United States

Small Business

Administration

Office of Advocacy

No. 197

May 2000

SMALL BUSINESS

RESEARCH

SUMMARY

Small Business Survival in Competition

with Large Multi-Unit Retail Firms

by Jack Faucett, Radesh Ganeshkumar, and Laurence O’Rourke

2000. [105] pages. Completed by Jack Faucett Associates,

4550 Montgomery Avenue, Bethesda, MD 20814,

under contract no. SBAHQ-98-C-0010.

This Small Business Research Summary (ISSN 1076-8904) summarizes one of a series of research papers prepared under contracts

issued by the U.S. Small Business Administration’s Office of Advocacy. The opinions and recommendations of the authors of this study do

not necessarily reflect official policies of the SBA or other agencies of the U.S. government. For more information, write to the Office of

Advocacy at 409 Third Street S.W., Washington, DC 20416, or visit the office’s Internet site at www.sba.gov/advo.

Purpose

The Small Business Administration’s Office of

Advocacy regularly tracks changes in the market

conditions in which small businesses, including

retailers, compete. “Main Street” independent retailers have faced competition in the past from large

chains and others opening stores in suburban malls.

More recently, so-called “category killer” or “big

box” stores have added further competition. Now the

Internet is adding a third level of competition for

large national chain stores and independent retailers

alike.

To learn more about how this third wave of competition is affecting the competitive balance in the

retail sector, and about possible policy implications

of such changes, the Office of Advocacy contracted

with Jack Faucett Associates for this two-part study.

Part 1, “Market Analysis of the Retail Book

Industry,” is a case study that examines the impact of

the Internet and other technological developments on

independent, multi-unit, and Internet-based booksellers. Part 2, “On-line Retail Market Dynamics”

provides an overview of competitive considerations

in several consumer segments.

Scope and Methodology

The researchers used a variety of sources for their

report. Part 1 makes use of data from the American

Booksellers Association, the Association of

American Publishers, NPD Group’s Consumer

Research Study on Book Purchasing, and the Bureau

of the Census. The firm became the first Advocacy

contractor to gather information by posting questions

on a bulletin board on its Web site. The researchers

also conducted interviews and digested academic,

online, and trade publications.

For Part 2 the firm turned to surveys and analyses

by investment advisors and market measurement

firms. The researchers present snapshots of current

and potential market penetration by on-line retailers

in toys, apparel, home furnishings, drugs/pharmaceuticals, office supplies, and electronics, along with

brief discussions of factors that enhance or limit the

potential for electronic retailers in each segment. The

report concludes with an assessment of factors

affecting small business competitiveness.

Highlights

Highlights of the researchers’ findings in Part 1 of

the report, “Market Analysis of the Retail Book

Industry,” include:

• Significant economies of scale exist in book

retailing, enabling the largest retail chains to expand

their market share. Nonetheless, independent booksellers have managed to survive by competing in

markets that chains do not dominate, such as by

exploiting prime geographic locations, specialization,

and niche markets.

• Hundreds of independent bookstores have established online stores. Barriers to entry on-line are low,
but these markets are more concentrated than traditional bricks-and-mortar markets because the small

retailers no longer have the advantage of convenient

location.

• The impact of online commerce varies by segment of the market. Many small rare-book sellers

have benefited from the emergence of auction sites

and rare-book search engines. Independents that

engage in mail-order sales have found online sellers

to be formidable competitors. The academic textbook

market may be more suited to smaller retail operations because the needs of student customers are

determined locally by the specific course offerings at

particular schools.

• Many aspects of Internet markets are favorable

to small vendors. Internet commerce service

providers have substantially reduced the technical

difficulty associated with setting up a database-driven web site capable of handling commercial transactions. Many independent booksellers have found that

an online presence can serve as a useful mechanism

for promoting traditional retail activity. Traditional

retail operations may also serve to reduce marketing

costs for online sites.

• Affiliate marketing can provide on-line small

businesses with some of the advantages that location

provides off-line retailers. Large Internet retailers

often derive as much as 2 percent of their revenue

from tie-ins to other sites. A number of small retailers are using such affiliate marketing, though there is

currently little data to evaluate the effectiveness of

these programs.

• Internet commerce enhances the market for

niche players. Access to large markets via the

Internet makes possible the emergence of specialized

“gnatagory killer” retail sites if such sites can differentiate themselves based on content and services.

• While the cost of getting on the Internet is low,

there are other barriers to effective competition by

small firms. The expense involved in marketing a

web site can be a significant barrier to entry for

small businesses. The researchers’ analysis of book

sellers’ financial data shows that combined occupancy costs and advertising expenses for Amazon.com

are 11 percent of sales, higher than the 9.6 percent

reported by a sample of independent off-line bookstores. Economies of scale in advertising, branding,

and cross-selling provide competitive advantages to

large online retail operations. 

• Other technological developments may also

shape the market. The falling cost of on-demand

printing may make it possible for small land-based

retailers to compete better with online businesses by

providing on-site production of publications.

Conversely, the emergence of electronic books may

give online retailers an advantage by allowing customers to download books without entering a store

or waiting for a package to be shipped.

Highlights of the researchers’ findings in Part 2 of

the report, “On-line Retail Market Dynamics,”

include:

• Although the Internet initially favored small

startup firms, online retail markets are likely to be

more concentrated than traditional retail markets in

the future. The low barriers to entry into Internet

markets suggest that those retailers that can achieve

economies of scale quickly may capture a large market share. Information is the main component of customer service in on-line markets. Site content is an

asset that can easily be scaled to serve a greater

number of customers.

• The potential utility of Internet commerce differs

across retail sectors. Many analysts expect Internet

retailing to be larger than mail-order retailing, which

currently accounts for approximately 3 percent of

total retail sales and 6 to 7 percent of many retail

categories.

• Internet commerce service providers have

emerged in many retail categories to help small firms

establish commerce-enabled Web sites. These firms

significantly reduce the technical burden of building

Web sites with extensive product data bases and

secure credit card transaction-processing capability.

• Online commerce is likely to become more integrated with catalog and store-front retail operations

in the future. Small traditional retailers who go

online have important resources that can be used to

reduce Web site marketing costs.

Conclusions

The Internet is a double-edged sword for small businesses. The Internet lowers barriers to entry into

markets, but it also increases the importance of

branding and allows large businesses to more easily

leverage economies of scale.

The Internet economy has been favorable to small

business startup companies, which have shown a

greater ability to innovate in this new market. As the

Internet economy matures, it is unclear whether this

favorable environment for small businesses will continue.
Ordering Information

The full text of this report, along with summaries of

other studies performed under contract to the U.S.

Small Business Administration’s Office of Advocacy,

is available at www.sba.gov/advo/research.

Printed copies are available from:

National Technical Information Service

U.S. Department of Commerce

5285 Port Royal Road

Springfield, VA 22161

Tel. (800) 553-6847

TDD: (703) 487-4639

Order number: PB 2000-104948

Price codes: A07 (paper); A02 (microfiche)

The National Technical Information Service’s complete data base of federally funded business research

is available on the Internet at www.ntis.gov.

Some studies related to this report include the 1999

Office of Advocacy staff report E-Commerce: Small

Businesses Venture Online and a 1996 contract study,

Lilliputian Strategies: Small Business Responses to

Big Business Entry, by Reginald Litz (see Research

Summary no. 172, December 1996).