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Where Are All the Profits in Online Retail?

In the online market share battle, customers benefit, but retailers lose profits.

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During the last 15 years, the demographics of online shoppers has shifted from the early adopters to nearly all Internet users. Along the way, there have been numerous failures (such as Webvan and Pets.com) for every success story (such as  Amazon.com (AMZN)). Despite these failures, the growth in online retail is undeniable, as 4.2% of all retail sales were transacted online in 2008, up from just 1.3% in 2000. Although the industry should continue to benefit from secular trends, we think industry dynamics and a slowdown in consumer spending will keep profitability low at the firmwide level. Therefore, we would only invest in the strongest companies at attractive valuations.

There are several reasons for the strong growth in online retail, including consumers becoming more comfortable making online purchases, the convenience of home delivery, and the ability to easily compare products from multiple retailers. In addition, advances in technology have improved the experience via quicker-loading Web sites, better search functionality, and better images and videos for product descriptions. According to the U.S. Census Bureau, online retail sales have increased at an average annual rate of 22% since 2000, compared with just 5% for total retail sales.

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Larry Witt does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.