Canadian e-tailers have to work hard to win.
An e-business revolution is under way and e-tailing will never be the same again. Nor will the Canadian economy. As recent reports have emphasized, the widespread development and implementation of e-business operations will be crucial to the competitiveness of Canadian businesses. David Pecaut, managing director of Boston Consulting Group (Canada) and co-chair of the Canadian E-Business Opportunities Roundtable, warns that “Canada faces a choice. We can capitalize fully and quickly on the e-business opportunity or remain complacent with our modest success and risk falling behind other advanced economies. We can make e-business a sustainable engine of growth and jobs for the Canadian economy or we can hesitate and watch many of our best ideas and people migrate to more hospitable environments. In short, we can lead or lag.” [The Globe & Mail, Jan. 25 ’00, p. B15]
While we completely agree with this concern, we wish to offer several additional observations:
- Internet access, obtained through the local cable or telephone network (also known as the local loop), varies significantly in terms of speed and capacity across the different regions of Canada. These differences create distinct market segments and limit e-tail’s overall success
- E-market segmentation—that is tailoring e-tail marketing to meet the needs of diverse audiences—is critical if e-tailers are to overcome the distinctive characteristics and differences in Internet usage among the various Canadian demographic groups
- Canada compares unfavourably with the U.S. and parts of Europe. In evaluating Canada’s speed of adoption, we think it important to place our Canadian experience in the global context. We must consider the differences between countries—for example, the relative lack of venture capital in Canada, especially when compared to the United States
- Government policies will have to play an important role if Canada is to become e-business competitive. Business laws and regulations require re-evaluation when applied to e-business, particularly with regard to enforcement practices.
We suggest that these various realities are creating significant challenges and placing severe limitations on e-business in general and e-tail in particular.
Although Canada has one of the best and least-expensive infrastructures in the world, we lag behind the U.S. by at least three years in delivering e-business over this infrastructure. The result is a less competitive economy and a competitive disadvantage, one that will exert an increasingly negative impact on Canada’s future.
Government and business leaders are proud to claim that Canada has one of the highest-quality, most accessible telecommunications infrastructures in the world. Nevertheless, the former Stentor Group, and Bell Canada in particular, continues to dominate the telecom landscape, especially in the local loop. While several new entrants are struggling, the question still remains: How can competition in the telecom infrastructure be enhanced to further reduce prices and foster more rapid innovation? The expansion and success of all e-businesses will depend on the creation of viable competition in the Canadian telecom market.
The biggest bottleneck in the e-business revolution occurs in the local loop, making capacity enhancement of the local loop the most important issue for all advanced countries in the 21st century. A Financial Times article has pointed to this reality: “By 2001, capacity on U.S. telephone networks will be 400 times the level of 1998, estimates Mark Bruneau, president of Renaissance Worldwide, a consulting firm. ‘The result will be a bandwidth glut,’ he says, ‘that will eventually be repeated in Europe, which he estimates to be three years behind the U.S. in this regard.’ ‘Until high-bandwidth local connections are developed to link customers to the new national networks, however, much of the new capacity may well go unused. It’s like a giant sewer pipe connected to millions of thin cocktail straws,’ says Mr. Bruneau. ‘There’s a big constriction in the network.’” [Financial Times, Jun. 30 ’99, p. 17]
As others have pointed out, the lack of local-loop bandwidth represents a severe constraint for Canadian on-line retailers: “Due to the limited amount of telephone bandwidth, [Internet] ads with a high multimedia content take longer to download, often annoying users. Advertisers and marketers must keep these issues in mind when developing on-line promotions. They must create on-line ads that consumers will be able to download with slower modems. The unfortunate reality is that ads without high multimedia content, though easier to download, are not as effective. This would in part explain the slower growth of on-line sales in Canada when compared to the United States, as well as the lower growth of dot-com e-support companies.” [“Advertising on the Web,” Ivey Business Journal, Jul./Aug. ‘99]
It has been reported that 79 percent of Canadian Internet users have a connection speed of 56.6 K bits/second or slower. Only 10 percent of users have the much higher bandwidth cable/T1/ISDN connections. Eleven percent have a 14.4 K or lower connection speed. The reality is that only 10 percent of Canadians have high-bandwidth, local-loop connections. Traditional telephone wires are simply inadequate for accessing Web sites with heavy graphics or multimedia applications. The primary reason for the lack of high bandwidth in the local loop is insufficient competition in the local exchange market. While Bell Canada and the former Stentor Group companies are providing more bandwidth in the local loop, the fact remains that high-bandwidth connections (such as ISDN and DSL or Digital Subscriber Line) are not available everywhere in Canada, much less at affordable prices.
For traditional telecoms, DSL (Digital Subscriber Line) offers more carrying capacity on existing copper wires. However, it deteriorates with distance and the signals interfere with each other if more than a limited number of customers are covered in each neighbourhood. Wireless and satellite technologies are still in the early stages, and some encounter weather difficulties and need “line-of-sight” with customers. In all likelihood there will be a variety of solutions, each geared to certain market niches.
At this point in time, it is not clear how the constriction in the local loop can best be overcome. One important emerging alternative is the Internet on cable. However, the long-term prospects of this medium are uncertain. Canada’s cable industry covers only a portion of the population and requires huge capital outlays in order to provide optimal broadband access. With cable penetration rates among the highest in the world, Canadians should be able to access the Internet using cable. Recent reports have shown that there are now more than one million households with cable modems in North America; 30 percent of those are in Canada. Internet-on-cable penetration is expected to exceed over 1.6 million Canadian and U.S. households by the end of 1999, with most of this growth coming in the United States. Cable modems are now available to over 32 million homes in North America. This represents about one-third of all cable subscribers, a figure that is expected to increase to 50 percent by mid-2000. This equals approximately 50 million North American households.
Despite the attraction of cable modems (much higher bandwidth compared to telephone lines), current take-up rates are less than three percent. The primary reason? The average price is still over $40 per month, compared to (albeit slower) telephone Internet access that costs less than $20 per month if anything at all. (all figures are in U.S. dollars unless otherwise noted). Prices are high, making affordability a key issue.
Differences in the speed and capacity of the local loop create distinctive market segments that require different strategies. In Canada, the degree of e-tail success will therefore differ between geographical regions: urban versus rural, large business versus small- and medium-sized business, and an array of different preferences among residential consumers.
There are also other forces that add to the market segmentation created by the disparities in speed and capacity of the local loop between cities and regions. Higher-income households are much more likely to use computer communications than lower-income households. The importance of relative incomes creates an interesting policy question in the Canadian context. If the extent of Internet commerce depends on higher incomes, what implications will there be for the universal provision of e-business in Canada, especially Internet commerce? Since economies of scale and scope are critical for generating a good return on investment in e-commerce infrastructure, it is likely that e-tailers will concentrate on areas with higher population densities and higher incomes. The Maritimes, Prairie provinces and the Canadian North, for example, could be left out of the virtuous cycle of economic growth.
Internet usage also increases with the educational level of households. The under-55 age group uses the Internet far more than older Canadians. People who live in cities make greater use of the Internet than do people in rural areas. It appears that usage rates also vary according to other population characteristics, such as ethnicity.
Developing an appropriate e-tail strategy therefore require a detailed study of these market segmentations. A blanket approach will fail to maximize the potential profits as some potential e-consumers are left out of reach or are targeted with inappropriate advertising. To be most effective, advertising messages—and even the range of products offered—will have to vary depending on a wide range of population characteristics.
CANADA VS. OTHER COUNTRIES
There are two primary components of Internet commerce, business-to-business (b2b) and business-to-consumer (b2c), also called on-line shopping, e-tail or Internet retail. In the U.S. and Canada, b2b accounts for most e-commerce activity—approximately 78 percent in the U.S. and 84 percent in Canada.
It is important to emphasize that e-tailers should be concerned with both b2b and b2c. For some e-tailers, improving the efficiency of purchasing from suppliers will have a greater positive impact on their business than b2c. For some e-tailers, improving the efficiency of purchasing from suppliers will have a greater positive impact on their business than b2c. Choosing lower-cost, more appropriate suppliers can have a greater positive impact on profits than incremental on-line b2c sales. Furthermore, b2b provides new opportunities to analyze more information about purchase patterns. It also allows the e-tailer to compare supplier prices, products and services more readily.
One measure of the relative amount of Internet shopping in the U.S. and Canada is per capita spending. Annual per capita e-tail spending in the U.S. is approximately $41, almost twice Canada’s rate of $23. The data do not tell the whole story. In 1998, according to an IBM Canada/Retail Council of Canada study, 63 percent of Canadian consumers conducted their on-line purchases on U.S. Web sites. Moreover, on-line shoppers in the U.S. spend more per-average purchase, and per year, than Canadian consumers. Bricks-and-mortar retailers in the U.S. are also more likely to have a presence on the Internet than are Canadian retailers. One of the reasons for lower Canadian on-line spending is that Canadians have lower disposable incomes and somewhat higher savings rates than Americans. Lower take-home pay, due to higher taxes and lower salaries, means that Canadians do not have as much money to spend as Americans, which in turn means a less-developed retail sector, Internet retail included. Nevertheless, the Canada-U.S. gap reflects more than income differences. It exists because of the lower Canadian involvement in e-tail, by both businesses and consumers.
Meanwhile, a host of new entrepreneurial U.S. corporations are offering e-business services in the United States. It is only a matter of time before Canada faces a massive invasion by these corporations, which threaten to capture important first-mover advantages. If Canadian businesses delay their response excessively, the participation of those businesses in new e-business services may be permanently low. This reliance on U.S. firms could have serious implications for the future of Canada’s economy.
The growth of Internet commerce in the U.S. has been staggering. From virtually zero in 1993, e-commerce sales have grown spectacularly. Estimates for 1998 range from just over $51 billion, according to Forrester Research, a Boston-based consulting firm, to over $300 billion, according to a study commissioned by Cisco Systems. Similarly, estimates of future growth range widely, from the relatively conservative 2003 estimates of over $700 billion to more than $1.4 trillion.
There are fewer estimates for e-commerce sales in Canada. An IBM Canada study for the Retail Council of Canada estimates that the value of Internet commerce will exceed CDN$80 billion by 2003, up from CDN$5.3 billion in 1998. According to surveys by International Data Corporation (IDC), which were quoted in the IBM Canada/Retail Council of Canada study, Canadians are more “wired” than Americans. IDC Canada reports that in 1999, 30 percent of Canadians had access to the Internet; this is expected to increase to 64 percent in 2003. Only 22 percent of Americans had access to the Internet, a figure that may increase to only 38 percent by 2003. However, U.S. Internet users are almost three times more likely to purchase on-line; 50 percent of American Internet users are expected to purchase on-line by 2003. Americans also spend more on a wider variety of goods than Canadians; they buy not only books and software, but also travel-related services, clothing, computer hardware and information services. Whether the figures are expressed in absolute or per capita terms, there is little doubt that Canada is falling behind the United States. But how do we compare with the rest of the world?
The penetration levels of Internet commerce in Europe are mixed. The Scandinavian countries lead the way, since they took critical steps to deregulate their telecommunications industries years ago. Regulatory forbearance has led to declines in prices and increased usage, including some of the highest rates of Internet connectivity in the world. By 1998, Sweden led the way in terms of connectivity at 39.6 percent, followed by Denmark at 24.6 percent and the Netherlands at 19.6 percent. These countries also have correspondingly high levels of on-line retail activity, rivalling per capita rates in the United States. European on-line sales are expected to have doubled in 1999, to approximately $288 billion, a figure that is expected to increase to $2 trillion by 2002. However, there is significant variation within Europe as countries with lower telecom costs, such as the Scandinavian nations, experience much higher growth than countries with less competition and higher telecom rates, such as Germany, Spain and Switzerland.
Yet the challenge of developing optimal legislation in Europe remains an issue. Government and industry groups in the UK, for example, have been wrangling over appropriate e-commerce legislation for some time. As of August, 1999, the government’s Electronic Communications Bill (first introduced in November 1998) had yet to be passed. As a result, British consumers spent only $160 million on-line in 1998, far less in absolute and per capita terms than consumers in the United States. Apart from an uncertain regulatory environment, a key obstacle to e-commerce in the UK is the fact that consumers are required to pay local toll charges rather than flat rates. Consequently, only high-income individuals in the UK can afford the high cost of “surfing the Web” or conducting on-line consumer research.
Internet usage is also increasing in emerging-market countries—for example, in Latin American countries. However, high access costs are limiting growth. Nevertheless, surveys conducted by the research firm eMarketer predict that the number of Latin American households on-line will increase from just 1.6 million in 1998 to 8.7 million by the end of 2000. Internet spending in the Asia-Pacific region (excluding Japan) is expected to have increased to more than $2.2 billion in 1999, triple the amount in 1998. Over all, a favourable regulatory environment has prompted greater Internet connectivity and business interest throughout the world, resulting in substantial increases in e-commerce over the past few years. Canada’s e-commerce sector is performing better than those in developing countries and some European nations, but is rapidly falling behind the U.S. and the Scandinavian nations.
WHY DOES CANADA LAG?
Canada’s activity and performance should be measured against those of the States, the world’s leader in e-business innovation and development. Why are Canadian retailers so far behind and what are their prospects for catching up?
There are several reasons for the lack of enthusiasm for e-commerce from Canadian business. Perhaps the most disturbing are the attitudes of Canadian business leaders towards the Internet compared to their American counterparts. In Canada, only 26 percent of the nation’s top retailers have an on-line presence; more than 39 percent have one in the U.S. and another 37 percent plan to have a presence on the Internet within the next year. In addition, many Canadian business leaders do not appreciate the Internet’s potential. This is worrisome, especially when a worldwide survey of top managers revealed that 90 percent of them believe the Internet will transform or have a big impact on the global marketplace by 2001.
Perhaps the most important factor is the difference in business culture between the U.S. and Canada. The Internet business world requires a high-risk, innovative and fast-moving environment that does not exist in Canada’s retail sector. Canadian retail has a reputation for being a follower of U.S. trends rather than an aggressive innovator. For example, a recent survey on e-commerce suggests that many Canadian retailers plan to wait until e-tail becomes more of a threat and starts to affect the bottom line before they take strong action.
Contrast this with U.S. executives who believe they had better move quickly or else somebody will come along and “eat their lunch.” There are a number of examples of rapid start-ups. One Internet bank went from being a concept to up-and-running in only three months; another company, ZainyBrainy.com, launched a site within 80 days after signing a contract with a specialized e-commerce consulting firm. Technological change and targeted consulting services have shortened the competitive time frame, resulting in ever greater competition in e-tail.
Some Canadian business leaders argue that being a follower will lead to benefits—a second-mover advantage—as these firms can learn from earlier mistakes. Unfortunately for Canadian e-tailers, this is simply not true. First-mover advantage is even more important in the Internet world than in bricks-and-mortar industries because the pace of change is much faster. The lesson from Amazon.com and Barnes & Noble is enlightening in this regard. With only a two-year head start, Amazon.com’s on-line revenues are 10 times those of Barnesandnoble.com. Only large investments in advertising have started to narrow the gap.
There are several other important factors that help explain Canada’s relatively slow pace of investment in Internet activities, both b2b and b2c:
- Risk-taking. Canadian executives are more risk averse than Americans
- Difficulties in calculating ROI. Calculating the ROI for information technology investments is notoriously difficult. Higher Canadian risk aversion makes this process more difficult by setting higher hurdle rates for e-business projects
- Legacy bricks-and-mortar infrastructure. Investments in Internet technology often make traditional infrastructure obsolete, yet they cannot be erased from balance sheets for financial and tax reasons. Moreover, this can often involve layoffs or expensive organizational restructuring, both of which will have important consequences for company morale and profitability
- Lack of immediacy. Canadian companies are often sheltered from U.S. competition, at least for now. The imperative for change will become apparent as time passes—but hopefully it won’t be too late for Canadian retailers
- Access to capital. Canadian companies have not benefited from the exceptional capitalization of U.S. dot-com and Internet companies. Lower D/E and P/E ratios in Canada mean less capital for investing in e-commerce technologies. Access to capital for investing in e-commerce technologies. Access to capital is made more difficult due to the reluctance of Canadian banks to lend for investments in which there is little or no physical capital to act as collateral
- Customer demand and critical mass. For e-commerce to be successful, a firm’s suppliers and customers must be on-line. A critical mass of companies must therefore be wired for investments to pay off. Canada has not yet reached this point. Furthermore, low demand reduces the need for companies to change. The result is a state of inertia
- Brain drain. Higher salaries, lower taxes and more rewarding career opportunities are drawing some of the best and brightest Canadians to work in the United States. This is a loss of entrepreneurial talent and a drain on the ability of Canadian companies to innovate
- Economies of scale and scope (EOS/S). EOS/S are extremely important in Internet commerce because infrastructures are easily scalable; minimal investments can handle 100 customers as easily as 100,000. The size of the U.S. economy, higher population densities and the tendency of U.S. Internet users to spend more on-line result in significant relative savings and higher profits when compared to Canadian retailers
- Lower prices in the United States. U.S. retailers are willing to operate on lower margins than Canadian retailers. In the IBM Canada report, Chapters’ president Larry Stevenson says, “The Canadian market…shouldn’t be sideswiped by the U.S. price war. It’s their battle.” As long as Canadian retailers do not provide Canadian Internet shoppers with reasons to shop Canadian—and price is the most-often quoted reason for purchasing on-line—they will continue to pursue the lower prices, better service and greater variety on U.S. Web sites
- Large investments to solve Y2K problems. Many Canadian companies were late solving their Y2K problems, further diverting their attention from e-commerce initiatives
- The lack of a strong Canadian presence in catalogue shopping. Catalogue shopping has infrastructure needs that are similar to those of Internet shopping. The most important are a customer service infrastructure (such as call centres) and delivery capacity (which may be underdeveloped due to Canada’s low population density or the relative lack of competition in parcel delivery). Parallel networks have allowed U.S. retailers to get into the e-tail market faster.
Being a laggard has serious implications for Canada. In the States, many new support industries have been built around the provision of value-added services to the e-commerce sector. For example, a new service firm called On-line Retail Partners specializes in developing e-commerce strategies and Web sites for bricks-and-mortar companies. With easy access to venture capital and with most U.S. companies looking to get on-line, e-business service industries in the U.S. are growing as quickly as on-line commerce. Canada is losing out on substantial employment and economic growth opportunities. American companies will become dominant as a result of first-mover advantages. Hence, a Canadian e-commerce industry may be permanently disadvantaged.
IS IT TOO LATE?
The implications for Canadian e-tailers are clear. The Economist reinforces this reality in a survey it conducted [The Economist, Jun. 26 ‘99]: “Recent experience suggests it takes little more than two years for [an Internet] start-up to formulate an innovative business idea, establish a Web presence and begin to dominate its chosen sector. By then it may be too late for slow-moving traditional businesses to respond.” Despite the fact that Canadians may prefer to shop with Canadian on-line merchants, the first-mover, price and selection advantages developed by U.S. retailers may mean it is too late. As The Economist states, “The challenge of doing e-commerce is huge. But the dilemma is that the fall of ’99 will be a banner year for e-commerce players. If you are not in by the fall of ’99, then you could potentially miss the boat.”
The danger facing Canadian e-tailers and all Canadian e-commerce companies is that as the U.S. becomes more competitive, American firms will look to Canada as a land of opportunity. E*trade has already set up a Canadian subsidiary. How long until Amazon.com and a number of other multibillion dollar dot-com companies turn their marketing efforts north? With infrastructure bought and paid for, the marginal cost of entering the Canadian market will be virtually zero. American e-tailers will be willing to accept much lower margins and provide higher-quality service, two of the most important factors in consumers’ selection of an e-tailer. The window of opportunity for Canadian companies is small and getting smaller as every day passes.
Recognizing the importance of e-commerce, the federal government developed the Canadian Electronic Commerce Strategy in the fall of ’98. The document represents one of the seven pillars of the government’s goal of making Canada the most wired nation in the world by the end of the year 2000, The report identifies four priorities for action:
1 Building trust in the digital economy by ensuring that e-commerce transactions are secure, personal privacy is protected and consumer rights are safeguarded on-line, as they are in the traditional marketplace.
2 Clarifying the rules of the marketplace to ensure that e-commerce is not hindered by legal/commercial frameworks, financial/tax issues or intellectual-property questions.
3 Ensuring that there is a modern, accessible information infrastructure.
4 Ensuring that Canadians are aware of the power of e-commerce and have the skills to make the most of its potential.
A noteworthy theme underlying this strategy is partnership with the private sector. CA*net 3 is the federal government’s flagship private/public sector partnership project. It is a collaborative initiative between several high-tech firms, universities and the federal government to provide a high-bandwidth Internet backbone network across Canada.
RE-EVALUATING BUSINESS LAWS AND REGULATIONS
In its decision to not regulate the Internet, the CRTC pointed to what it referred to as “appropriate tools [that] already exist to deal with offensive and illegal content, tools such as Canadian laws of general application, industry self regulation, content-filtering software, as well as increased media awareness.” [Francoise Bertrand, Report on New Media; www.crtc.gc.ca/ENG/NEWS/SPEECHES/1999/S990517e.htm]. We believe that these tools still need to be applied and refined if both customers and honest e-tailers are to be protected from unscrupulous suppliers and competitors.
CANADIAN LAWS OF GENERAL APPLICATION: There will be a need to tailor enforcement to the new realities of e-business. It is true that fraud is fraud whether it occurs on Main Street or on the Internet highway. It is also true that false advertising is false advertising whether it appears in a newspaper or on a Web site. However, the processes for enforcement and apprehension will no doubt have to be different, and these processes will no doubt be a learning experience for those who have responsibility for Canadian laws of general application.
INDUSTRY SELF-REGULATION: There will also be ongoing experimentation with regard to the adoption of appropriate policies and the censure of those who violate them. Here, in particular, industry associations will have new roles to play. There will always be some participants who fail to adhere to the industry protocols, accompanied by the problem of how these violators should be dealt with.
CONTENT-FILTERING SOFTWARE: No doubt content-filtering software will encounter new software that can defeat it. There will be a never-ending spiral of increasing complexity in order to limit the transmission of materials such as pornography or hate literature.
INCREASED MEDIA AWARENESS: The media will continually confront new issues requiring investigative reporting. The processes for media investigation and reporting will not be the same as those focusing on traditional retail transactions.
While it is true that these tools and structures may indeed form the basis for effective regulation, their success will not be automatic. Rather, their success will require continual vigilance, frequent evaluations and analyses, and the creation of public pressure to support particular protocols and behaviour. The CRTC’s decision to not regulate the Internet should not be taken as evidence that problems do not exist.
When modifying existing regulations and policies as they apply to e-business, we must recognize the strong and persuasive argument that Canada should be part of international deliberations to achieve common global practices.
For retailers, affordability, quality and breadth of telecom services become critical components in determining how fast they’ll be able to adapt to e-tail. Hence a new set of policy and regulatory issues claim attention, including government action to:
- Foster greater competition in local access, in both telephony and cable, as well as promote investments in high-bandwidth wireless networks
- Alter the tax system to encourage entrepreneurship and risk-taking, and to increase the availability of venture capital
- Provide special programs and funding to help businesses get started on the Internet
- Invest in educational programs to ensure that Canadians develop the skills required to compete in the e-business world
- Re-evaluate the entire range of industrial policies, from the tax system to subsidy programs, in order to provide more encouragement to the telecom sector and e-business.
Consistent policies on the part of all Canadian governments, in concert with aggressive investments by the private sector, should give Canada a strong place in the global Internet economy. Canadian retailers will have to successfully adopt the e-business way of doing business if they want to ensure their future profitability. Unfortunately, the window of opportunity is closing quickly.