- Disintermediation refers to the notion that Internet-based selling was going to displace pre-existing distributors or conventional retailers (where applicable) due to certain operating attributes innate to the Internet world rendering intermediaries less than necessary. Some manufacturers would go direct to end-users of products. Disintermediation was supposed to help manufacturers.
- Transparency referred to the notion that the Internet would empower consumers to easily compare prices of sellers for like items. Transparency would make price the focus of consumers for many types of products they wished to purchase at the best possible prices. Transparency was supposed to help customers.
We have an investment in an Internet-based retailer. It sells products manufactured and branded by others. Many of these products are available at your local Home Depot. This company has several Internet-based competitors.
I had the opportunity to get a glimpse of a close competitor ("Competitor A") and compare it to our portfolio company. This company is substantially larger (3X in revenues) than "portfolio company" and has been around a lot longer. This company carries very many of the same products from the same manufacturers.
A close comparison of the two companies reveals something pretty interesting. Our portfolio company realizes gross margins in the 33% range (plus) while those of Competitor A are right at 20%.....This is an exceptionally large difference in gross margin between two competitors selling nearly identical products provided by the same manufacturers.... This would suggest that portfolio company is selling its products at prices substantially higher than those of Competitor A. The premise of "Transparency" would suggest that the Competitor A would run us out of business...BUT just the opposite is happening............ HOW CAN THIS BE?
A review of the posted selling prices of Competitor A suggests that customers can buy from them at prices approximately 10% lower than from our portfolio company. At our average product selling price of $150, the 10% price differential accounts for 8 points of the 13 point margin differential (33% - 20%). So if price were otherwise held equal, portfolio company would still have a 5 point gross margin advantage over Competitor A . Why?
We have spun thus around many different ways and there is only one conclusion we were able to draw. Portfolio Company's gross margins are significantly better because it is buying product at a cheaper price..How does it do this if it is so much smaller than Competitor A?
Secret Sauce
Portfolio company's investment thesis is that it helps manufacturers solve specific types of problems (can't reveal these problems and solutions exactly but they deal channel issues and other sellers of the products - perhaps like Home Depot or Competitor A) In a way Portfolio Company is "disintermediating" these other sellers with purposeful benefit to the manufacturer). I believe that Competitor A's investment thesis is that it provides products to customers at low prices with wide selection. This is sort of like Amazon's focus. Competitor A is sort of a customer to the manufacturer more than a problem solver for the manufacturer and its principal aim is those who buy its products. Competitor A thus has a model built around "transparency."
So...it may not be a perfect conclusion but a plausible one that disintermediation plays result in more profitable companies than transparency plays. In other words...helping the supply side -manufacturers appears to result in higher profitability than helping the demand side-customers (which may result in more volume as thus more profits but at lower margin levels). This may be countered by the notion that suppliers may be more anxious to help problems solvers and thus provide more supply to them. Thus would result in lower volumes to Competitor A. Ironic...that the high volume strategy could result in lower volume...
I suspect my conclusions here are lightyears behind...but at least they provide some empirical context for issues thrown out there years ago...
