O-ho the Wells Fargo Wagon is a’comin’ down the street, Oh please let it be for me!
—The Music Man
Before you can truly understand e-commerce in emerging markets—and the mistakes it’s already made—it’s helpful to remember how e-commerce evolved in the United States. So I want to go back in time, to the American frontier—an open market if ever there was one.
* * *
IT’S 1875 ON the Nebraska plains, and as you watch the summer sun rise over your wheat fields, things are looking up. It should be a bumper year on the 160 acres that you occupied for five years and finally acquired from the US government. Thank goodness for the Homestead Act, you think to yourself. It’s harvest time, and from now on, all profits from every harvest will be yours.
A rooster crows, telling you it’s time to get the day started. You head outside and secure your horses to a mechanical reaper. You take a seat atop the reaper and grab the reins. With a strong whip and a loud “Yaaarrr!” you set the horses in motion. But before the squeaky wheel behind you has made a full revolution, you hear a loud snap! The horses veer off to the side, and the reaper spins out of control before finally wobbling to a standstill.
Darn it, you think. The leather on that brittle old harness must have broken. You dismount the reaper, examine the harness, and realize the leather is beyond repair. You’ll need a new harness. So you unhitch the horses, take off the harness, saddle up your strongest horse and put the other in a field, and head off on the hourlong trip to town to visit the general store.
The dusty road takes you past neighboring homesteaders. Some are out in the fields. Spread across the countryside are a mix of wooden homes and wheat fields, some still occupied and some abandoned by homesteaders who found living off the land too hard or too lonely compared with the bigger towns and cities they came from.
After clomping along a dusty road for an hour, you arrive in town, which is not much more than a small cluster of wooden buildings. You head straight to the general store, a two-story log structure that also hosts the town’s church. After tying up your horse, you walk in through the swinging doors, pleased to see some familiar faces.
“Well, look who’s here!” announces the shop owner, Lee Addison, as you enter the room. You make the rounds, shaking hands with the other farmers, and take a seat in a rocking chair next to an empty barrel that doubles as a table. Gina Addison, who is married to Lee, soon puts a glass of lemonade on the table for you. “This will help you cool down,” she says. “There’s more where that came from.”
“So what brings you to town?” asks Lee.
“Broke my harness this morning. I’m hoping you’ve got one here I can buy.”
“I think I’ve got one in the storeroom. It runs fifty dollars. Let me go check.”
Lee heads to the back of the store and you turn to your friend John Moore, who lives down the road. “Fifty dollars?” you whisper. “I love old Lee, but that’s a lot of money for a harness. Farming is a good living, but in my next life I’m going to run a general store. That’s where the real money is.”
“I know what you mean,” John replies. “Lee’s a good man. But while we’re out there sweatin’ in the fields, he’s sitting pretty here, sippin’ lemonade and making a handsome profit. But ever since I got that Montgomery Ward catalog, I buy my big-ticket items there.”
“Montgomery Ward? What the heck is that?”
John cranes his neck to make sure that Lee’s not within earshot, lowers his voice to a whisper, and pulls out a small booklet with Montgomery Ward Catalog at the top. “Here, take a look,” he says. “I’ll bet you can find that same harness in here for half the price of what old Lee’s sellin’ it for.”
Curiosity piqued, you flip through the book until you come across a selection of harnesses. You’re amazed by the variety: double-buggy harnesses, single-strap harnesses, long-tug harnesses, plow harnesses, and even goat harnesses.
Running your finger along the page, you come to a double harness. It’s only $25!
“Told you so,” says John. “It’ll only take a few weeks to get here, and I’ve got a harness I can lend you in the meantime. And if you don’t like the new one, you can send it back for a full refund.”
“But do you trust these fellas with your money?” you ask. “There are a lot of hucksters out there.”
“I pay it cash on delivery. When you get to the American Express office, take a look at the harness. If you don’t like it, you can send it back. Satisfaction guaranteed.”
“No penalty?”
“Not even a dime. In fact, the wife and I are putting in an order next week. If you’d like, you can put your order in with ours.”
You take John up on his offer and put in an order. And because you are saving money, you decide to add a couple items—a new hand mirror for your wife and a harmonica for your son.
“Keep the catalog,” John says. “I’ll get a new one with the order.”
You hear old Lee’s footsteps and quickly slip the catalog into your satchel. “Let’s just keep this between us for now,” John says. “I don’t want old Lee gettin’ upset. I have to see him at church every Sunday.”
Lee comes back into the room with the harness. “I found what you’re looking for,” Lee announces. “Why don’t you come have a look?”
“Thanks, Lee. It looks nice. But I think I may have found a solution. What do I owe you for the lemonade?”
“All right, sir, as you wish,” Lee says with a puzzled look. “Don’t worry—the lemonade is on me.”
You slap a penny on the counter and shake Lee’s hand. He deserves something for the fresh lemonade, after all. “Thanks, Lee. Always a pleasure.”
You walk out the swinging doors, untie your horse, and climb into the saddle. As you ride away, Lee scratches his head and turns to his wife. “He’s a nice fellow. But that sure is a long way to ride for some lemonade.”
THE EVOLUTION OF RETAIL
When we think of the first e-commerce innovators, several names come to mind. Amazon’s Jeff Bezos. EBay’s Pierre Omidyar. Even my former boss at Alibaba, Jack Ma. But few people would put Aaron Montgomery Ward on their list. In fact, what I remember of Montgomery Ward from my childhood is a crumbling old department store in a nearby shopping mall.
But Montgomery Ward was the Jeff Bezos of his time. If a TechCrunch Disrupt conference had been held in 1875, Montgomery Ward would surely have been the headliner. His business model was both innovative and disruptive, changing the way people shopped in the American West.
In 1872, the year Montgomery Ward was founded, the United States was the great emerging market of the world. The Civil War was nearly seven years in the past, and the peace accelerated a huge migration from East to West. The original spark for this migration was the Homestead Act, which Lincoln signed in 1862, thirteen months after the start of the Civil War, to encourage western migration by offering settlers 160 acres of public land. To earn the land homesteaders had to pay a nominal fee and live on the property for five years. After that it was theirs.
Before the Homestead Act, only 14 percent of Americans lived west of the Mississippi River. By 1890 that figure had nearly doubled.1 About 70 percent of the population still lived in rural areas,2 but the westward expansion helped make Chicago a major hub for the growing railway system. And where the railroads didn’t go, express delivery services such as Wells Fargo and American Express served the western settlements with horse-drawn wagons.
The settlement of the West created an agricultural boom as the value of agricultural products tripled during the last five decades of the nineteenth century.3 During this period manufacturing became increasingly important, and by 1900 the United States led the world in manufacturing, producing twice as much as England and half of all of Europe combined.4 Although the diversity and availability of products quickly increased in the coastal cities, such goods had not yet found their way to the homes of customers scattered throughout the American West.
Residents of rural areas typically shopped at the local general store, which played an important part in the social lives of its customers, who had few other gathering spots. The general store was where the shopkeeper dispensed the latest crop intelligence and gossip about neighbors, and men might throw back some whiskey while complaining about the latest goings-on in Washington.
Yet farmers often resented store owners, who captured sizable margins on the products they sold. At the general store flour might be twice the wholesale price. The markup on shoes was 60 to 200 percent. Wool suits cost three times the wholesale price. And if customers purchased products on credit, they typically paid a punishing interest rate of 12.5 percent.5
Against this backdrop came Aaron Montgomery Ward, a former general store manager and traveling salesman. Ward had worked and lived among farmers and was familiar with their problems. He came up with a catalog business so he could sell directly to them. With $2,400 and his brother as a partner, Ward’s first catalog was a single sheet of paper, just a price list for a handful of products. By 1874 it had grown to a seventy-two-page catalog with images, prices, and product descriptions.6
The Montgomery Ward catalog was the first general-item mail-order catalog to be published and shipped to farmers. Ward told his customers they would receive “the lowest wholesale prices.… By purchasing with us you save from 40 to 100 percent which are the profits of the middleman.… Don’t waste your money by paying $35.00 for an article which you can get for $20.00.” Throughout the catalog were small nudges for skeptical shoppers to take a leap of faith: “Never let good opportunities go by. If you do, you will never be rich.”7
Ward knew westerners would be skeptical, so he encouraged buyers to check his references, saying, “We do not wish to be classed with the numerous swindlers of our city, and particularly desire every person to make inquiry about us before giving us an order. If this plan is always followed, honest men will be supported and swindlers will die out.”8 He encouraged his customers to tour Montgomery Ward’s warehouse in Chicago. He also encouraged customers to contact his team, saying, “We cheerfully answer inquiries” and “We have 25 typewriters always ready to wait on you.”9
If you didn’t want to pay COD, you could send payment by US Post Office money order, American Express money order, or cash at a local Express office (and “express” at the time meant package deliveries done by horse and wagon). Where these services were not available, customers could pay with postage stamps. And anyone who examined their order upon delivery and found it not to their liking could simply return it for a refund.10
Before long, the Montgomery Ward catalog was available throughout rural America. By 1904 Ward was mailing more than three million of his six-hundred-page catalogs. While his catalogs did not replace the general store, they certainly challenged and disrupted it. Long trips to the growing cities to buy hard-to-find items were not as necessary. Montgomery Ward had brought Chicago’s Michigan Avenue to shoppers on the frontier. With his catalog he’d put a well-stocked store on every kitchen table.
THE RISE OF BIG RETAIL
Had the Internet come along in Montgomery Ward’s time, the majority of retail might have leapfrogged online, with Ward pioneering the way. But, as we know, this didn’t happen, and America’s physical retail infrastructure began its slow and steady evolution.
While catalogs battled general stores for retail dominance in rural America, cities gave rise to department stores, America’s new “palaces of consumption.” In 1878, when Macy’s opened for business, a New York Times headline announced “The Great Sixth-Avenue Bazaar; Opening Day at Macy’s & Co.’s—A Place Where Almost Anything May Be Bought.” Other department stores appeared, including Marshall Field’s in Chicago and Hudson’s in Detroit. These glistening department stores, with their festive lighting and attractive window displays, became entertainment destinations, attracting city dwellers and visitors alike to spend an entire Saturday browsing the wide selections while dining at the stores’ restaurants and tea rooms.11
The industrial revolution gave rise to a growing middle class hungry for new products. Seeing this trend, Ward and his rival, Richard Sears, extended their businesses beyond the catalogs, starting and aggressively growing their own retail stores. Ward had no stores in 1926 but had five hundred just three years later.12 Sears rapidly grew his retail empire as well, building not just department stores but, after 1950, entire shopping malls, with Sears stores serving as the anchor tenant. J.C. Penney appeared in the western United States and built a large chain of department stores.13
America’s growing culture of consumption survived the Great Depression and World War II, only to explode during the postwar boom. With the Depression and two wars behind them, Americans were more than ready to shop. When they turned on their television sets for the first time, they were exposed to a steady stream of product propaganda created by Madison Avenue. With the winds of national media at their backs, regional brands sailed outside their traditional boundaries and grew into national brands.
During the 1950s the demographics of the United States were changing along with its geography. The growing interstate highway system, combined with white flight from the cities, encouraged the growth of suburbs. When the white middle class moved to the ’burbs, retailers followed, and American shoppers drifted away from downtown department stores and into the enclosed malls, strip centers, and mass retailers that took their dollars from the 1950s into the 1990s. In the suburbs retailers faced lower costs of doing business and less expensive land, which helped them cut prices. Increasing car ownership meant shoppers could not only get to the malls but also stock up on products, filling the huge trunks of their cars with a month’s worth of supplies.14
Retailers’ consolidation into regional chains gave them even greater economies of scale. But it took a former general store owner named Sam Walton to recognize that American retail was ripe for yet another dramatic step.
THE WALMART EVOLUTION
If Montgomery Ward was the great retail disruptor of the nineteenth century, Sam Walton was his twentieth-century counterpart. His Walmart took physical retail to the limits of efficiency in a pre-Internet world. Combining scale with technology to bring down prices dramatically, he laid the groundwork and provided the inspiration for Jeff Bezos and Amazon. Walton’s journey is worth exploring, because it helps explain the critical evolutionary step that emerging markets missed out on.
In 1945, when Sam Walton opened his first general store, a Ben Franklin franchise, retail in rural America was still fragmented and inefficient, with few chains that reached beyond their home markets. As Walton writes in his autobiography, “Our [Ben Franklin] store was a typical old variety store, 50 feet wide and 100 feet deep, facing Front Street, in the heart of town, looking out on the railroad tracks. Back then, those stores had cash registers and clerk aisles behind each counter throughout the store, and the clerks would wait on the customers. Self-service hadn’t been thought of yet.”15
Having clerks fetch products off the shelf might have helped prevent shoplifting, but customers found the process slow and annoying. But more significant than the slow service was that shoppers in rural America still had the same primary complaint they’d had for a hundred years—high prices. Retailers’ margins ran from 30 to 45 percent, yet they offered little selection.
Walton pioneered the idea of accepting lower margins in exchange for higher volumes. Women’s panties gave Walton his eureka moment: he saw that discounting prices on women’s underwear at prices well below those charged by his competitor across the street led to much higher sales volumes. In what seems like common sense now, Walton explained his insight by saying:
Here’s the simple lesson we learned—which others were learning at the same time and eventually changed the way retailers sell and customers buy all across America: say I bought an item for 80 cents. I found that by pricing it at $1.00 I could sell three times more of it than by pricing it at $1.20. I might make only half the profit per item, but because I was selling three times as many, the overall profit was much greater. Simple enough. But this was really the essence of discounting.16
Selling high volumes of discounted products was the founding principle of the first Walmart, which opened in 1962 in Rogers, Arkansas. Walton was not the only one who figured this out. The same year, several other major discount chains opened, including Woolco, Kmart, and Target. Backed by parent companies that were goliaths of retail, like F.W. Woolworth, S.S. Kresge, and Dayton-Hudson, Walmart’s discount competitors enjoyed strong financing and decades of experience. Yet Walmart would eventually best its competitors and emerge as the titan.
So what made Walmart succeed where others struggled?
In Walton’s own words, it was necessity: “The things that we were forced to learn and do, because we started out underfinanced and undercapitalized in these remote, small communities, contributed mightily to the way we’ve grown as a company.”17 Indeed, an inefficient rural retail infrastructure meant that Walmart was able to leapfrog past its competitors and establish an entirely new way of doing business.
Walmart’s explosive growth was an all-American tale of entrepreneurship. In the eight years after Walton opened that first store in Rogers, Walmart went on to build thirty-two stores with combined annual sales of $31 million. The strategy was to saturate rural markets: “Each store had to be within a day’s drive of a distribution center. So we would go as far as we could from a warehouse and put in a store. Then we would fill in the map of that territory, state by state, county seat by county seat, until we had saturated that market area.”18
An avid pilot, Walton scouted for locations from the cockpit of his two-seat turboprop airplane, which he originally bought as a way to get from one store to another. “But once we started really rolling out the stores, the airplane turned into a great tool for scouting real estate.… From up in the air we could check out traffic flows, see which way cities and towns were growing, and evaluate the location of the competition—if there was any. Then we would develop our real estate strategy for that market.”19
One important factor helped propel Walmart beyond its competitors—Walton’s early embrace of the computer. In 1966 Walton enrolled in an IBM school for retailers and saw the potential of using computers to capture sales information and manage inventory and logistics. He recruited a techie from among his classmates to help put together a computerized warehouse and distribution system. “We were forced to be ahead of our time in distribution and in communication,” he wrote, “because our stores were sitting out there in tiny little towns and we had to stay in touch and keep them supplied.”20
By 1980 Walmart had 276 stores that were generating $1.2 billion in revenue. With its distribution centers serving as the hub, routes to the stores serving as the spokes, and computer systems seamlessly linking them, Walmart was able to saturate retail in rural America. Walmart’s expansion ultimately defeated the inefficient variety stores out on the frontier. “They were so accustomed to getting their 45 percent markup, they never let go,” Walton later explained. “It was hard for them to take a blouse they’d been selling at $8.00 and sell it for $5.00, and only make 30 percent. With our low costs, our low expense structures and our low prices, we were ending an era in the heartland. We shut the door on variety store thinking.”21
Walmart’s explosive growth continued and the company seemed unstoppable. As Walmart entered the 1990s, it was the largest retailer in the United States. By 1992 it had 371,000 employees. The early 1990s saw Walmart begin to expand globally, and by the summer of 1995, it had nearly 2,500 stores.22 Inspired by Walmart’s successful business model, big-box retailers and category killers emerged, such as Toys “R” Us, Circuit City, and Barnes & Noble. One by one, these retail chains sucked up the business of smaller retailers, courting customers—and controversy—along the way. They pushed down prices, squeezing the margins of local retailers who couldn’t compete with the scale and efficiency of their discount competitors.
By 1995 the efficiency of US retail seemed to have reached its upper limits. Virtually any product a consumer needed was within arm’s reach and at a reasonable price. Want a Coke? Just stroll down to the local 7–Eleven or reach out to a vending machine. Want a new dress? Head to the nearby air-conditioned mall to shop in a wide variety of department stores and specialty retailers. Need groceries? The local supermarket has everything you could want. Want a book? Head to Barnes & Noble.
Indeed, by 1995 the US retail market was about as efficient and convenient as one could imagine. Products were readily available and prices were reasonable.
The American retail landscape had evolved from independent general stores and mom-and-pop shops to glossy air-conditioned stores with nationally recognized names in neon. Payment was easy: by credit card, debit card, or personal check. Shipping was convenient, reliable, and inexpensive.
Not sure about a product’s quality? Just read Consumer Reports. Not sure about a retailer’s integrity? Call the Better Business Bureau to find out if anyone has lodged complaints against that business. There seemed to be no new frontiers for retail.
Of course, as everyone now knows, the opposite was true—1995 was the start of a new era, when Netscape’s IPO triggered the Internet revolution, with retail taking center stage. But when the Internet age arrived, it built on an efficient and mature physical retail infrastructure that had already embraced computers and data analysis. This perfect confluence of developments set the cogs of invention in motion for a young financial analyst in New York …
THE AMAZON REVOLUTION
For about fifty years Sam Walton carried the retail baton, pioneering the discount retailer business model. His folksy personality, sense of showmanship, and understanding of rural retail had made Walmart the king of the hill. But the advent of the Internet ushered in a new, more data-driven era, requiring a different set of skills. And a quant jock from Wall Street—Jeff Bezos—would take the baton from Walton and carry retail into the era of e-commerce.
Bezos got his initial inspiration for Amazon while working for a New York financial firm with a strong belief in quantitative analysis as the Internet began to take off. Analyzing the market, Bezos decided that books represented the best product category from which to start his “Everything Store.” So he headed to tax-friendly Seattle, Washington, and started Amazon in his garage.
Although he and Walton approached retail with different personalities and from different angles, Bezos drew a great deal of inspiration from Sam Walton and Walmart. Walmart was an incredibly efficient, data-driven company that used technology to keep costs down. But Bezos did not need twenty-five hundred storefronts and addresses from which to sell his products. By bypassing physical storefronts and selling directly through his website from his garage, Bezos was able to squeeze a few more crucial drops of efficiency out of the Walmart model.
Amazon took advantage of the systems and processes that Walmart had helped create. Bezos poached some key logistics managers from Walmart, built on Walmart’s expertise, and applied it to an online model. The basic science and technology of managing inventory in an efficient market was already there—it just needed a simple upgrade.
Bezos also benefited from other established links in the e-commerce chain. Customers could easily pay for their purchases with credit cards. The US Postal Service (USPS), although the butt of many jokes, was reliable enough for e-commerce: the mail-order catalog industry had already trained the postal service. And if the USPS proved too slow and bureaucratic, consumers could choose from a variety of reliable express shipping services that could deliver products overnight. Most important, Amazon’s system could easily track its products.
Bezos also benefited from the world’s best Internet infrastructure at the time. The US population was quick to adopt the Internet, and dial-up speeds were at least fast enough to upload product images before customers gave up.
By the dawn of the twenty-first century, Bezos had a firm grip on the baton that had been handed from Montgomery Ward to Sam Walton. The success of Bezos’s inventory-led model landed him on the cover of Time as the Person of the Year in December 2000. Amazon was on its way to becoming the dominant online store for everything. But while Amazon focused on new items, the Internet had no equivalent for used items and collectibles, which gave rise to the other e-commerce giant of its day.
EBAY: THE EVERYTHING ELSE STORE
Bezos pioneered the inventory-led model, but he was not the only one riding the e-commerce wave. In the San Francisco Bay Area, Pierre Omidyar, a software programmer, was experimenting with a site called AuctionWeb. When the first item Omidyar listed on the site, a broken laser pointer, sold to an electronics enthusiast in Canada, Omidyar realized that the Internet might be a great way to connect buyers and sellers of used items and collectibles. His marketplace quickly attracted people trading in all sorts of odd goods and collectibles. Within a year AuctionWeb’s sales reached $7.2 million. One year later, driven partly by the Beanie Baby frenzy, AuctionWeb’s sales reached $95 million.23
As his website grew massively popular, Omidyar changed AuctionWeb’s name to eBay in 1997. A year later he hired a seasoned MBA, Meg Whitman, as CEO. Six months after that Whitman led eBay to a highly successful IPO on Nasdaq. Using the IPO money, Whitman helped power eBay’s international expansion and extended eBay’s auction model to western Europe, where it proved to be a hit. EBay’s business model worked because it allowed sellers to empty out their basements and attics and find buyers for items that would otherwise not have found a market. EBay’s model proved that strangers in the United States and western Europe could trust each other to do business online. EBay argued that its success had proved that, when it came to e-commerce, “People are basically good.”
By 1999 eBay had joined Amazon atop the list of e-commerce media darlings, with Whitman and Bezos gracing Business Week’s cover, under the headline “eBay vs. Amazon.”24 Amazon grew into the leading everything store for new products. EBay grew into the leading store for everything else: used goods, collectibles, and one-of-a-kind products. The only remaining question was, which of these companies would ultimately dominate global e-commerce?
THE AMERICAN INDEPENDENTS
While the e-commerce whales eBay and Amazon captured most of the imagination and media attention, a number of other sizable fish were swimming in the same ocean. Existing retailers and individual brands began to build their own online retail stores. They moved more slowly than their purely Internet counterparts but still represented the majority of e-commerce sales in the United States. Operating their own websites offered several advantages over selling on a platform like Amazon. With their own websites they could control the branding, service, and overall customer experience. And they could direct their existing customers to their websites through their offline marketing efforts. In addition, many of these merchants offered catalogs from which their customers had been ordering products by telephone for many years. These merchants knew how to fulfill orders remotely through an efficient shipping and delivery infrastructure in the United States.
But one factor above all others allowed e-commerce by independent retailers to flourish in the United States—a high-trust environment, something that most residents of industrialized countries take for granted. Indeed, the fundamental requirement for e-commerce is trust. One element is trust between the merchant and the customer. Because brands and retailers in the United States had a history with consumers, they found this trust relatively easy to transplant from an offline environment to an online one. For example, customers knew that J.Crew would honor its return policy online, just as it did offline.
A second component of trust is more abstract—trust in institutions that protect customers in case of fraud or a dispute between a buyer and seller. Customers knew that credit agencies, media, and nonprofits like the Better Business Bureau held vendors accountable. They also knew that, in the event a dispute couldn’t be resolved, they could turn to the courts for protection. Most online shoppers assumed that, so long as they were dealing with a merchant based in the United States, reasonable protections were in place, and merchants would honor and fulfill their online purchases.
These factors allowed thousands of retailers to emerge online, coexisting with eBay and Amazon. Retailers could simply create their own online storefront, plug in to the existing logistics and payment infrastructure, and be up and running on the Internet. Combined, these retailers constituted the majority of the e-commerce market. To bring traffic to their online stores, they could simply market their URL to existing customers or place banner ads on other websites. Later, when Google pioneered search advertising, retailers had even more cost-effective ways to bring traffic to their websites.
THE END OF AN ERA AND DAWN OF A NEW ONE
In December 2000, just one year after Time named Jeff Bezos Person of the Year, Montgomery Ward announced it was closing its doors after 128 years, shutting 250 stores and dismissing its 28,000 associates. The retailer cited a disappointing holiday season, no doubt influenced by the growing influence of e-commerce. Ward’s collapse was a strong reminder that today’s disruptors can become tomorrow’s fallen giants.
Montgomery Ward had abandoned its catalog in 1985, the same year that the first dot-com domain name was registered.25 It’s easy to see what Aaron Montgomery Ward’s retail revolution might have looked like if it had happened in the Internet era. All it takes is a look westward from his base in Chicago, past the wheat fields of America’s frontier, across the Pacific Ocean, and into the heartland of China.