Is Zalando a Disruptive Company?

As Marc Andreessen succinctly put it: “Software is eating the world” – disrupting markets and obsoleting traditional players in ever more markets.

As Steve Blank and Bob Dorf highlighted, this is happening in two distinct ways: by just moving to a digital sales channel (i.e. selling over the Internet), or by making the product itself digital.

In both cases, the transition is disruptive to the respective market, but I believe there’s a big, qualitative difference in the impact of the disruption – a difference that is easily overlooked but that is fundamental to company valuation.


How Exactly is Software Eating the World?

Let’s understand the two different ways how software is eating the world: in one of the first chapters of “The Startup Owner’s Manual”, Steve Blank and Bob Dorf distinguish these two cases:

  1. Moving from a physical channel to an Internet channel – while still selling a physical product
    That’s the case of hardcopy book sales via Amazon, or shoe sales via Zappos in the US or Zalando here in Germany.
  2. By turning a physical product into a digital one
    Moving from CDs to digital music files, from hardcopy books to e-books, from leatherbound time planner to cloud-based personal productivity apps like Evernote or Wunderlist. Or, in the enterprise case where this happened already a while ago: from  paper-based business processes to enterprise application software.

So, What’s the Market Impact?

In both cases, the market impact is disruptive:

  1. Moving from a physical channel to an Internet channel – while still selling a physical product
    An Internet-based retailer in many cases can provide better customer value than a traditional retailer: because of cutting out layers in the distribution chain and due to economies of scale, the Internet-based retailer typically can offer a broader selection at the same or better price than a local retailer. Shopping can be done 24/7 and fast delivery options are increasingly common.
    This disrupts traditional retail shopping – whether on high street, in shopping malls, or through traditional mail order.
  2. Turning a physical product into a digital one
    In consumer markets, this transition provides i
    nstant gratification: shopping is 24/7 and delivery happens immediately. Electronic content is accessible anywhere, as consumers can carry extensive content libraries in small, mobile devices. Social media enable new forms of communication, socializing, and entertainment – also available anytime anywhere via mobile devices.
    In the enterprise market, software, Internet and social media enable new business processes and workflows, and support automation and global collaboration.
    In both the consumer and the enterprise market, turning a physical product into a digital one disrupts established vendors who are not willing or not able to take advantage of the switch to digital products. This is already evident in several content industries, from music to magazine publishing.

In conclusion, both types of “going digital” are disruptive to their respective market places and the digital pioneers often capture huge parts of the market from the incumbents.

But There’s a Huge Difference

Because of that, I often see expectations that somehow all these disruptive companies have the potential to become as profitable as leading software, Internet or social media companies, such as Microsoft, Google, or Facebook.

However, there is no evidence and no logical reason why a company selling a physical product via the Internet should enjoy a better profit margin than their traditional competitors did before they were disrupted. And that means net profit margins in the single digits.

Yes, there is the cost advantage of cutting out middlemen in the distribution channel – but on the other hand, the competition is only one click away and the price transparency afforded by the Internet will drive down profit margins.

Basically, you can become the #1 in a huge market and disrupt the old guard, but still, that won’t give you Google-like profit margins.

In contrast, a disruptive company with a digital product will benefit from the cost structure advantages of the digital model and may ultimately generate Google-like profit margins.

So what does that mean for Zalando? I believe Zalando is already well into the process of disrupting fashion retail – but based on its current business model, it will not generate the kinds of profit margins that Microsoft, Google, or Facebook enjoy.

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