Web 1.0 Redux?

Recent positive earnings and outlooks from Amazon (AMZN-Q), Netflix (NFLX-Q), and Digital River (DRIV-Q) seems to have caught the market a little by surprise. Why has the old Web 1.0 e-commerce model experienced such a relative resurgence? And should investors buy, hold or sell in the sector?

The overall upward trend in online usage benefits from both demand-side and supply-side drivers. This alone should be seen as positive.

Demand Side
During the Holiday Season, it appears that consumers were less about shopping experience and more about buying utility. As well, higher unemployment and economic insecurity means fewer commuting trips and less destination travel, both of which typically generate more in-store shopping. Its a lot less fun trudging to the local Wal-Mart than it is to shop at Sak Fifth Avenue on the cancelled trip to New York. Furthermore, "deals" can be repeated online with less consumer hassle associated with parking and crowds.

As the economy worsens, we should see this trend strengthen because, well, it's happened before. In the early 1990s, Faith Popcorn rose to fame in part because she coined the term "cocooning", which described the trend of people staying at home more. In retrospect, this trend was due primarily to the recession, and once the economy returned to health, the niteclubs began to fill again. It's reasonable to suggest that 17 years later, people are likely to behave similarly. Netflix appears to be a clear beneficiary of this trend. During the early 1990s, the clear beneficiary was...Blockbuster (BBI-NYSE). Same trend, different delivery.

E-commerce is benefitting from maturity. In these uncertain times, e-commerce has been around for nearly 15 years, and most consumers have online buying experience. As well, the technology has greatly evolved to offer better perceived security, privacy and choice. Unlike in the past, there is consumer pull, which is far more cost effective.

Brand matters. Just like marketing budgets flow to Google (GOOG-Q), and IT services contracts flow to IBM (IBM-NYSE), e-commerce flows to "safe" dominant brands. This benefits Amazon directly. On the other hand, eBay (EBAY-Q) has experienced lingering service issues that has eroded some of its brand equity recently, which could be partially reflected in its poor Q4 performance.

Supply Side
Based on the transcripts of the various conference calls, it appears that retailers and manufacturers are rationalizing distribution channels, and moving towards highest efficiency, highest measureability. Increasingly, transactions are being moved online.

Benefiting Digital River directly, manufacturers and retailers are cutting more costs by outsourcing the online retail infrastructure. The Company has reported some impressive contract wins. Amazon has taken it further by outsourcing its excess infrastructure through its Elastic Cloud Computing (ECC) business, which grew year-over-year by over 30%.

During 2009, we should see more retailers rationalizing physical networks, while attempting to hold onto consumers via online marketing programs and more e-commerce activity. Multi-channel retailers with the most advanced online retailing capabilities should benefit most.

An area of increased investment is likely to be in the area of transaction efficiency. How can the discovery/decision/buy process be shortened? We should see more attempts at integrating transactions into marketing with more mobility. Look for more integration between affiliate marketing and e-commerce, possibly in the form of increased M&A during the year.

So are the stocks buy, hold or sell? It depends on the investment time horizon, but stocks like Amazon, and Digitial River, with clear hooks into the infrastructure are likely more appealing long-term than category plays such as Netflix where competition could become fierce fast. The stock has had a nice run since the fall and I would be taking profits. It may be a good time for Netflix to think about strategic acquisitions. eBay may find itself in the wilderness during this recession as it struggles to evolve its business model, mitigate some of the potential channel conflicts associated with its Power Sellers, regain consumer confidence, and figure out what to do with Skype. eBay may sit this one out.

I do not own any of the stocks mentioned above.