Tuesday, July 26, 2005

The end of the economy of scale?

I'm not so diligent that I read every story in the Money & Investing section of the Wall Street Journal -- I don't do due diligence with the Forex report (though the yuan revaluation has given it a spark) and I have to say the credit markets and options report are usually a little over my head. But I do read Justin Lahart's Ahead of the Tape column everyday, mainly because it's above the fold on the front page and I can read it on the train in the morning without spilling my coffee. Today's column covered Amazon.com's growth figures. Lahart thinks Amazon's growth will slow as more retailers open up shop online servicing ever more refined niches. Because so little overhead is necessary to run an online business, the economies of scale that once worked in large firms' favor seems to apply less and less. Anyone with an Internet connection can more or less start an international business and reach customers in every geographic market.

I can't fault the theory, but I think it fails to account for the power of branding. Once overhead money went into transportation and warehouse space and office furniture and payroll systems and the like, now more of that money can go into brand building and advertising -- these are the areas where large players can regain the edge afforded by economies of scale. Joe Blow's Internet business will never be able to create a brand identity -- he lacks even the verification eBay and Amazon provide their third-party vendors with their customer-feedback system, which they can administer with an air of neutrality. For better or worse, size implies trustworthiness in modern retailing, it implies (perhaps erroneously) a history of success in pleasing customers -- the size stands in for word of mouth, which our atomizing society has rendered more and more difficult to come by. The Internet, which masks the size of the firm you're dealing with, thus seemed a less safe and secure marketplace to explore for the average consumer, until Internet superbrands emerged. Cultural ubiquity rather than their physical size now conveys the trustworhty impression for the eBays and Amazons. Also, the brand itself, the iconography of a commodity's origin has a value independent of a good's utility, of course. The cache of a brand can only be created by large-scale investment in PR and advertising. Online retailing will likely only become as efficient in undermining large companies as Lahart imagines when consumers become comfortable conducting all their shopping blind, indifferent to who they are buying from.

It seems more likely that the pervasive presence of small, fledging retailers will drive more people to big name retailers. Dealing with a corporation makes shopping impersonal, allows it to be an exchange with only one person in it, letting that person believe it is all about him and only him. It can seem as though the company exists to serve his ends, that its elaborate codes of customer service have all been concocted to provide him with his satisfaction. But dealing with small retailers makes an exchange more personal, more redolent with the obliging friendliness, complexity and courtesy and deference that goes into interpresonal exchanges -- you are no longer at liberty to expect it to be all about you and be as selfish as you fantasize about. Dealing with faceless big retailers, you can be as petulant as you want without feeling embarassed -- you're not making demands from an entity that has any feelings of its own. The essence of shopping as a leisure activity lies in its proving playgrounds for solipsistic fantasy -- that ceases once we humanize the other party to the exchange.

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