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Inflation, Credit Crunch Hit e-Commerce

e-commerce and the economy
E-commerce spending has grown at a brisk pace for the last several years, outpacing offline retail growth by leaps and bounds. That pattern is still holding, but the tough times are beginning to catch up with online retailers, according to several analysts tracking the e-commerce economy.

A quick glance at the numbers from comScore (NASDAQ: SCOR) confirms the trend. From 2002 through 2007, e-commerce spending on nontravel items had posted annual increases between 21 percent and 26 percent. Spending so far in 2008 is up just 12 percent.

"We're facing some realities here that are very problematic," said comScore Chairman Gian Fulgoni in a presentation last week on the e-commerce economy.

One of those realities is that while e-commerce continues to post faster growth rates than offline retail (a predictable byproduct of a mode of shopping still moving toward the mainstream), growth in e-commerce spending actually fell faster than the offline channel from the fourth quarter of 2007 to the first quarter of 2008.

It's not surprising to see spending growth fall off in the beginning of the year as shoppers -- both online and offline -- settle in for a long winter of paying down holiday credit card debt. But the steep downturn in e-commerce stands out.

"The drop in e-commerce suggests that something happened that was different with e-commerce than with retail," Fulgoni said.

comScore identifies the main culprit as inflation, which in June hit its highest point in 27 years, according to data from the Labor Department.

The logic is simple. Rising prices mean that Americans are spending more of their budgets on the essentials, leaving them with less discretionary income. And the costs of staples such as food and fuel, which are not generally bought online, have risen dramatically.

"Inflation is far and away the most important economic concern among all income groups," said Magid Abraham, comScore's president and CEO.

According to comScore's July polling, 82 percent of consumers said they have cut back on spending due to worries about the economy. Across income brackets, roughly 70 percent of those polled said that they had either invested their tax rebate or used it to pay off debt or bills, suggesting that, as in 2001, the economic stimulus package did not generate the consumer spending that its supporters had hoped.

Of course, the price of gas can cut both ways. Patti Freeman Evans, an e-commerce analyst at Jupiter Research, said in a separate presentation that the Internet is becoming a more important channel as people become more judicious about running errands.

"We are seeing the Web continue to increase its influence in terms of transactions, but also in terms of offline planning," Evans said yesterday in an online research presentation sponsored by the e-commerce industry group Shop.org.

[cob:Pull_Quote]Despite comScore's concerns about the hit e-commerce is taking from dwindling discretionary income, the firm has identified the same shift in consumer behavior that Evans reported.

"There is a trend toward using the Internet more in an effort to save on gasoline costs," Fulgoni said.

So for the purchases that consumers are going to make anyway, outside of food and fuel, the Internet may be becoming a more appealing channel, with the inflation squeeze making the ease of comparison shopping online that much more important.

Each of the researchers also pointed out that there remain bright spots in the souring economy, most notably Amazon (NASDAQ: AMZN), which recently reported a 102 percent increase in second-quarter profits.

[cob:Special_Report]But Amazon may be an aberration. Before the macroeconomic situation will see a general improvement, the credit crisis is going to have to sort itself out, according to Ira Kalish, director of global economics and consumer business at Deloitte Research.

"As day follows night, we can be pretty reasonably reassured that there will be a recovery," Kalish said during yesterday's presentation. "What's really going to have to happen is a full cleanup of all the bad assets out there."

As a counterpart to inflation, the credit crunch is other main drag on consumer spending. With prices rising, people who had overextended on their mortgages or other consumer loans are now finding that the well has dried up.

"Consumers aren't going to be able to use their homes as cash machines [anymore]," Kalish said, painting a dark picture of a hangover that is only beginning to settle in.

"The housing crisis is not over," he said, adding that "the bubble is still bursting," which is creating a "negative wealth effect on consumer spending."

The researchers all agree on two things: that the downturn is likely to last for at least the rest of the year, and that they do not have a crystal ball.

Kalish, who might have the gloomiest outlook of them all, still sees hope for the "fleet-of-foot" merchants that can wait out the current storm.

"In this credit environment, we are going to see some retailers disappear," he said. "The good news for most of the retailers that do survive is that once the economy starts to recover, there will be the opportunity to invest in the kind of things that will make them grow."