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  • Steven Woda

What’s Wrong With eBay? It’s Simple Economics

What’s wrong with eBay? Before I answer this question, you should download this Wharton case study by Dr. Eric Clemons of The Wharton School, University of Pennsylvania. Dr. Clemons is one of the world’s most renowned experts on information economics, and this case study is currently being taught at Wharton this semester. It goes into great detail discussing eBay’s current challenges, and I believe you will find it insightful.

Okay back to the question… What’s wrong with eBay?

Suddenly, there is so much discussion about what is going on with eBay. Buyers seem to be shopping elsewhere. Sellers are complaining about deteriorating economics and looking for new, more profitable sales channels or going out of business altogether. Third-party service providers are reading these tea leaves and choosing to relieve their dependence on eBay’s success and more importantly, the risks of falling victim to eBay’s policy team. The media is reporting continued fraud and emerging customer service problems. Designer brands and manufacturers are suing eBay over massive counterfeit sales and intellectual property abuse. Key managers are leaving for greener pastures. New competitors are emerging in a big way. Analysts are waking up and asking real questions. Investors don’t seem to be buying, and in many cases, they have been selling. A lot of my eBay customers have been calling me lately asking for an opinion for what is going on.

First of all, let’s review a few facts. These are not my opinions, but rather, real data points.

  1. eBay is growing slower than the rest of eCommerce

  2. Read Scot Wingo’s insightful analysis

  3. 41% of eBay’s users apparently quit in 2006

  4. 56 million active users in 2005 grew to 78 million active users in 2006, but during that time, eBay added 45 million new registered users

  5. 100 of eBay’s top 1,000 U.S. eBay sellers by feedback rating have either quit eBay or gone out of business

  6. Based on my detailed analysis of The Sellathon 10,000 data for August 2006

  7. 59% of eBay’s sellers apparently plan to stop selling on the eBay platform in the next six months

  8. Here is the AuctionBytes survey of 1,225 eCommerce merchants

  9. A number of high profile, large sellers have gone out of business on eBay in 2006

  10. BusinessWeek’s Robert Hof writes about eBay’s former #2 rated seller, GlacierBayDVD, going out of business

  11. AuctionBytes reports Sell2All’s financial default

  12. eBay prices are a fraction of what sellers can get on other channels

  13. Jonathan Garriss at GothamCityOnline, one of eBay’s largest shoe sellers, says prices are 20-50% lower on eBay than on his other sales channels, and we have many, many merchant customers that will confirm this amazing statistic

  14. The fraud problem continues to grow

  15. No official eBay figures here because eBay quit sharing the data with FTC and, but anyone working in the space will have a strong opinion on this

  16. Tiffany & Co (TIF), Louis Vitton (LVMH), and Christian Dior (DIOR) have all filed lawsuits against eBay suggesting that 90+% of the goods sold on eBay claiming to be produced by these brands are in fact counterfeit

  17. Louis Vitton and Christian Dior lawsuit discussed on a popular ecommerce merchant forum

  18. Tiffany lawsuit discussed on Fraud, Phishing and Financial Misdeeds

  19. eBay’s stock is down almost 48% from its high as of today (9/27/06)

  20. You can research eBay’s stock at Google Finance

So, what is wrong with eBay?

Ugly seller economics? Yep. That is for sure, but that isn’t the core problem. That is the net effect of the core problem.

Rampant fraud? Some folks think that if Rob Chestnut and the eBay Trust & Safety department could simply catch all the bad guys, then everything on eBay would be fine. I believe that is a little naive. Mr. Chestnut is never going to catch all the bad guys or even a fraction of them, but I am sure he and his team are working hard and having lots of successes. The problem with this line of thinking is that it is a losing proposition. It reminds of that game we have all played at the county fair, "Whac-A-Mole". You will never hit all the moles, and when you get too focused on one mole, you miss all the others. Chasing bad guys has its place, but you need a more fundamental solution. I also believe fraud will always exist, and so you need to concentrate on a more scalable, effective mechanism. More on that later.

Not enough buyer demand? Many eBay experts and Wall Street analysts are crowing about a lack of buyer demand, and they will cite some of the statistics mentioned above and the story can be quite convincing. Well anytime you have too much risk and uncertainty in a marketplace, you will have less buyers. The risk averse buyers will seek safer harbors. I guess that should be pretty obvious, but I can tell you that many eCommerce "experts" don’t fully grasp this basic economic concept (I can talk more about this another day). Too little buyer demand is certainly a problem, but again, it is the result of a more fundamental problem.

Many believe that the marketing department simply needs to do a better job of telling consumers about eBay. Marketing is obviously not the problem. Every human on the planet with a computer or TV knows what eBay is as well as its value proposition.

Too much seller supply? eBay’s Bill Cobb recently announced fee increases to "reset the balance of the eBay marketplace". A balanced supply and demand is critical to a healthy marketplace, so I don’t fault the line of thinking. Also, auctions are more profitable to eBay, so okay, I guess that is fine. My worry is that eBay management believes that raising fees is a way of pushing low quality product off the platform when in reality, I think it does just the opposite. If you don’t understand the core problem I am about to diagnose for you, then it is easy to think this might be a good strategy. It is a common perception in the eCommerce world that market failures are largely due to bad inventory and that if you charge no or low fees, you invite bad inventory. That is only true when buyers can’t tell which inventory items are the poor quality items and which items are the pristine items.

That brings me to eBay’s core problem.

eBay’s core problem is simple economics!

More specifically, eBay’s core problem is the existence of information asymmetry and the lack of an effective seller certification and performance guarantee mechanism. Information asymmetry exists when one party has more or better information about the product than the other party. In eCommerce and on eBay, the seller clearly has an information advantage over the buyer, and this is information asymmetry.

In 2000 and 2001 while working on the business plan for buySAFE, I talked to thousands of people about what I viewed as an inevitable problem for eBay and eCommerce, information asymmetry and the lack of an effective signaling mechanism. My belief then was the same as it is now, stringent, meaningful seller certification and strong, comprehensive performance guarantees will enable eBay and eCommerce to be successful channels for small and medium-sized merchants. Without it, small and medium-sized businesses won’t be able to optimize profits, and eCommerce marketplaces will become Markets for Lemons (You should read my blog post on "What’s a Market for Lemons?" in order to see an illustration that defines what I am talking about here.)

While working on the business plans, every professor, classmate, venture capitalist, eBay manager, expert and entrepreneur rolled their eyes at me, and then they lectured me on how eBay and PayPal had clearly solved the problem with feedback ratings and back-end buyer protection plans. That was six years ago, and given the facts I have just described above combined with buySAFE’s incredible growth over the last two years in eCommerce, I would suggest that the information asymmetry problem was and is real, and somebody on eBay’s management team needs to recognize this sooner versus later.

Have you ever seen the famous New Yorker cartoon by Peter Steiner from 1993 where the two dogs are sitting at a computer? One of the canines says to the other with a nice smile, "On the Internet, nobody knows you’re a dog". Yep. That is so true, and on the Internet, buyers have difficulty telling who is a professional, legitimate merchant as well. The key to dealing with information asymmetry? Signaling.

If effective signaling mechanisms are the key to solving eBay’s information asymmetry problem, then what is the most effective signaling mechanism? Again, absent an established, recognizable merchant brand, I believe stringent, meaningful seller certification and strong, comprehensive performance guarantees provide the strongest possible signal of professionalism, trustworthiness, and reliability. Obviously, that is what buySAFE does when it bonds sellers and transactions, but I will address this in more detail in a future post. I should also note that the Professional eBay Sellers Alliance (PESA), eBay’s largest, independent seller organization, has been a strong proponent for stringent, meaningful seller certifications as well.

When information asymmetry isn’t addressed, what happens in the long-run? As I mentioned above, economists believe that markets can eventually become "Market for Lemons". Again, you should check out the following post for details on "What is a Market for Lemons?".

Ecosystems are fragile. They can completely unwind when they fall out of balance. Any biologist will tell you that this is true. eBay’s marketplace is an ecosystem, and we need to recognize that the core challenge to this ecosystem and the eCommerce ecosystem in general, is information asymmetry.

I hope this is a helpful commentary. I want to end by saying that I am eBay’s biggest fan, and I hope it can sustain its amazing run. We will all be better off if eBay can succeed.

There are lots of information sources for what is cooking at eBay and in eCommerce, but if you want unique insights into what is really driving behavior and marketplace activity, I highly recommend the following three blogs: buySAFE blog by Jeff Grass eBay Strategies blog by Scot Wingo AuctionBytes blog by Ina Steiner

One new source of information is from Randy Smythe from GlacierBayDVD. Randy is one of the nicest, smartest guys I know (and a pretty good golfer too), and when his eBay business went under, I was very upset about it. Randy is roaring back and sharing his terrific insights with us in his new blog, and I highly recommend it.

I welcome your thoughts and insights as well, so please feel free to weigh in with your comments.

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