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The Electronic Commerce, or e-commerce, industry is one of the fastest moving 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, 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. Smartphones continue to lead the way all over the world, although tablets are growing very fast, followed by other devices.  comScore estimates that non-computer Internet traffic in the U.S. was 6.8% in August 2011, with smartphones accounting for two-thirds and tablets accounting for most of the rest. Other countries with significant Internet traffic through non-computing devices include Singapore, the U.K., Japan, Australia, Canada, Spain, India, France and Brazil, in that order.

In the fourth quarter of 2011, over 47% of U.S. mobile phone subscribers used smartphones to connect to the Internet, compared to 31% at the start of 2011. Recent market research indicates that price comparisons, product reviews and product availability are checked online through mobile phones roughly a third of the time. Around 20% of consumers even check prices at rival websites while they are in a store, and a third of these shoppers are diverted.

While smartphones are extremely convenient when on the move, tablets have several advantages of their own. In fact they are a boon to the e-commerce industry, since the larger screens offer better visibility of online stores and merchandise, thus facilitating purchases. In an earlier study, the Etailing Group determined that 68% of tablet owners surveyed made an online purchase, compared to 48% of smartphone users. Given the unique advantages of the devices, it appears that they are working in conjunction to boost total online retail sales.

The popularity of the iOS-based devices has given the OS the largest market share, although Android is hot on its heels.

Digital content and subscriptions, jewelry and watches, consumer electronics, toys and hobbies, and consumer software were the hottest-selling items in the fourth quarter of 2011, with each category growing at least 18% from the year-ago quarter.

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 can 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 Inc. ([url=]AMZN[/url]), eBay Inc. ([url=]EBAY[/url]), Inc. ([url=]PCLN[/url]), Expedia Inc. ([url=]EXPE[/url]).

Amazon has for some time depended on the Kindle platform to boost book sales. But considering the growing competition from tablets, particularly Apple’s ([url=]AAPL[/url]) iPad, the company decided to broaden the scope of the device. Therefore, the recently launched Kindle Fire will not only help sales of books, but also all kinds of other digital content, including songs and movies. Future versions of the device may even be on par with the iPad.

Another recent development includes the sale of discount coupons, where Groupon ([url=]GRPN[/url]) 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 ([url=]GOOG[/url]), 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 recent IPO would enable the company to invest in much-needed technology and thereby differentiate itself.

Another concept that has come up recently can best be termed social marketing. This is a concept being tried out by Facebook, the most popular social networking site in the world. Currently, around half 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.

A recent study by the E-tailing Group reveals that of 100 U.S. consumer product merchants with e-commerce websites surveyed, 98 had a Facebook account. Around 90% of these redirected the user to the merchant’s own page, 96% had loaded brand-building videos, 56% had product-oriented videos, 44% had store locators and 38% had promotions.

Retail e-Commerce

ComScore has provided fourth quarter 2011 retail ecommerce sales numbers. The firm estimates that sales increased 14% from the fourth quarter of 2010, representing the fifth straight quarter of double-digit growth.

Moreover, total retail sales in the fourth quarter were 68.2% higher than the third quarter of 2009 (the bottom) and 62.5% higher than the second quarter of 2008 (pre-recession).

The 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.

Free shipping remains a major lure, with an e-tailing group survey showing that 73% of customers wanted unconditional free shipping, with 42% agreeing that free shipping would be welcome when they reached a certain spending level. Overall, 52% of purchases in the last quarter included free shipping, compared to 49% in the year-ago quarter.

Total retail e-commerce is currently 4.6% of total retail sales, according to the monthly retail trade survey by the U.S. Census Bureau. Forrester Research estimates that this share will go up to 11% by 2015.


The U.S. Commerce Department expects international travel to the U.S. to continue over the next few years. Visitor volume is currently expected to increase 6-8% a year from 2012 to 2016, leading to a 49% increase in the number of users during the period. Visitors from the Middle East are expected to be the slowest-growing (29%). South America, Asia and Oceania growth rates are expected to be comparable at 83%, 82% and 82%, respectively.

The fastest growth is expected to come from China (232%), South Korea (200%), Brazil (150%), Russian Federation (139%) and India (94%). 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 1.8% increase in demand for hotel reservations this year, which along with a 0.5% increase in hotel supply will lead to higher occupancy rates (60.9% expected in 2012 compared to 60.1% in 2011). This will also raise hotel rates by 5.1%.

eMarketer estimates that online sales of leisure and unmanaged business travel in the U.S. increased 8.5% in 2011 (2012 estimates not available yet). eMarketer believes that the increase in spending was mainly on account of higher airfares, hotel rates and ancillary fees, which increase the aggregate dollar amount of online bookings. Booking through mobile devices was expected to grow significantly, with 11.8 million new users.

However, another report by PhocusWright mentioned that when online penetration of the travel market reaches 35% in any country, growth rates are likely to slow 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

With practically all market research indicating solid growth in e-commerce sales over the next few years, online players are vying with each other to come out with convenient and secure payment solutions. Perhaps the most recent was the FIS Mobile Wallet from Fidelity National Information Services Inc. ([url=]FIS[/url]). The solution is basically a bar code reader that feeds information related to the purchase into the user’s smartphone and uses it as a medium to transfer the information to the cloud.

Online purchase of merchandise is also possible. The solution provides maximum security, since the transaction is carried out entirely in the cloud through the retailer’s and banker’s applications, and personal information is not shared at the time of purchase.

Google's digital wallet allows a customer to make a payment by waving a 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 some way 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. However, cost of POS terminals could turn some merchants away, particularly if the FIS solution catches on. However, this is an evolving area and customer relationships will be key to success going forward.

The digital wallet was a great improvement over eBay’s 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) are also being adapted due to the realization that people are now spending more time online. Banks therefore have 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 36% of consumers questioned in the middle of 2011 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%.

According to an Emphatica study, mobile banking has not picked up sufficiently in either the U.S. or Canada due to security-related concerns. However, an analysis by Deloitte shows that mobile banking could become the most-preferred banking method by 2020. The study estimates that 20-25 million "Gen Y" consumers will become new banking customers by 2015.

It is believed that high smartphone penetration, higher income within this group and greater digital sophistication will drive increased demand for mobile banking services. Since mobile banking is expected to be the most cost-efficient for banks, investment in technology to improve and expand mobile banking services is likely to increase.


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. Last year saw a huge increase in security breaches, something that may be expected to continue.

Alternative payment systems will continue to gain popularity. While some of these payment systems, such as eBay’s PayPal have been around for a while, other systems, such as Google’s digital wallet and the FIS Mobile 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. This year, the market will benefit from the major national election and the summer Olympics. eMarketer estimates that the market will grow 23.3% in 2012 to $33.8 billion, compared to the 23.0% growth in 2011. However, growth rates are expected to drop over the next few years: 17.7% in 2013, 13.5% in 2014, 8.9% in 2015 and 7.8% in 2015.

Falling growth rates notwithstanding, the share of online ad spending in total ad spending is expected to increase from 20% in 2011 to 31% in 2016. By contrast, TV ad spending is expected to drop slightly from around 38% of total ad spending in 2011 to less than 37% in 2016. Print is expected to decline even more significantly, from 22.6% in 2011 to 16.4% in 2016.

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. Also, of all the forms of display advertising, video and banner ads are expected to grow the strongest from 2011 to 2016.

Contrary to previous expectations, it now appears that search will remain supreme throughout, although its share will give way slightly to video ad spending which will nearly double. The lower pricing of video and banner ads has made them popular with brand advertisers, so ad inventories are solid. Another factor favoring display ads is the proliferation of smartphones, where the smaller screens make display ads more effective than text ads.

Facebook, which is soon to have its IPO, is the largest player in the display ad segment with a 28% share. Yahoo ([url=]YHOO[/url]) is in second position with 11%, followed by Microsoft ([url=]MSFT[/url]), Google and AOL ([url=]AOL[/url]) with less than 5% each (comScore estimates). [There is some controversy in market share numbers provided by IDC and comScore; we are going with comScore.]

The underlying drivers of growth of the display format 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, 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 at this point. However, longer-term opportunities abound, as have been outlined below.

Online travel company Priceline ([url=]PCLN[/url]) is in a strong growth market. Consequently, it 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 ([url=]OWW[/url]) is a much smaller player with more limited resources, it too should benefit from these trends. However, expansion in China will be disappointing, as local players and the government continue to make operation difficult for U.S. players. Occupancy tax issues are likely to remain a point of contention and online travel agents have recently scored a few wins.

The search market is dominated by Google Inc ([url=]GOOG[/url]), 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, but also challenger Microsoft, who’s Bing search engine continues to gain ground.

A much smaller provider of Internet advertising solutions and online marketing services, ValueClick Inc. ([url=]VCLK[/url]) should also benefit from the strength in the online advertising market (particularly display), the recently acquired Dotomi, 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.


As far as e-tailers go, the foremost remain ([url=]AMZN[/url]) and eBay ([url=]EBAY[/url]). Amazon’s opex has been on the rise and is likely to remain high through the year, as the company invests to take growth to the next level. Although we expect the strong revenue growth to continue, the continued addition to its operating leverage will keep earnings depressed for some time.

As international sales gain momentum and the shift from offline to online purchasing continue, margins should respond and trickle down to the bottom line.  However, we don’t see this happening in the next 6 months (which is our long-term investment horizon).

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.

Online travel company Expedia ([url=]EXPE[/url]) is not likely to do as well as Priceline, as the company will feel the impact of the TripAdvisor spinoff. Moreover, it has exposure to the air ticket segment, where competition is on the rise and airline policies are raising ticket prices. The resultant decline in air ticket sales is negatively impacting its results.

Meanwhile, competition continues to intensify for Akamai Technologies, Inc. ([url=]AKAM[/url]), 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, such as Google, Yahoo!, AT&T, Verizon, Cisco or Lucent 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 ([url=]YHOO[/url]) 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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