By Brian Salsberg and Yuka Morita

To get a reputation for foresight, here’s a simple rule: If you predict a number, omit a date. If you mention a date, fudge the numbers. McKinsey opted to forgo this advice in March 2010, when we published our analysis of the future of Japan’s online retail market. We forecast then that online shopping (a $33 billion market in 2009, excluding non-physical goods such as digital media and tickets) would grow to $56 billion by 2015. We also predicted that e-commerce standouts Rakuten and Amazon Japan would continue to increase their market share and squeeze out those whom we termed “slow movers.”

So how did we do? Pretty well. By 2011, Japanese e-commerce retail spending had already reached at least $46 billion. With growth running at 7%, that puts the market on course to exceed our headline figure of $56 billion by 2015 and hit $62 billion the following year.

As for the Rakuten/Amazon juggernaut: The two giants continue to outgrow the market significantly, with a combined market share that grew from an estimated 32% to 40% in just two years and could hit 50% soon. Rakuten, launched in 1997, continues to lead most segments, including

drugs, food and beverage, beauty care, and consumer electronics. It features 95 million products and more than 35,000 associated merchants; merchandise sales (i.e., excluding tickets and downloads) is about ¥1 trillion (US$12.5 billion). More than three-quarters (76%) of online shoppers say they visit Rakuten.

Amazon Japan, launched in 2000, remains an ambitious and shrewd number 2; 62%

of online shoppers visit it. Amazon is the only non-Japanese online retailer of any significance (Yahoo! Japan, a shopping portal, is not a retailer) with an estimated \500 billion ($6.2 billion) in sales. Founder and CEO Jeff Bezos is aiming for 30% a year revenue growth. Amazon’s service, including free and same-day delivery, which competitors have begun to copy, has earned it profound consumer loyalty. The company is pushing into new categories,

Online retail in Japan: Too late for new entrants?

Consumer and Shopper InsightsJuly 2012

Excludes CtoC, motor vehicles, ticket sales, travel, online gambling, delivery food, returns

SOURCE: Euromonitor 2012, METI, McKinsey

4,7534,548

4,3464,135

3,9053,637

3,3472,988

2,6802,394

2,091

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

20161514131211100908072006

Japan retail e-commerce revenues, actual and projected

JPY trillions

Exhibit 1:The e-commerce growth opportunity

E-commerce sales are on track to hit $62 billion by 2016.

including food and most importantly fashion; it is also adding new distribution centers to its current nine, and is preparing to launch a Japanese version of the Kindle.

But interestingly, of the top 10 Japanese e-commerce companies, only Joshin, an Osaka-based consumer electronics retail store operator with about $5 billion in total sales (online and off), is a bricks-and-mortar player. Two others are traditional catalog players (Nissen and Shensuaki). Compare this to the US, where, seven of the top 10 online retailers are traditional heavyweights like Sears, Staples, Office Max, Wal-Mart and Best Buy.

Why the difference? Japanese bricks-and-mortar players have been reluctant to invest too much online, largely because they generally enjoy privileged positions in their traditional space. Due to self-reinforcing mechanisms that favor the status quo, Japanese companies tend to be slower than American ones to accept change and to reinvent themselves (a case in point is the distinctly old-school department stores). This is problematic because the keys to success for online stores and physical stores are entirely different.

For more than a decade, Rakuten, Amazon and others have grown, and taken market share, at a fierce pace. Even so, many traditional players still have not built many of the capabilities required to succeed online. The president of the online unit for Seven&I Holdings (the parent company for a number of groceries, 7-Elevens, department stores and other entities), recently told the Nikkei, Japan’s leading business newspaper, “We are behind devoted online retailers by at least 10 years in terms of services and technologies.”

For traditional retailers, what matters most are location, merchandise

assortment, and the in-store experience. Online retail, by contrast, is all about fulfillment and logistics, plus the online shopping experience and the customer lifecycle management (CLM) engine. It has taken a long-time for traditional retailers (in Japan and elsewhere) to realize just how complicated and demanding online retail is. And when they have tried, the going has often proved rougher than they expected. Yamada Denki, a major consumer electronics chain, for example, launched the online Yamada Mall in 2010, but sales are running well short of projections.

Even the bricks-and-mortar e-commerce leaders, including Uniqlo, Japan’s top apparel retailer, get only a small percentage of their total sales online. Consumer electronics (CE) is a particular anomaly. Three firms dominate (Yamada Denki, Yodabashi Camera, Bic Camera). Still, online revenues account for less than 10% of the total, compared to 24% and growing in the U.S., according to the NPD Group. Stores in Japan have little incentive to push customers online; for their part, consumers find in-person shopping simple enough because CE stores are ubiquitous, particularly near commuter train stations.

There are two reasons for the relative weakness of pure online retail plays in Japan. First, the strength of mega-portals such as Rakuten (and to a much lesser extent Yahoo! Shopping) and online fashion malls such as the Zozo network of shopping sites, make it more difficult to compete without significant investment in infrastructure and marketing to attract enough eyeballs. Second, in some categories, such as CE, convincing Japanese manufacturers to source supply at their best prices is a challenge.

There are some high-flyers: sales at Start Today, which operates the fashion-forward ZozoResort site, and MOA, which runs a popular CE site called A-price.com (in addition to stores on Amazon and Rakuten), are growing fast (54% and 57%, respectively, from 2008 to 2010). In 2011, ZozoTown’s revenues were JPY 80 billion ($1 billion). Success has come from exploiting a gap in the market (online fashion) and also from an innovative business model. While ZozoTown holds most of its inventory on consignment, it provides turnkey services to its “tenants,” including ordering, shipping, warehousing and even models and photographic services. Interestingly, ZozoTown recently launched a printed catalog, indicating that even this

Exhibit 2: Japan’s top 10 online retailers

1 Rakuten Largest e-commerce retailer (80 million users)

2 Amazon Biggest online book retailer; also offers general merchandise

3 Yahoo Online information portal that offers online shopping in addition to its search engine and Internet directory

4 Japanet Takata Direct sales company, based in Kyushu. Established in 1986, started online sales in 2000.

5 Senshukai Catalog retailer

6 Start Today Operates ZozoTown website, established in 1998; specialty is apparel.

7 Nissen Mail-order/catalog retailer targeting women 25 to 59;

8 Joshin Denki Leading large-scale discount consumer electronics chain operator.

9 Dell Dell’s Japanese subsidiary; sells PCs and peripherals.

10 Stream Online retailer of PCs and home electronics.

SOURCES: Fuji Keizai, company websites, Teikoku Data Bank, Toyo Keizai

successful online firm sees multichannel as the winning model in Japan.

Two other companies are worth a mention—if for no other reason than that they could be considered takeover bait for a hungry attacker. Oisix, established in 2000, specializes in online sales of organic vegetables, and has also established alliances with some 400 physical stores. Sales are an estimated $100 million. Then there is Japannet, which began as a home shopping CE player. Its online division, which started in 2000, has estimated sales of $577 million.

Coming soon: The shape of the market to come

So that is where the online market is now. Where is it going?

Total retail sales in Japan have dropped every year since 2006; over the same period, online sales have grown strongly. Though the rate of growth is slowing (down from 9% in 2006-11), given the dismal overall market, the performance

of online stands out. We believe that retail e-commerce in Japan will continue to grow in importance. One statistic that supports that assertion: the number of Japanese consumers shopping online from their PC ten or more times per year has increased markedly (from 37% of total consumers to 49%), with mobile shopping also increasing.

Still, there are certain areas where Japanese consumers appear loathe to do their buying remotely. One is luxury. In recent research on Japan’s luxury market, we asked consumers what elements they valued most about the in-store buying experience. The top two answers were: 1) The staff was kind, and 2) The staff was knowledgeable. In effect, consumers were telling us that they value the experience of buying luxury as well as the actual ownership

of the product. But while we expect luxury buyers to continue to favor stores or e-commerce, even here, we see room for growth, particularly for more moderately-priced items, helped along by the likes of Gilt.com and other event/time sales sites.

Catching up with Rakuten and Amazon Japan is a stretch; there is little reason to believe they are about to falter. Still, there are some areas of particular promise, such as online groceries and skincare/cosmetics. These online categories are smaller than the top three (CE, apparel, and books and software), but are growing faster.

For online grocery, look at it this way: the UK, like Japan, is a densely populated island nation. In Britain, online grocery is massively popular. Not so in Japan. The difference may be that Japanese shoppers are pickier; there is evidence that they like to do their own quality checks and value the in-store shopping experience. Indeed, a recent survey found that 70% of Japanese housewives

had never bought groceries online. The opportunity is implied in the response to a follow-up question: only 37% said that they never would.

So there are an awful lot of people who are at least theoretically willing to buy food online. And, in fact, they are beginning to do so: F&B is the fastest

-growing online category (22.6% via personal computers, 37% via mobile) and among the most fragmented. (Rakuten has a dominant share, but this is an aggregator of thousands of merchants too small to go at it alone) . Demographics are also in the category’s favor: A growing number of homebound elderly people could learn to value the convenience of shopping by click. At the same time, younger consumers who grew up with online retailing can be expected to rely on it more than their parents.

Aeon, Seven&I and Seiyu have all been pursuing the online F&B market, which is beginning to reach critical mass. According to the Fuji Kezai Group, online food sales are \78 billion ($9.7 billion). Ito Yokado (flagship GMS in the Seven&I group) has the largest market share (43%), followed by Aeon, 23%; and Seiyu, 17%. All the major food retailers say they are committed to increasing online sales.

It is too early to declare a winner here, but given the fact of continued retail consolidation, we see a time when a small number of firms will build nationwide businesses with superior customer experience and ordering and same-day or next-day fulfillment. Gaining market share won’t be easy, with the likes of Oisix and Amazon joining the food fight. Moreover, given the razor-thin margins typical of the business, success will require ensuring the right fulfillment model (typically a combination of in-store and warehouse); a competitive shipping policy; the right combination of same day, next day and “click-and-collect” delivery; and the right basket mix.

The skincare/cosmetics category is another fragmented online category with potential. According to Fuji Keizai, online computer sales in the category are growing a22% a year, and via mobile, 35.8%. At the moment, the online leaders are largely single-brand catalog players like DHC and Orvis. No formidable dedicated multi-brand portal, such as a Sephora or a Douglas, exists. (Cosmetics advice site @Cosme has tried to transform itself to a retail category killer of sorts.) While Shiseido and others have said they plan to invest heavily in online, the reality is that they see traditional stores as the lifeblood of their business.

Shiseido has 13,000 stores, and only started its business-to-consumer website last April, because it feared

that going online would damage its relationships with its own outlets as well as department stores and pharmacies. The site offers most Shiseido products to shoppers, but also encourages them to go to the actual stores, referring them to the closest ones and helping them to set up appointments for services. Given the ambivalence of the sector’s major players, we think the eventual Internet winner in this category could well be someone we haven’t heard of yet -- a disruptive attacker with little to lose.

* * *

To answer the question we started with: Is it too late for new entrants? The short answer is yes, it is too late for some categories (ie, books, where Amazon has

a 50% market share), but the window is still open in others. But maybe not for long. As Amazon, Rakuten and ZozoTown continue to grow and to please their many loyal customers, new entrants will need to either (a) focus on less-developed sectors or (b) leverage their brick-and-mortar presence, plus mobile, to create a compelling multichannel proposition.

http://csi.mckinsey.com

Brian Salsberg is a principal in McKinsey’s Tokyo office and leader of the Consumer & Shopper Insights center. Yuka Morita is a business analyst in Tokyo. The authors would like to thank Tomoko Hibino-Niitani, a knowledge specialist, for her contributions to this article.