In October 1999, when dot-com fever was threatening to turn into an epidemic, two marketing professors from Wharton and the London Business School presented a paper at a conference in Linthicum, Md. Wharton’s Peter Fader and LBS’s Bruce G.S. Hardie argued – and their perspective seemed almost heretical at the time – that selling consumer goods on the Internet was little different than selling them in a supermarket.

The professors pointed out that these “similarities could signal an end to explosive growth over the World Wide Web and danger for e-commerce vendors who don’t properly monitor their sales patterns or understand the dynamics of on-line buyer behavior.” Most significantly, according to Fader, while sales might appear to be going up, this was almost entirely because of the influx of new customers. “But if you track individuals, repeat purchases are a lot lower than what Wall Street is betting on,” Fader said.

With 20-20 hindsight, those words now seem to have been right on target. As the dot-com epidemic has abated, companies are now paying far more attention to the fact that the Internet may be just one of many channels that they must use to serve their customers. The net’s speed makes it an efficient channel, but before companies can profit from its efficiency, they must closely analyze the factors that can help convert casual website browsers into buyers, and buyers into repeat customers. Fader and his colleagues have continued to work on these issues, and will present their latest findings at a Wharton workshop on May 30.

Outside academia, some consulting firms too have studied these questions. Among them is McKinsey & Company, which analyzed more than “250,000 data points describing the behavior of on-line visitors to the sites of hundreds of companies, employing different business models, during the 18-month period from January 1999 to June 2000,” as an article titled “E-performance: The Path to Rational Exuberance,” in the McKinsey Quarterly recently reported. In an attempt to gain insights from McKinsey’s research, Knowledge at Wharton spoke to McKinsey’s Luis D. Arjona, associate principal in the San Francisco office, and Steve Hong of the firm’s New York office, who participated in the study.

Knowledge at Wharton: What were your most important findings about the way companies attract, convert and retain customers on the web?

Arjona: The main insight we uncovered was the most successful e-business performers were those that adopted a discipline that was always present in well-run organizations. Having a bright idea, a few million dollars in the bank from VCs, and a group of young and energetic founders were not enough to distinguish yourself in the long run. From the metrics, it is easy to see the trend and how you compare with other players. Of course, the public relations engines were active, and some companies were able to distinguish themselves in principle from others. In practice, however, very few sites had the results they were expecting. And the companies that did were following rules that have always characterized good practices in business. So that’s the big umbrella insight under which we found many trends about how companies were attracting, converting and retaining customers.

Knowledge at Wharton: When companies want to attract visitors to their websites, did your study show what works and what doesn’t work?

Arjona: First, let’s make a distinction between bringing visitors to a site and bringing qualified visitors to a site. That’s a huge difference. For example, users of Knowledge at Wharton are most likely people who are aware of Wharton’s reputation and understand the value of its research – and they trust it as an information source. That is very different from a consumer site which is mass-market oriented. Such a site may receive a number of visitors whose interests are not aligned with what is offered on the site. As a result, the site ends up attracting a bunch of visitors who are not qualified.

Our research showed that companies that had learned what their value proposition was – and for what type of visitors – were able to create websites that resonated with their visitors. When companies did this, they could increase their efficiency of being able to attract the right kind of visitors, lower the cost of attracting qualified visitors, and also increase the rate at which the visitors are converted from one-time viewers to repeat visitors. So from our point of view, the first question a company should ask itself should be, whom do you want to attract to your website?

Hong: We found in some of our interviews that sometimes there was a tradeoff. Some companies focused on targeting their customers and their main aim was to convert high-quality customers into regular users. At certain times, however, particularly towards the end of their financial year, when it was important for them to show that they had met their targets, these companies dropped their targeting strategy and went all out to get a mass audience. They were so focused on their attraction strategy that they didn’t care about the quality of their visitors, as long as their numbers went up.

This was particularly true in the case of middle managers in dot-com startups. Especially towards the year-end, they would swing from a conversion strategy to an attraction strategy. Interestingly, this practice was frowned upon internally at these companies. The managers would say, “We didn’t want to do that, but we had to do it in order to meet our numbers.” Eventually they planned to move back to the conversion strategy.

Arjona: So what you are staying is that though these companies would have liked to focus on attracting qualified customers, based on market expectations they had to focus on the numbers. They thought that as long as their numbers were going up, they were on the right track. The reason for this error is that investors did not know the right metrics to follow. They focused on things that seemed obvious, such as volume. I suspect that as a result of the latest shakeout, investors are going to start demanding performance measures that are different and more effective.

Knowledge at Wharton: In terms of distinguishing between random visitors and qualified customers, are traditional companies doing a better job than the dot-coms? Your research seems to suggest that while the incumbent companies may be better than the dot-coms at things like order fulfillment, the dot-coms may be better at using the Internet to reach their customers.

Arjona: We have collected three rounds of benchmarking data. In our early research, when we compared incumbents and attackers, we found that incumbents were already quite successful in attracting a large number of visitors to their websites. That is easy to understand, because the incumbents had strong brands, such as Wal-Mart, Kmart or Target. These are names that people know. When we looked at conversion and retention, however, and the behavior of changing visitors into actual customers or repeat customers, we saw that the dot-coms were doing better than the incumbents.

Knowledge at Wharton: Why?

Arjona: That was in the first half of 1999. In the second half of that year, the trend shifted. Incumbents continued to have a big edge in attracting visitors, but they also became much better at conversion and retention. Previously, the dot-coms had been better at converting visitors into customers. Their ratio of repeat customers to customers was very high. Our explanation was that the dot-coms had more online experience than the incumbents, they knew how to treat their customers better, and they had by and large more appealing websites. Over time, however, the incumbents began to do better in conversion and retention. My belief is that incumbents will do very well in this regard in the future. Some dot-coms too, however, will distinguish themselves and be sustainable businesses in the long run, competing with the incumbents.

Knowledge at Wharton: What kind of incumbents and dot-coms are most likely to succeed?

Arjona: Among the incumbents, we have found that the most successful are those with experience in direct marketing. Multi-channel players that have stores but also have had catalog sales are able to do quite well online. I don’t want to name names, but we know there is a limited set of these companies – Victoria’s Secret, Lands’ End, J.C. Penney, and so on. Among the dot-coms that are doing things right, I believe, are those that have something you cannot do offline. Those firms are able to develop large databases about their customers and deliver services and recommend products that other companies cannot.

For example, think about the value that Amazon brings to its customers. When it first approached its customers, it said it was Earth’s biggest bookstore. Where else could you find a store with eight million books? Take any book carried by any wholesaler in the U.S., and Amazon had it. If you were to go to a bookstore, no matter how large it was, you could never find that kind of choice. On top of that, Amazon allowed customers to buy a book with one click. For customers who aren’t so interested in the social aspects of book purchasing – walking through the bookstore, browsing through the volumes, having a cup of coffee – but in simply closing the transaction because they know which book they want, Amazon can tell such people, “Come in, and you’ll be done in five minutes.”

Hong: This wasn’t one of our survey participants, but another example might be Napster. Anyone who’s looking for even an esoteric piece of music can find it in one of the virtual communities on Napster. No store can compete with the volume of music that Napster can provide to users.

Arjona: So far we’ve been speaking about who is likely to create value long term. But there are also companies that are doing very well in terms of attracting an audience, as measured by the number of hits. I know a number of players that have a large volume of traffic, but they don’t have a clue yet what they will do with that traffic.

For example, consider a news portal, with millions of visitors who come to read its news. That’s great – but the point is, what good does this do? Will it be able to attract advertising? Wrong. The vast majority of advertising revenues on the web go to just a handful of sites, so if you aren’t part of that tiny minority, you probably will not get much advertising. You need to be able to do something more with that audience than just trying to get advertising dollars. In the case of such sites, we don’t see how they are going to create value in the long term.

Knowledge at Wharton: Based on your research, were you able to identify online business models that work better than others?

Hong: I found that most content sites are moving into transactions in some way. Most of the pure content sites have found that they cannot generate profits by focusing on advertising alone, and they seem to be moving towards a mixed model. A lot of them are struggling with trying to define the right mix.

Knowledge at Wharton: Has the advertising model for content sites failed?

Arjona: It’s hard to say if the model has failed, though it is true that it has worked only for a very small number of content sites. Still, companies will continue making that play. But consider this: How many television networks do you have in the U.S., which is a huge market? Three or four. How many entertainment conglomerates do we have? That number continues to decrease. Eventually on the web, too, I think there will be just a handful of players.

Knowledge at Wharton: What major trends do you see for the next 12 months?

Arjona: One trend we see very clearly is the online-offline combination. Dot-com firms are trying to align with offline players. Offline players are definitely improving their online operations. In the future, there will not be dot-coms any more. There will just be companies that are less successful and more successful in running their offline and online operations.