innovation to their tried-and-true business models or risk going the way of the five-and-dime. Successful retailers will be those who see consumer power not as a threat, but as an opportunity. They will use data mining not to control the customer, but to empower and personalize. They will move across industry boundaries not for financial diversification, but to deliver products and services more conveniently to customers. They will package products and services not to cross-sell, but to solve customers' problems and make their lives easier. And they will develop new economic engines not to create a higher "share of wallet," but to deliver greater value to customers.

The bad news for retailers in the coming revolution is that competition will be fierce. The good news is that the customer is on your side.

 

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Pierre Loewe is a founding director of Strategos and executive director of the Strategos Institute.

Mark Bonchek is director of research at the Strategos Institute.

Strategos is a global strategy innovation firm based in Menlo Park, California, that helps companies reinvent themselves and their industries.  The Strategos Institute is a knowledge-creating community of executives, consultants and academics learning how to embed an ongoing capacity for strategy innovation in organizations.