E-Commerce Gets an F Without the ‘D’ Word

For a time, when retailers thought about e-commerce, they thought about the high-tech necessities: the right Web address, a flashy display and an easy-to-use site.

Then came the unglamorous reality: None of that matters if you can’t get the product to the customer.

That means that order fulfillment, the part of retail having to do with banks of order takers and warehouses filled with boxes and forklifts, is suddenly getting new attention.

“The ‘e’ in e-commerce is misplaced,” said Kevin Silverman, an analyst with securities firm ABN Amro in Chicago. “It’s ‘d-commerce’ or ‘f-commerce’--distribution or fulfillment. You can’t e-mail a sweater to somebody.”

Experts in what is known as back-office operations are now so in demand that they get corner-office respect. Williams-Sonoma Inc.’s investors panicked in March when Chief Financial Officer and logistics dynamo Dennis Chantland announced his retirement from the retail store and catalog company. The stock regained the one-day 19% drop, and the company recently named John Tate, chief financial officer at Dole Food Co., to succeed Chantland.

And as retailers from the bricks-and-mortar world venture onto the World Wide Web, formerly unsexy distribution companies have become acquisition targets.

In February, Federated Department Stores Inc. bought catalog and fulfillment house Fingerhut Cos. In April, Toys R Us Inc. bought a fulfillment center from Proteam.com, a direct-sales company once known as Genesis Direct Catalog.

Barnes & Noble Inc.’s attempt to buy Ingram Book Group, the country’s largest book wholesaler, was another sign of how critical distribution is to success in e-commerce. But that combination was too powerful for government regulators, whose opposition encouraged Barnes & Noble to withdraw its offer and instead announce plans to build two distribution centers for its online business.

Analysts say it will be fulfillment that separates the e-commerce players from the also-rans during the Christmas selling season, the period expected to account for a large part of what could be more than $36 billion in online sales for 1999. Some online merchants are unprepared to handle a crush of orders, said Chris Merritt, a principal in Kurt Salmon Associates, an Atlanta-based consulting firm specializing in consumer products, direct marketing and fulfillment.

“There will be some spectacular failures this holiday season,” he predicted.

As the back office comes to the fore, companies well-versed in shipping individual packages from warehouse to customer are stepping up to take advantage of new opportunities. FDX Corp.’s FedEx and United Parcel Service of America Inc. have started taking and shipping orders for online merchants.

Online retailers that have already mastered fulfillment consider it a critical factor behind their growth. Amazon.com was fortunate that its first product was a relatively easy one--few people return books--to handle. The company was able to slowly build a distribution arm and, with it, the goodwill of its customers.

Company lore has Amazon.com founder Jeff Bezos exploring fulfillment firsthand in the early days, sitting on his floor every night packing up the orders, loading them in his car and driving them to the post office.

By this holiday season, the Seattle-based company expects to have 3.5 million square feet of distribution space at seven centers nationwide, more than 10 times the company’s fulfillment capacity last year.

With a massive fulfillment system now in place, Amazon plans to leverage its reputation for efficient handling as it expands across the retail spectrum, most immediately into music, videos, toys and auctions.

“I tell my guys that we are a major part of the customer experience,” said Jimmy Wright, Amazon’s chief logistics officer. “We are not as romantic as a Web site, and we’re certainly not in the limelight like a Web site; but if we have the greatest site in the world and the women and men who operate these distribution centers fail to execute, we won’t have customers.”

Though seemingly mundane, fulfillment today is almost as high-tech an undertaking as the Web sites it increasingly serves, with sophisticated picking, packing and shipping systems, inventory-tracking software and computerized order-taking facilities.

Few anticipated that e-commerce would expand so rapidly. In 1997, when Fingerhut began offering its fulfillment services to other companies, it was because it had more capacity than it needed, not because it had a vision of exploding opportunity.

“There was no way we saw e-commerce back in those days and what it has evolved to today,” said John Buck, the president of Fingerhut Business Services, which handles the fulfillment operation.

Besides handling fulfillment for its new owner and its own catalog, Fingerhut provides the service for companies eager to stake claims in online commerce right away, without the delay that setting up a distribution operation would entail.

Wal-Mart Stores Inc. and EToys Inc. said in June that they would use Fingerhut to handle Internet orders, joining Levi Strauss & Co., Intuit Inc. and Wet Seal Inc. Buck projects Fingerhut Business Services’ annual revenue will rise to $100 million next year from the $40 million expected for this year, and suggests it could become a $1-billion operation within five years.

E-commerce is rapidly taking up the excess capacity of other fulfillment firms.

Two years ago, Merritt said, the industry probably had 3 million square feet of available distribution space. Now there’s less than 1 million, and it’s going fairly quickly, even as the total amount of space increases along with the number of companies offering it, he said.

Competing in the third-party fulfillment business are about 20 companies, including not only catalog firms but also small shippers such as Pennsylvania-based Arnold Logistics, which handles orders for Right Start Inc.’s online toy store.

Many of them are small; only a handful have more than 500,000 square feet of space, and none comes close to Fingerhut’s nearly 4 million square feet--which is about 14% more than what Amazon has.

Merritt said that in the short term, extra space and the competition for big-name clients should keep prices for fulfillment service fairly low. But soon, he said, demand will outstrip supply and prices are likely to rise.

Fulfillment was a natural diversification move for FedEx, which already had elaborate systems and vast warehouse space.

Two years ago, FedEx took over fulfillment for the Hewlett-Packard Co. Web site. The site transmits orders to FedEx’s computers in Memphis, FedEx’s home base and the place where FedEx warehouses HP’s inventory.

FedEx handles 20 or so other clients. One is ProFlowers.com, which requires rapid pickup and delivery of individual orders but needs no warehouse. When orders come in to ProFlowers, they are routed to growers with FedEx technology who can immediately arrange for pickup of the floral arrangement. FedEx then picks it up and delivers it to the recipient.

The ability to have fulfillment services that both pick up and ship individual packages could allow other companies to do without warehousing altogether, said David Roussain, HP’s managing director of e-commerce marketing.

Analysts expect big retailers such as Wal-Mart to do their own fulfillment at some point.

“The very good brands are going to want to control it to control how their customer is treated,” analyst Silverman said.

Direct-marketing neophyte Toys R Us, which is preparing to challenge online seller EToys, concluded that it needed to handle its fulfillment operations itself.

Toys R Us has brought its stores into the e-commerce process, allowing Web site shoppers to avoid shipping charges by picking up merchandise and making returns at them.

“The minute you outsource, it’s just something that’s out of your hands,” said Toys R Us Chief Executive Robert Nakasone. “What happens at Christmastime when you’re using a Fingerhut? They’re servicing Wal-Mart. How do you get your service priorities to the top of the list?”

(For its part, Fingerhut said it is confident that its state-of-the-art technology and extensive experience will enable it to efficiently and promptly handle each of its clients’ businesses.)

For smaller retailers, though, the financial obstacles to building or acquiring a fulfillment system can be daunting. They will need to find fulfillment partners or risk being left out of the e-commerce party. And that suggests the growth of the third-party fulfillment business is just beginning. Indeed, when privately held UPS announced last week that it would raise funds by selling a 10% stake to the public, analysts predicted the proceeds would go toward logistics systems.

“The rubber hits the road at fulfillment,” said Bruce Temkin, senior e-commerce research director at Forrester Research in Boston. “No matter how the product gets sold, it’s much more complicated to actually deliver it, which is what it’s all about. The only companies that are able to succeed are the ones that have an efficient, low-cost distribution network.”