The perceived simplicity and elegance of the virtual world has the lure of a hyperefficient channel compared with physical stores. After all, shedding the expense of leasing retail space and the costs of overhead, inventory, and distribution makes it seem logical to charge less and profit more. Unfortunately, reality is different.
Key operating costs like fulfillment and customer service are actually higher online, often 300 and 100 basis points, respectively. That creates a performance headwind for the online channel, so it's no surprise that while overall e-commerce profitability is up, operating margins in the business remain tight. What's more, about 30 percent of Web-based businesses report negative operating margins. Core competencies ripe for refinement include merchandising, pricing and promotions, and customer analytics.
Too many managers associate the importance of execution with owning the asset, and thus respond emotionally, deciding to build on their own, versus other, options. Specifically, owning online technology (which typically represents 3 to 7 percent of sales) and fulfillment (another 8 to 11 percent of sales) both create downward pressure on productivity without offering a matching upside.
No technology choice comparison is complete without an analysis of upfront and ongoing costs. Despite a demonstrably lower--often zero--upfront cost, many IT decision makers react negatively to hosting models based on a percentage of sales. Revenue-share models are very attractive for an e-commerce business not yet at scale, but the absolute cost from the variable structure can cause sticker shock when compared against the assumed operating costs of an in-house solution.
Technology ownership is a source of competitive advantage for retailers. A Web site is an ideal candidate for outsourcing or hosting, although many companies continue to make buy-or-build decisions based on an unbalanced, unrealistic assessment of criteria. Many e-commerce managers believe that an outsourced model results in a loss of business control, a decrease in responsiveness, and increased data risk.
Our collaboration with companies that have made the hosting leap suggests it can offer a number of benefits. Many get more functionality than they did using their own IT groups. This is largely a result of hosting providers having more experience solving a wider range of issues for many retailers. Also, fear of sharing operational data quickly disappears when the hosting provider proves that data visibility and security mechanisms are in place. This fear is allayed further when the responsibility of scaling the platform becomes someone else's problem.
Criteria that can truly make the difference between a good business decision and a bad one are often underemphasized. Several leading multichannel retailers have offloaded their online platform and redesigned their site in as few as three months, for example, compared to nine to 12 months if kept in house. Plus, the hosting providers' tactical knowledge and experience in improving key drivers of site and financial performance, such as abandoned shopping carts and order conversion rates, are impressive even to experienced online and multichannel retailers. (Of course, not all hosting providers are created equal, and due diligence regarding potential partners is as important as the outsource versus owning decision itself.)
In-house IT projects rarely fall within original estimated costs. A revenue-share approach is a compelling, symbiotic model when the online channel is growing or is below full potential. The outsourced model can also allow for a learn-as-you-go approach, giving the retailer the opportunity to take back the hosted solution when scale is achieved.
Companies evaluating their options for accelerating, starting up, redesigning, or reducing the costs of their e-commerce technology should take a good look at a hosting option. Viewing a balanced set of criteria through an objective lens could lead to both lower costs and improved performance of the online channel.
Simon MacGibbon is a consultant in McKinsey & Company's San Francisco office; Jeff Schumacher is a partner in the Los Angeles office.