Internet Strategies in the Apparel Industry Research by Robert H. Gertner
The mid-1990s marked a major turning point for apparel companies
confronted with the new retail landscape created by the Internet.
Forced to devise Internet strategies almost immediately, some
companies plunged into Web site development, while others discovered
that existing distribution methods hindered their ability to
respond to the e-commerce opportunity. New research shows that
differences in organizational form can account for the speed
with which firms in the apparel industry have adapted to the
Internet and the success some of the firms have experienced.
Take the customer searching for a particular brand and style
of khakis, perhaps Nautica or J.Crew. In the physical world,
this customer can easily find the Nautica khakis at a department
store such as Bloomingdale's, or shop at a company-owned store
for the J.Crew khakis. However, if the customer prefers to shop
online, there is a much larger divide between these two seemingly
identical products. A quick search of the Bloomingdale's Web
site may yield ten Nautica brand products, none of which are
the right khakis, maybe none of which are khakis at all. Switching
to the Nautica Web site, the customer may find product photos
and store locators, but still no way to purchase the khakis
online. After 10 or 15 minutes of frustration, the customer
then looks up J.Crew's Web site and finds a dozen different
styles of khakis, all of which can be immediately purchased
Robert H. Gertner, Wallace W. Booth Professor of Economics
and Strategy at the University of Chicago Graduate School of
Business, uses this example to illustrate the following question:
For two products that seem to be very close substitutes for
each other, why is one of them easily available online while
the other is not?
In the study "Vertical Integration and Internet Strategies
in the Apparel Industry," Gertner and Robert S. Stillman
of Lexecon, an economics consulting firm, explore the speed
with which different firms in the apparel industry began selling
online and their success to date. Large differences among firms
selling similar products with similar brand names made the apparel
industry ideal for examining the relationship between organizational
form and the ability of firms to adjust to changes in economic
For retail, as with all other industries, the vertical chain
starts with the raw materials and ends with the consumer. Vertical
integration is the extent to which there is common ownership
of various parts of that chain.
Gertner and Stillman's findings suggest that vertically integrated
specialty retailers, such as The Gap and J.Crew, tended to start
selling online sooner than nonintegrated vendors, such as Nautica,
and department stores. In addition, vertically integrated retailers
offer greater breadth and depth of product choice online.
Adapting to E-commerce
In a 2000 survey by the National Retail Federation and Forrester
Research, apparel ranked second in the number of small ticket
items purchased online, just short of books, the number one
seller. However, the Internet accounts for less than one percent
of total sales of apparel in the United States. The importance
of online sales is expected to grow, but brick-and-mortar stores
remain the principal channel for apparel sales for the foreseeable
future, and the predominance of traditional distribution channels
greatly affects the e-commerce perspective of retail executives.
There are significant differences between vertically integrated
and nonintegrated apparel companies, all of which affects their
ability to adapt to e-commerce opportunities. Some brands are
distributed through vertically integrated specialty retailers
and catalog companies that handle these brands exclusively.
Examples include Abercrombie & Fitch, Eddie Bauer, The Gap,
J.Crew, Lands' End, The Limited, and L.L. Bean. Other apparel
brands are distributed primarily on a nonexclusive basis through
department stores and other nonintegrated retailers. These companies
include Calvin Klein, Nautica, Polo Ralph Lauren, and Tommy
Hilfiger. Many of these nonintegrated companies also operate
their own retail stores, but typically do most of their business
as vendors to department stores.
For the purposes of the study, the authors focused on the aspect
of vertical integration that varies the most among the sample
firms: the extent to which the firms own their own retail distribution
In order to determine the reasons why vertically integrated
specialty retailers, such as The Gap, decided to invest in online
sales sooner than department stores and nonintegrated vendors,
the authors examined a data set of thirty firms in the apparel
industry. They based their findings on company reports, newspaper
and trade press articles, consulting reports, phone calls, and
interviews with company executives.
The authors built their sample around The Gap because it is
widely regarded as a leader in online apparel sales. The rest
of the sample was constructed by identifying vendors and retailers
selling merchandise similar to that offered by The Gap.
Their results show that nonintegrated firms are approximately
two years behind integrated firms in introducing online sales.
The online product selection for most of the vertically integrated
retailers in the study typically is the same or greater than
the product selection available in their stores or catalogs.
The selection is much more limited for the products of nonintegrated
firms sold through department store Web sites.
Despite the fact that online sales account for only a tiny
portion of total sales, all the retailers in the study emphasized
the ways in which the Internet can complement their efforts
to make shopping easier and to communicate better with their
"One of the interesting things we discovered is that on
some level, the opportunity for multichannel retailing was very
attractive to a lot of these companies," says Gertner.
For example, a customer who makes a purchase at a J.Crew store
will walk out with a shopping bag stamped with "jcrew.com,"
thus promoting another distribution channel. If managed effectively,
the Internet represents a new way to reach consumers that will
complement traditional channels.
Apparel firms with catalog operations at the start of the e-commerce
age had an important advantage when starting up online sales.
Firms that operate catalogs almost always use the same systems
to fulfill online orders. This level of synergy between online
and offline operations is not easily replicated by nonintegrated
firms, most of which are reluctant to use third-party companies
to fulfill online orders. Given issues such as customer service
and handling returns, multichannel retailing is much more difficult
to implement for nonintegrated firms without a large network
of stores or catalog operations. However, the study shows that
the extent of vertical integration remains a significant determinant
of Internet strategies even after controlling for the presence
of catalog operations.
Transaction and Coordination Costs
Why can a firm such as The Gap seize e-commerce opportunities
with greater speed and effectiveness? According to the authors,
several factors affect the ability and incentive of firms to
sell their products online.
For nonintegrated vendors, such as Nautica or Tommy Hilfiger,
selling their products through a department store's Web site
involves many coordination costs. The time and effort spent
negotiating brand guidelines for a vendor's portion of the Web
site is one such cost. For each new vendor that a department
store wants to add to its site, a new set of negotiations is
usually required for a variety of issues, such as the quality
of product photographs and descriptions.
Vertically integrated firms must also coordinate online efforts
with traditional retail channels, but a senior management team
has the ability to force solutions on any problems that may
arise. Their ability to make final decisions regarding online
sales methods is the key reason why integrated firms have fewer
In addition to significant coordination costs, nonintegrated
vendors may encounter difficulties, referred to as channel conflict
problems, if they sell merchandise from their own Web sites.
In several cases, the authors found that department stores objected
to vendors selling to customers directly from their own Web
sites, because such initiatives were viewed as direct competition
for sales of the same products.
"In deciding whether to offer online sales capability,
nonintegrated vendors need to assess how their department store
partners are likely to respond to this threat and whether there
should be changes in the terms of the contractual relationship
between vendors and department stores," write Gertner and
Issues of externalities, which refer to the effect of a decision
on parties who are not part of the decision, also make it difficult
for nonintegrated vendors to sell their products online. Since
department stores only get a small fraction of the profits from
selling a vendor's product online, they have less incentive
to build the best possible online showcase for the vendor. Similarly,
if vendors pay for part of the development of department store
Web sites, the lack of brand exclusivity also becomes an issue,
since many other brands will benefit from the improved site.
It's Only Temporary
Gertner points out that this research suggests a larger issue
that all companies should take into account when considering
any outsourcing decision. "Outsourcing often means giving
up more effective coordination, which becomes most important
when there is a significant change in the environment, such
as the Internet, or a recession or boom," says Gertner.
"While all these transaction costs and coordination costs
make it much more difficult for a company like Nautica to get
online quickly, we don't think this will persist forever,"
says Gertner. Vertically integrated companies are able to respond
faster and more effectively to the abrupt changes created by
the Internet, but if enough people want to buy brands such as
Nautica online, the authors believe that these companies will
find a way to make it easy for consumers to do so.
Robert H. Gertner is Wallace W. Booth Professor of Economics
and Strategy at the University of Chicago Graduate School of