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A lot of retailers wonder if offering an online shopping option will simply cannibalize their brick-and-mortar sales – and by how much.
Andrea Pozzi has been studying this question, and he documents the positive impact of online sales in a paper that’s just been published in the RAND Journal of Economics. It’s good to get some answers, and some of them are surprising. Pozzi agreed to talk with us about his research and findings.
Andrea Pozzi is currently an Assistant Professor at the Einaudi Institute for Economics and Finance, in Rome (Italy) and a Research Affiliate at CEPR. His fields of expertise include empirical industrial organization and quantitative marketing, and he has worked on characterizing consumer behaviour in online markets, as well as market structure and pricing strategies in the retail sector. Pozzi’s research has appeared on the American Economic Journal: Microeconomics, the International Journal of Industrial Organization, and the RAND Journal of Economics.
BMC: Can you give us a top line on your paper, The effect of Internet distribution on brick-and-mortar sales?
Dr. Andrea Pozzi: Using a major US supermarket, the paper looks at a classic brick and mortar retailer introducing an online channel with delivery to the home. The chain offered its customers the opportunity to shop online alongside their regular visits to the stores, thus exposing the retailer to the potential risk of cannibalizing sales.
Instead of cannibalizing, however, this strategy paid off well: The online shopping channel accrued new sales for the chain at a rate that was twice what was lost to cannibalization.
- The analysis calculates that for each dollar of sales through the supermarket's website, 65 percent represented fresh revenue and only 35 percent represented cannibalization.
- A back-of-the-envelope calculation shows that, at this rate, entry into the online segment can pay for its cost, and then some.
Where did this incremental revenue come from?
The evidence suggests that the introduction of the online channel strengthened the position of the supermarket chain vs. its competitors. Big-box grocery retail chains typically offer better prices and wider product selection than small retailers. However, they tend to be located in the suburbs, away from densely populated areas. The fact that households shop frequently for grocery goods makes location disadvantage more salient in the supermarket industry. Shoppers are keen to drive every once in a while to a Best Buy to get a deal on a new camera or a vacuum cleaner. Going to the same trouble several times a week to save a few cents on liquid soap or canned peas may not be as alluring.
The analysis also shows that the online channel is significantly more effective in generating new sales from customers living farther away from the retailer’s brick-and-mortar stores, probably because they’d always wanted to shop there and now it was convenient to do so. Thus, selling on the web and offering home delivery can help grocery retailers and draw in customers they could not compete for otherwise.
In other words, even though the Internet may not necessarily expand the market for groceries, it can represent effective tool to steal business from competitors. This is further suggested by the fact that the online service brings in an even higher share of incremental sales in areas where the chain faces more competition, since this is where there is more potential for stealing business.
What were some of the factors that contributed to the success of this retailer’s online offer?
The success achieved by this retailer depended in large part on being a first mover. This supermarket chain was the only major grocer offering online shopping in 70% of the markets where they made the service available. In the remaining markets, as the number of online competitors grew, the amount of new business gained by the chain declined steeply. Being a first mover can mean a lot.
What was the competitive setting where the study was conducted? Had there been previous attempts at ecommerce by other food retailers or any obvious activity by pure-play online grocery retailers?
Some of the markets where the retailer introduced the ecommerce service had witnessed prior attempts to sell grocery online, usually from pure players. Indeed, the crash of Webvan, the forced downscaling of Peapod, and the success of Tesco in the UK have created the perception that in-store picking, rather than dedicated warehouses, was the best way to fulfill online grocery orders. This meant that only brick-and-mortar retailers with a high density of physical stores in a given area would be able to sell groceries online profitably. This historical evolution may help explain why the retailer I studied went unchallenged in most of the markets where it rolled out the service.
Things may change as online grocery looks more and more promising, and it could attract a wave of new entrants. But if the benefits of selling online decline as fast as my estimates suggest, pioneers may have gained more than a first mover advantage; they may have almost pre-empted the market.
Were you able to learn anything about the characteristics of the shoppers who made heavy use of ecommerce or who were early adopters?
The households in my sample are heterogeneous in their intensity of e-commerce use. The average fraction of online orders is 15%, but for users in the top decile of the distribution, nearly one in two grocery trips takes place online. More intensive use of the internet channel is associated with higher spending. A 1% increase in the fraction of online trips corresponds to a 14% increase in the total amount spent at the chain during the sample period.
Those who adopt shortly after the online option is made available also use it more often. Not surprisingly, fast adopters are more educated, spend more, and live further away from big-box stores.
Some of these early adopters were also new customers for the chain. I observed that introducing the service in a zip code doubles the probability of attracting a new customer (i.e. a household that I hadn't observed buying at the chain in the six prior months). Using the online shopping service seems to be the main reason these new customers went to the chain. After joining, their fraction of trip and spending online was much higher than the average.
An orginal article on Pozzi's research has been published the Fall issue of the RAND Journal of Economics.
Special thanks to Dr. Neal Hooker of The Ohio State University for introducing us to Andrea Pozzi. We are excited to share his research with Brick Meets Click readers.
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