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October 2008, Global Retail Insights #GRI214419

Retai l and Onl ine Commerce Infrastructure: Understanding Total Cost of Ownership

W H I T E P A P E R Sponsored by: Akamai

Scot t Langdoc October 2008

G L O B A L R E TAI L I NS I G H T S OP I N I O N

For over a decade, traditional retailers have looked at the emergence of the Internet-based sales channel with both passion and trepidation. It has been obvious to the industry that online commerce represents a great growth opportunity; however, early on, many merchants felt the channel represented more evolution than revolution, and they were unsure of how long-standing customers would adjust their loyalties or adapt their shopping behaviors. Today, traditional retailers are facing a customer base that increasingly expects a transparent multichannel shopping experience, led by powerful Millennial-aged consumers who demand nothing less than a perfectly performing online retail environment anywhere and anytime.

Unfortunately for many retailers, the challenge of supporting an advanced multichannel shopping environment comes with increasing legacy costs and complexity � not just in capital investments in servers, storage, and networks but also from a broad list of indirect infrastructure expenses. As merchants evaluate their online commerce technology strategies (for customers as well as suppliers) they must make sure to quantify this expanded view of one-time and ongoing costs when deciding how best to leverage new Web technologies.

Findings from recent Global Retail Insights (GRI) research has shown that an increased list of financial and operational benefits, driven from new (usually outsourced) online commerce infrastructure platforms, can be significant for retailers at different revenue and online maturity levels. These measurable benefits should become central in any business case justifications or future online infrastructure vendor selections.

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Page 2 #GRI214419 ©2008 Global Retail Insights, an IDC Company

I N T H I S W HI TE P A P ER

This white paper provides a comprehensive view of numerous legacy costs as part of a total cost of ownership (TCO) assessment of a retailer's in-house support of its online channel infrastructure. It explores the potential benefits to TCO that can result from a migration to outsourced, purpose-built online commerce infrastructure models. The document also analyzes research results that show how different retailers at different levels of online selling maturity can be directly impacted by a better understanding of current costs and future benefits. Lastly, it provides specific metrics to use as sample guides when undertaking this evaluation.

S I T U A TI O N O VE R VI E W

R e t a i l e C o m m e r c e : A D r a m a t i c S h i f t f r o m C o m p e t i t i v e A d v a n t a g e t o B u s i n e s s I m p e r a t i v e

To many traditional retailers, the emergence of online selling was intriguing � but not enticing enough to counteract ongoing investments in brick-and-mortar selling technologies. The success of many online-only retailers such as Amazon proved that consumers were growing comfortable with buying a wider variety of merchandise online. Early industry adopters of multichannel selling established Web sites that were often run independently of traditional stores with separate inventories and pricing strategies, yet still provided a point of differentiation from retailers slow to add online capabilities. Even while recent retail ecommerce sales growth in the United States has been slowing when compared with its early meteoric rise, the U.S. Department of Commerce is predicting that over $140 billion of 2008 sales will be derived from online, representing over 4% of total retail sales. According to Internet Retailer, in 2007, the top 500 retailers grew online sales over 21%, representing nearly 61% of the total retail ecommerce sales volume that year.

2008 represents a tipping point in the move from early multichannel selling � where online capabilities by traditional retailers were considered differentiating � to the newest model where consumers expect complete multichannel flexibility as a normal part of the retailer offering. As noted in GRI's Worldwide Retail Industry 2008 Top 10 Predictions, any traditional retailer that does not move toward multichannel transparency immediately risks its overall business success as a higher percentage of total industry sales move to online. Figure 1 depicts the contributing or resulting impacts from business-to-consumer (B2C) or business-to-business (B2B) applications.

©2008 Global Retail Insights, an IDC Company #GRI214419 Page 3

Retailers have backed up this move toward multichannel operations with increased technology spending. The GRI Worldwide Retail IT Spending Guide, Version 1, 1Q08 forecasts that worldwide ecommerce software spending will reach nearly $208 million in 2011, while volume server spending (of which 5�10% is typically oriented toward ecommerce when internally managed) will exceed $2.01 billion in 2011.

F I G U R E 1

e C o m m e r c e B u s i n e s s D r i v e r s

Shopping Experience

Advanced Web Technologies

Bran

d V

alue Financial

Performance

B2B & B2CApplications

Online CommerceInfrastructure

Shopping Experience

Advanced Web Technologies

Bran

d V

alue Financial

Performance

B2B & B2CApplications

Online CommerceInfrastructure

Source: Global Retail Insights, 2008

T h e T o t a l C o s t o f O w n e r s h i p o f a L e g a c y B 2 C e C o m m e r c e P l a t f o r m : M o r e T h a n Y o u T h i n k

Traditional retailers of all sizes that continue to manage and expand their internal ecommerce technology to keep pace with both sales growth and new Web features must face the need to understand all of the various cost components that go into this specific strategy and not just the capital-oriented investments for new server and network equipment. Given the up-front size of ecommerce infrastructure capital, it is not surprising that management is typically focused on this


spending. However, when a retailer considers all the cost components that make up the TCO of supporting its own ecommerce platform, the full economic impact of that model can become quite daunting. Global Retail Insights suggests retailers look at this spectrum of TCO cost components and organize these components into four major categories (see Figure 2):

1. Capital costs. The most visible and traditional investments in ecommerce platforms, these costs include selection and acquisition of servers to support Web site, application, and database processing, as well as appropriate storage, network infrastructure, and datacenter infrastructure upgrades required for server farm expansion.

2. Operational costs. These involve the ongoing month-to-month direct and indirect expenses around operating an ecommerce selling infrastructure. This category includes power and cooling costs for hardware platforms, which can run as high as $80 per month per server. It also includes the labor and associated expenses with ongoing platform monitoring and management.

3. Support costs. This category is another iterative part of the expense model of maintaining an internal ecommerce platform and an efficient B2C and B2B experience. It includes typical internal help desk activity as well as call center spending on expensive phone orders � usually two to three times the per-transaction cost of a completed Web order. It can also include specific investments in site performance tuning and server planning, especially for retailers with current or future plans for global sales expansion.

4. Opportunity costs. These are the "soft" costs associated with not making the right investments in the upkeep and expansion of a retailer's internal ecommerce environment. This category represents the money "left on the table" and includes the impacts of conversion rate, site downtime, cart abandonment by potential buyers, as well as missed sales and profit potential from lack of global or new geographic expansion. It also can capture the risk management costs surrounding a retailer's brand image with its loyal (yet shifting) consumers.


F I G U R E 2

T C O M o d e l : L e g a c y e C o m m e r c e I n f r a s t r u c t u r e

CapitalCosts

SupportCosts

OperationalCosts

OpportunityCosts

Cost Categories

�Servers (Web, App, DB)�Storage�Network equipment�Datacenter configuration

Direct & Indirect Costs

�Power�Cooling�Site control/monitoring

�Call center�IT help desk�Maintenance�Performance tuning

�Conversion�Site downtime�Site abandonment�Global growth�Brand/banner image

CapitalCosts

SupportCosts

OperationalCosts

OpportunityCosts

Cost Categories

�Servers (Web, App, DB)�Storage�Network equipment�Datacenter configuration

Direct & Indirect Costs

�Power�Cooling�Site control/monitoring

�Call center�IT help desk�Maintenance�Performance tuning

�Conversion�Site downtime�Site abandonment�Global growth�Brand/banner image


T h e N e w R u l e s o f B 2 C a n d B 2 B C o m m e r c e : A d v a n c e d T e c h n o l o g i e s a n d C a p a b i l i t i e s

Even as retailers assess a broader list of costs (and potential benefits) of their internal ecommerce infrastructure platforms, the growing opportunities presented by a slew of new Web-oriented technologies and application strategies (as referenced in Figure 3) are being shown to have positive � and in some cases significant � financial impact on ecommerce sales and profitability. Some of these new advancements include:

● Dynamic applications. The rapid acceleration of Web 2.0 technologies such as AJAX gives retailers the opportunity to create a more engaging and interactive environment with shoppers. This can involve better merchandise review, integrated social network, and collaborative guided selling. Effective use of these technologies in creating a better online shopping experience can increase conversion rates 30% to 45%.


● The power of motion. Retailers in many different segments, especially in specialty and hardlines, have seen the influencing power of Web-based video as a tool for ensuring the full breadth of information and support is given to shoppers and potential buyers. Video-savvy retailers have seen ecommerce sales increase as much as 40%, while return rates decrease.

● Predictive site performance. Even with all the best demand management tools, retailers often struggle with the challenge of "lumpy demand," where specific promotions or increased holiday spending creates distinct "spikes" in visitor traffic � often at the expense of page loading and search speeds. Short-term impacts include customer dissatisfaction with the online experience and lost sales; long-term impacts include the permanent loss of customer loyalty and share of wallet. Many retailers operating their own environment will keep spare server capacity (as much as 10�20% of typical operating requirements) available to deal with these short increases in volume � at much capital and expense investment. The alternative is to run a leaner operation and risk running out of capacity to serve customers.

● Geographic transparency. Even with specific geographic focus on the traditional retail stores, many retailers with powerful brands are using their Web sites to branch out to other emerging markets. This often requires unique hosting arrangements in different geographies as well as significant network and integration expense.

● The new global supplier network. With much of the ecommerce infrastructure focus directed toward the consumer, it's often easy to forget that most retailers maintain a highly decentralized supplier network and are increasingly in need of more real-time connectivity and collaboration with partners on issues such as ordering portals, private label development, promotion planning, and data synchronization. As suppliers become more geographically dispersed, global connectivity becomes more important. Accordingly, traditional retailers should give B2B infrastructure and activities a similar level of attention as they give the infrastructure and activities for mainstream consumer ecommerce. A 4,000-employee company often transforms into a 40,000-person distributed value network, all expecting a high-performance application.


F I G U R E 3

A d v a n c e d R e t a i l e r e C o m m e r c e F u n c t i o n a l M o d e l

B2C eCommerceApplications

VideoDynamicContent

Full SiteSearch

Cross‐ChannelIntegration

GlobalSelling

PLM

DataSynchronization

SupplyVisibility

CollaborativePromotions

Sourcing

B2B Portal

Retailer Online Commerce Infrastructure

Shoppers Suppliers

B2C eCommerceApplications

VideoDynamicContent

Full SiteSearch

Cross‐ChannelIntegration

GlobalSelling

PLM

DataSynchronization

SupplyVisibility

CollaborativePromotions

Sourcing

B2B Portal

Retailer Online Commerce Infrastructure

Shoppers Suppliers


D i f f e r e n t R e t a i l e r B u s i n e s s M o d e l s C r e a t e V a r y i n g e C o m m e r c e I n f r a s t r u c t u r e T C O I m p a c t s

With a better understanding of the total TCO picture for ecommerce infrastructure, retailers can make a more quantifiable analysis of the value proposition of platform outsourcing. However, given the wide disparity in retailer configurations and ecommerce maturity, it quickly becomes evident that "mileage will vary" between retailers and their specific cost and benefit metrics.

To determine which specific factors different retailers would see impacting TCO benefits for outsourcing an ecommerce infrastructure platform, Global Retail Insights conducted an analysis of select retailers across different geographies and different sales volume (both total revenue and online only). The study focused on what unique ecommerce capabilities were in use or being considered for deployment, and their direct and indirect impacts on costs or sales performance. Survey results from retailers were collected in three major geographic regions (North America, Europe, and Asia) and included questions involving current and future ecommerce spending and actions. The replies were organized into two defined retailer profiles based on total revenue levels.


Profile #1: Online Retailers with $10 Million to $100 Million in Total Revenue

Survey Results Analysis. On average, survey respondents in this revenue range tended to have smaller, more pragmatic approaches to their online channel then their larger brethren. Almost 60% of this group of retailers in the study did less than 5% of their total revenue via ecommerce, with 30% of the same group receiving less than 10,000 visitors per month to their site. The geographic scope was also more contained � fully two-thirds of retailers in this group focused only on ecommerce business in their "home region" and had no global expansion plans. Also limited was use of newer Web and integration technologies � less than 20% of smaller retailers in the study were using video, only 15% were using dynamic applications, and only a third had any form of online, real-time store inventory visibility.

Though demand spikes experienced by these retailers were smaller than those of the larger retailers in the study, 45% of the SMB retailers in the study addressed capacity issues primarily through purchase or leasing of additional internal ecommerce systems. Most of the B2B activity for these smaller retailers was oriented toward eprocurement (50%) and basic data exchange (75%) and not more advanced capabilities such as private label development or product life-cycle management (PLM) (30%).

Completing the TCO Business Value Worksheet. In helping to model some of the expanded benefits (both cost reducing and revenue producing), Global Retail Insights has created a worksheet that uses a specific retailer example configuration following criteria provided by survey respondents in the primary research. This example data, calculated against a verified set of ecommerce-oriented improvement metrics, helps establish the value proposition for improving the typical retailer's ecommerce infrastructure.

Using an example retailer with $80 million in total annual sales and $5.6 million in current online sales, we can isolate eight specific improvement metrics that generate new online revenue, reduce costs, or improve margins. We use a defined net margin percentage to extract incremental profit from any projected sales increases so that it can be combined with direct cost reductions. As shown in Figure 4, with these potential improvements defined, this example SMB retailer could drive over $350,000 in annual TCO benefits after migrating to a new ecommerce infrastructure.


F I G U R E 4

T C O B e n e f i t s W o r k s h e e t f o r E x a m p l e S M B R e t a i l e r

Example RetailerAnnual sales $80,000,000

% of sales from online 7%

Total online sales (yr) $5,600,000

Average online net profit 6.5%

Average visitors/month 20,000

Average online order size $333

Conversion rate 3%

Use of rich applications 15%

Use of video 20%

Cross‐channel integration 35%

Number of suppliers 2,200

Average search speed 5.5 seconds

Potential Annual TCO Impact $353,250

Profit from sales increase

Annualized cost reduction $156,000

Outsourced eCommerce Infrastructure � Potential TCO Benefits (Annualized)

Cost Component ImpactImprovementAnnual Business

BenefitDynamic applications & video Revenue20% sales increase $1,120,000Site abandonment Revenue25% reduction in abandoned transactions $400,000Conversion rate RevenueAverage 3% increase $600,000Site availability RevenueUptime from 99.5% to 99.9% (35 hours) $22,610Search speed Revenue9% conversion improvement $500,000Geographic expansion Revenue10% sales increase 392,000

Call center � phone ordersSupplier network

Annualized sales increase $3,034,610

Annualized sales increase

Average online net profit %

$3,034,610X 6.5%

$197,250

15% call volume reduction2 minutes saved/PLM transaction

$36,000$120,000

CostCost

Revenue

Revenue

Example RetailerAnnual sales $80,000,000






Conversion rate 3%


Use of video 20%




Potential Annual TCO Impact $353,250


Annualized cost reduction $156,000



BenefitDynamic applications & video Revenue20% sales increase $1,120,000Site abandonment Revenue25% reduction in abandoned transactions $400,000Conversion rate RevenueAverage 3% increase $600,000Site availability RevenueUptime from 99.5% to 99.9% (35 hours) $22,610Search speed Revenue9% conversion improvement $500,000Geographic expansion Revenue10% sales increase 392,000





$3,034,610X 6.5%

$197,250


$36,000$120,000

CostCost

Revenue

Revenue


Profile #2: Online Retailers with $100 Million to $5 Billion in Total Revenue

Survey Results Analysis. Our study shows that the depth and breadth of ecommerce activities is broader for larger retailers than for their smaller colleagues. While on average online sales as a percentage of the total was still relatively small in our study sample, a full 30% of retailers did as much as 10% of their sales online � twice the smaller retailer average. Visitor counts were also higher; half of the larger retailers in the study had between 10,000 and 100,000 visitors per month, and 30% had between 100,000 and 1 million monthly visitors. Two-thirds of the large retailers in our survey showed current or future market expansion as part of their ecommerce strategy. While dynamic


application usage was shown to just be expanding for the majority, nearly 85% of larger retailers today are using video on their B2C sites. Store inventory access was much higher, with two-thirds allowing online shoppers to see store stock levels.

Demand variability from marketing actions was more pronounced among the larger retailer respondents, with 60% seeing volume "spikes" between 50% and 100%. Larger retailers were also focusing on more advanced capabilities for B2B ecommerce with their supplier community. Nearly 50% noted PLM as the application area requiring speed improvement today.

Completing the TCO Business Value Worksheet. Using an example large retailer with $1.8 billion in total annual sales and $162 million in current online sales, we can isolate eight specific improvement metrics that generate new online revenue, reduce costs, or improve margins. We calculate sales against an average net profit margin to normalize the benefits to an annualized TCO impact potential. As shown in Figure 5, this example tier 1 retailer could drive over $4.4 million in annual TCO benefits after migrating to a new ecommerce infrastructure. Even with only half (9% versus 20%) of the sales increase of the smaller retailer example (due to incremental use of new dynamic applications), the larger revenue base of this profile still has the potential for a $14.5 million sales increase, along with $2.7 million in profit improvement from the incremental efficiency of better and broader B2B transaction management resulting from a more responsive and scalable ecommerce infrastructure.


F I G U R E 5

T C O B e n e f i t s W o r k s h e e t f o r E x a m p l e L a r g e R e t a i l e r

Example RetailerAnnual sales $1,800,000,000






Conversion rate 2.5%


Use of video 80%




Potential Annual TCO Impact $4,419,066


Annualized cost reduction $2,892,000



BenefitDynamic applications & video Revenue9% sales increase $14,580,000Site abandonment Revenue25% reduction in abandoned transactions $414,720Conversion rate RevenueAverage 2.5% increase $777,600Site availability RevenueUptime from 99.99% to 99.995% (7 hours) $4,522Search speed Revenue9% conversion improvement $648,000Geographic expansion Revenue7% sales increase $11,340,000





$27,764,842X 5.5%

$1,527,066


$192,000$2,700,000

CostCost

Revenue

Revenue

Example RetailerAnnual sales $1,800,000,000






Conversion rate 2.5%


Use of video 80%




Potential Annual TCO Impact $4,419,066


Annualized cost reduction $2,892,000



BenefitDynamic applications & video Revenue9% sales increase $14,580,000Site abandonment Revenue25% reduction in abandoned transactions $414,720Conversion rate RevenueAverage 2.5% increase $777,600Site availability RevenueUptime from 99.99% to 99.995% (7 hours) $4,522Search speed Revenue9% conversion improvement $648,000Geographic expansion Revenue7% sales increase $11,340,000





$27,764,842X 5.5%

$1,527,066


$192,000$2,700,000

CostCost

Revenue

Revenue


O u t s o u r c i n g t h e R e t a i l e C o m m e r c e I n f r a s t r u c t u r e : T h e B u s i n e s s C a s e

Even if the financial justification for outsourcing an ecommerce infrastructure platform becomes easier once it is based on a broader TCO assessment of legacy costs, approval to move forward still means making the appropriate business case justification to senior management � a case that needs to align the specific project objectives with the identified financial and operational benefits. For IT and business stakeholders to have any hope of succeeding in their quest for agreement on this technology investment, much of the business case must be made on two important points:


● Using a TCO mindset to explain all current costs and potential improvements. It is imperative that decision makers digest the full spectrum of direct and indirect costs that underpin a self-run ecommerce infrastructure, and then include in their evaluation all future costs as they relate to sales growth, new applications, and unpredictable demand swings. This TCO-centric understanding helps make the value proposition of service-oriented external infrastructure model more compelling � especially when the risks associated with missed opportunities such as lost sales and weakened brand are taken into account.

● Defining the need for flexibility and scalability. One of the major market challenges for retailers moving more toward complete cross-channel operations is ensuring they are technology enabled, not constrained, when planning new sales or marketing initiatives. Too often, the legacy nature of internal ecommerce platforms restricts merchants from being able to aggressively expand their online presence. The ability to deliver a compelling TCO-oriented cost reduction and sales growth strategy, along with inherent performance and reliability improvements to support these new online initiatives, helps further the case for a strong outsourced ecommerce infrastructure.

C O N C L U S I O N

One of the most critical keys to success in next-generation retailing will be the quick adaptation to fast-changing consumer buying behavior. As more shoppers favor online-centric retail (or at least the choice), it is imperative for retailers not just to discuss but to deliver complete cross-platform technologies and business processes that respond to different consumer needs and further the value of the retailer's brand. As the industry continues to be hypercompetitive and online selling becomes a required cost of doing business, it is important that new technology investments focus on the overarching improvement of the total cost of ownership � all while delivering a responsive and scalable online commerce platform.

The opportunity to establish strong retailer brand differentiation alongside a growing, online-centric shopper society exists right now � and the level of attention paid to that opportunity can easily be the difference between long-term retail success and complete business failure.


E S S E N T IA L GU I DA N C E Any retail IT strategy that stops short of offering fully transparent cross-channel operations will be at a competitive disadvantage and risks being on the wrong side of the industry leader versus laggard evaluation.

The only way to make an accurate assessment of a retail ecommerce infrastructure strategy is to fully understand all of the components that make up the direct and indirect costs of operating the current legacy model using a TCO benefits methodology.

Rather than attempt to capture every single potential cost component or business value opportunity when assessing TCO benefits, retailers are encouraged to build a model that isolates and focuses on those metrics most directly impacting cost reduction or online selling and multichannel operations. These assessments should target major benefits such as improving site performance, increasing conversion rate, and reducing abandonment. Retailers should create a vendor selection strategy that is geared toward companies with specific retail industry experience and laser-focused core competency in Web technologies and ecommerce infrastructure. They should orient their evaluation toward maximizing the financial returns highlighted in the new TCO benefits model they have developed.

M E T H O D O L O GY

This research was sponsored by Akamai. The primary research component of the paper consisted of formal interviews with IT and ecommerce executives from 30 retail companies in North America, Europe, and Asia regarding their current ecommerce activities and future objectives. Results of the study are presented in aggregate form in the figures throughout this paper. Extensive secondary research was also performed by Global Retail Insights in the course of preparing this study.

Global Retail Insights feels strongly about the business value of conducting a TCO analysis for Web commerce infrastructure investment. However, this paper is not intended to recommend any specific solution or vendor.

C o p y r i g h t N o t i c e

Copyright 2008 Global Retail Insights, an IDC company. Reproduction without written permission is completely forbidden. External Publication of Global Retail Insights Information and Data: Any Global Retail Insights information that is to be used in advertising, press releases, or promotional materials requires prior written approval from the appropriate Global Retail Insights Vice President. A draft of the proposed document should accompany any such request. Global Retail Insights reserves the right to deny approval of external usage for any reason.

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