e-Commerce Stock Outlook – June 2011

The Electronic Commerce, or e-commerce, industry is one of the most developing sectors of the economy. The industry is evolving very rapidly, so data collection and evaluation are particularly difficult. Consequently, one has to rely largely on surveys by both government and private agencies.

According to the U.S. Census Bureau, the manufacturing sector is the largest contributor to e-commerce sales (42% of their total shipments), followed by merchant wholesalers (23.4% of their total sales). These two segments make up the business-to-business category.

Retailers and service providers generated just 4.0% and 2.3%, respectively of their revenues online, a slightly higher percentage than they were in the prior year. The Bureau categorizes these two segments as business-to-consumer.

The business-to-business category makes up 91% of total e-commerce sales, with the balance coming from the business-to-consumer category. The fastest-growing segments were manufacturing and services. [All the above data from the U.S. Census Bureau relate to 2009, as published in May 2011.]

Key Drivers

Since the industry is in evolution, the drivers are varying, or changing flavor. For instance, the initial push came from the time savings and convenience of online transactions. To this were added the benefits of comparison shopping and personal recommendations. As technology required for personalized recommendations developed, it became more available and its benefits more evident, most e-tailers started adding the feature until it is now considered a must-have.

Today, the biggest driver of growth in the industry is the adoption of smartphones, tablets and other mobile Internet devices (MIDs). According to comScore, 31% of U.S. mobile phone subscribers are already using smartphones to connect to the Internet. With just under a million of the devices selling every week, it is not surprising that people visiting an online store from their smartphone increased 90% from March 2010 to March 2011.

The advent of tablets brought another wave of change, as the larger screens offered better visibility of online stores and merchandise, thus facilitating purchases. The e-tailing group has reported that 68% of tablet owners surveyed made an online purchase, compared to 48% of smartphone users. Moreover, only 22% of tablet owners did not make a single purchase compared to 36% of smartphone users. The shopping experience on tablets appears to be more satisfactory than on smartphones.

Books and magazines, clothing and accessories, digital books and tickets are the hottest-selling items on MIDs.

Consumer electronic goods are leading the way in U.S. e-commerce sales, according to comScore, with around 50% of all computers and 30% of all consumer electronic goods being purchased online. This is in line with what one of the leading consumer electronics retailers Best Buy Co (BBY) reported in the last quarter (1.8% decline in total revenue compared to an 11% increase in domestic online sales).

Wal-Mart Stores (WMT) also stated that its online business was growing strongly, with both traffic and order sizes picking up. It also stated that consumer electronics was an important category. Other packaged goods, such as soap and groceries grew 10% from 2009 to 2010, according to comScore.

Wal-Mart’s U.K. wing, ASDA, saw online grocery and general merchandise sales growing 20.8% in the last quarter over the prior year, while its online general merchandise business in Brazil grew 41.1%, indicating that the online opportunity in international markets is also significant.

Another area moving very rapidly to an online model is entertainment (in the form of books, music, video and games). Since reading books, listening to music, watching video and playing games can be done using the device connecting to the Internet, the barriers to direct consumption are rapidly evaporating. Therefore, previously unconnected electronic goods, such as TVs and game consoles are now being modified to enable connectivity.

On the other side of the fence, online versions of books, music, video and games that could be downloaded and consumed on a traditional computer or any other connected device are becoming available. Since the shift in consumption patterns is resulting in multi-functional electronic gadgets that are no longer optimized for a particular activity, there is a great drive to develop technologies that could improve the quality of each experience.

e-Tail Strategies

The changing environment where consumers are increasingly connected have prompted retailers to develop new sales strategies. While many of the big traditional retailers and companies with well-known brands have opened their own online stores, others (including many smaller players) are increasingly tying up with websites like Amazon.com Inc. (AMZN), eBay Inc. (EBAY), Priceline.com Inc. (PCLN), Expedia Inc. (EXPE).

One of the most recent developments in the e-tailing sphere is the sale of discount coupons, where Groupon appears to be the forerunner. Groupon and its closest rival LivingSocial offer discount coupons with a very low shelf life from local players looking for sales. The company offers huge discounts to attract buyers and collects a percentage of the sales thus generated.

This kind of business is very competitive since it has very low barriers to entry. As a result, not just Amazon and Google, but also a host of other much smaller parties have started doing business in this format. Technology investments are also required in order to serve customer needs effectively. It is expected that Groupon’s recently-announced IPO would enable the company to invest in the business as necessary.

Another concept that has come up recently can best be termed social marketing. This is a concept being tried out by Facebook, one of the most popular social networking sites in the world. Forrester Research estimates that over 50% of the U.S. population has a Facebook account, and this is the potential that the platform will initially address.

SocialStore, as it is called, uses MarketLive’s Intelligent Commerce Platform that enables marketers to display product information, promotions/discounts, shopping carts and check-out options. Both comparative shopping and comparative pricing are possible. The basic advantages of the system that are currently being touted are that it allows easy brand building, creates meaningful commercial relationships and makes use of account-holders’ social connections to attract new buyers.

Retail e-Commerce

ComScore has provided first quarter retail ecommerce sales numbers. The firm estimates that sales increased 12% from the first quarter of 2010, representing the second straight quarter of double-digit growth and the sixth straight quarter of positive growth.

Moreover, the unadjusted figures from the U.S. Commerce Department puts total retail sales in the first quarter of this year 1.2% higher than during the first quarter of 2008 (pre-recession), compared to e-retail sales growth of 26.3% during the same time period.

ComScore also stated that the number of buyers increased 7%, the transactions per buyer increased 9% and the value per transaction declined 4%. The data validates our theory that there were a larger number of mobile transactions for lower-value items.

Forrester Research believes that rapid growth in online retail sales in the U.S. will continue to come at the expense of brick-and-mortar outfits. ComScore adds that this increase is mainly on account of the lower prices and convenience of online transactions.

It also stated that high gas prices and a persistently high level of unemployment were driving consumers to increase their online purchases. It is therefore expected that online sales would suffer only slightly even if prices were to go up further.

Free shipping remains a major lure, with ComScore estimating that 61% of customers were somewhat likely to cancel their purchases in its absence. Overall, 47% of purchases in the last quarter included free shipping, compared to 49% in the previous quarter (which was also the holiday season).

Total retail e-commerce is currently 8.6% of total retail sales, according to ComScore. Forrester Research estimates that this share will go up to 11% by 2015. 2011 is expected to see a 12% growth in the U.S. and a 13% growth in Europe.


The U.S. Commerce Department expects the overall travel market to grow at an average rate of 6-8% from 2010 to 2016, with China, South Korea, Brazil, Russia and India, in that order, expected to be the largest contributors. All of these countries, with the exception of India, are expected to grow at triple-digit rates, while India is expected to grow at just under a triple-digit rate. Travel and tourism is one of the country’s strongest industries, contributing a trade surplus in each of the last 20 years.

According to a report by PricewaterhouseCoopers, the improving economy will result in a 3.2% increase in demand for hotel reservations, which along with a 0.6% increase in hotel supply will lead to higher occupancy rates (59% expected in 2011 compared to 57.6% in 2010). This will also raise hotel rates by 5.1%.

According to eMarketer estimates, US online sales of leisure and unmanaged business travel will increase 8.5% this year. eMarketer believes that the increase in spending is mainly on account of higher airfares, hotel rates and ancillary fees, which increase the aggregate dollar amount of online bookings. Booking through mobile devices is expected to grow significantly, with 11.8 million new users.

However, another report by PhocusWright mentioned that when online penetration of the travel market reached 35% in any country, growth rates were likely to slow down to single-digits. The research firm mentioned that only the U.S., U.K. and Scandinavia had reached this level of penetration and most other markets across Europe, Asia and Latin America would continue to show good growth rates.

Payment Systems

The most recent development in payment systems is Google Inc’s (GOOG) digital wallet, which allows a customer to make a payment by waving his mobile phone over a POS terminal. While the near-field communication (NFC) technology used in the system is already in use in some parts of Europe, the concept is relatively new to the U.S. Other than convenience, the main attraction being highlighted is the security of the payment channel, since neither the customer nor the retailer would be recording the personal information related to the customer.

Adoption of the device, although it is a ways off, will have a remarkable effect on the volume and value of mobile transactions, since it should increase the percentage of higher-value sales through the mobile platform.

The digital wallet is a great improvement over eBay’s (EBAY) existing payment system, Paypal, which takes away a significant percentage of earnings from the retailer or person providing the service. Moreover, although the system is itself secure, there is always a security risk for a buyer not used to dealing with Paypal, since it requires that you provide personal information.

Traditional payment systems (from banks) also realize that people are now spending more time online and have therefore stepped up their investments in related IT. The results of a survey by the American Bankers Association (ABA) show that U.S. consumers are increasingly going online.

More than 35% of consumers questioned in the middle of 2010 felt that the Internet method of banking was their most preferred, a significant increase from 2009, when 25% felt that the Internet was their most-used method. Moreover, Internet banking is the most preferred for age groups below 55 and the second-most preferred for age groups above that. Preference for ATMs continues to decline.

eMarketer reported that a Novantas study showed a similar shift in customer preferences. According to that study, the percentage of customers transferring funds online went from 34% in 2005 to 67% in 2010, product research through the Internet went from 46% to 77%, while balance checking went from 44% to 76%. However, according to an Emphatica study, mobile banking has not picked up sufficiently in either the U.S. or Canada, due to security-related concerns.


With online transactions expected to boom over the next few years, the top-most concern remains security. While banks will spend significantly on secure payment systems, hackers are expected to have a field day, largely targeting the flood of customers going online. The recent data breach at Citibank, a part of Citigroup (C), is testimony of this fact.

Alternative payment systems will continue to gain popularity. While some of these payment systems, such as eBay’s PayPal have been around for awhile, other systems such as Google’s digital wallet are still in the making. Alternative payment systems never really gained momentum in the past because of the low volume of transactions. However, as online transactions continue to increase, many more such systems could suddenly become more available.

We expect mobile security to become a major focus area for technology companies, since this is the stumbling block to payments through the mobile platform (currently just 2% of U.S. online spending). Additionally, hackers continue to multiply and data breaching has become commonplace.

Online Advertising

The U.S. online advertising market has seen some very strong growth in the past few years, despite the recession that impacted the entire economy. eMarketer estimates that the market will grow 20.2% in 2011 to $31.3 billion, compared to the 14.9% growth witnessed in 2010.

However, growth rates are expected to drop over the next few years: 17.6% in 2012, 12.0% in 2013, 10.4% in 2014 and 8.8% in 2015. Falling growth rates notwithstanding, the share of online ad spending in total ad spending is expected to increase from 20% this year to 28% in 2015. By contrast, TV ad spending is expected to remain steady at around 38% throughout.

The current strength in online advertising is coming primarily from the growing popularity of the display format. Of all the forms of online advertising, display (including video, banner ads, rich media and sponsorships) is expected to see the strongest growth over the next few years, overtaking search by 2015. It is already pretty close on the heels of search ($9.91 billion in 2010 compared to $12.0 billion for search).

The lower pricing of video and banner ads has made them popular with brand advertisers, so ad inventories are solid. eMarketer expects that 39.4% of ad budgets will be devoted to branding in 2011, fueling growth in display ads. Facebook is also expected to have a significant impact.

The underlying drivers of growth are the continued increase in the number of users, greater propensity of users to consume online, a growing inventory of advertisements that serve to lower advertisement prices and the push into display advertising.

Search advertising is expected to remain popular, however, because results are measurable, and therefore, more predictable than other media. This also makes the market more resilient in recessionary conditions, since advertisers are more confident about the results of their spending.


We can strongly recommend very few stocks in the sector right at this point. However, slightly longer-term opportunities abound, as have been outlined below.

Online travel companies, such as Expedia Inc (EXPE) and Priceline.com (PCLN) are in a strong growth market. Consequently, they should continue to benefit from international expansion and customers moving online.

Domestic growth will likely be slower and mainly driven by the continued improvement in the economy. While Orbitz Worldwide (OWW) is a much smaller player with more limited resources, it too should benefit from these trends.

However, China will be disappointing, as local players and the government continue to make operations difficult for U.S. players. Occupancy tax issues are likely to remain a point of contention and online travel agents appear to be fighting a losing battle.

As far as e-tailers go, the foremost remain Amazon.com (AMZN) and eBay (EBAY). Amazon’s opex has been on the rise and likely to remain high through the year, as the company invests to take growth to the next level.

Although estimates have been going down and earnings growth is likely to be limited in 2011, we believe the company remains one of the most attractive long-term investments, with a solid growth strategy and good prospects both nationally and internationally.

The search market is dominated by Google Inc (GOOG), which has seen phenomenal growth rates over the last five years. The company is a leading innovator, using its engineering talent to extend its position in the computing platform to the mobile platform. The company has a huge cash balance that we were concerned was not being put to the best use.

However, it remains acquisitive, which should further round out its product portfolio, build on current strengths and help expansion into new areas. Google’s main challenge is the increasing competition from not just archrival Yahoo Inc (YHOO), but also challenger Microsoft Corp (MSFT), who’s Bing search engine continues to gain ground in the U.S.

A much smaller provider of Internet advertising solutions and online marketing services, ValueClick Inc. (VCLK) should also benefit from the strength in the online advertising market (particularly display), international expansion, restructuring actions and strong cash flows. However, as firms with larger advertising budgets increase spending on Internet advertising, many of the services performed by ValueClick could be done in-house. This is a risk of investing in the stock.


E-tailer eBay continues to play catch-up with Amazon. The company is undergoing a metamorphosis, with a new image, new strategies and technology investments. We expect eBay’s results to improve going forward, driven by its Paypal payment platform. However, Amazon remains the better play, in our opinion.

Meanwhile, competition continues to intensify for Akamai Technologies, Inc. (AKAM), which provides distributed e-business infrastructure services and solutions. The low barriers to entry are also a concern, since this is a market adjacency that any large Internet or networking company could venture into. Falling bandwidth prices are a pressure on margins, while rising bandwidth costs are attracting new players. However, broadband penetration and momentum in online media and entertainment remain tailwinds.

Yahoo! (YHOO) is second only to Google in the search market, although the company has not seen much gain in market share. Management remains focused on the display segment, which should pay dividends if projections for that market hold good.

Yahoo has a leading position in email applications and is building on this position through acquisitions and upgrades, which should ultimately help it turn around. However, monetization of the search alliance with Microsoft remains behind schedule and there is some controversy related to its Asian assets, which are the main attraction in the shares.

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