APRIL 12 I COVER STORY I BY SARA FARR
The New E-tail
Tucked into an unassuming industrial park in central Orange County, Calif., sits the headquarters of a company that may be revolutionizing the online music instrument business.
Run by 25-year-old Internet entrepreneur Nathan Nguyen — named one of "The Richest Kids in America" in Mark Victor Hansen's book of the same name — Instrumental Savings roared into the online marketplace during the past five years. In that time, it has established itself as an e-tailer to beat on price while rewriting the rules of the school music retail market. And still, Nguyen said he doesn't see himself as a brick-and-mortar's competition.
"We are unique because we operate both an online and a brick-and-mortar store. Compared to our online operation, the brick-and-mortar yields greater profit margins, but our online division total profit is greater due to overall sales volume. Online [retail], at its core, competes on price, and while it is the worst way to do business, it is also a great entrepreneurial challenge to compete on operational excellence."
The way Nguyen sees it, brick-and-mortar stores lose customers because they don't offer them enough reasons to stay, especially in a depressed economic climate.
"When our brick-and-mortar store experiences challenges, we don't assume that our online store division or our competing online stores are to blame. If we failed to engage our local communities and earn their business relationships, we never had them in the first place for us to say we lost them. If a local [customer] bought their musical equipment online rather than at our local store, it is because we never gave them a reason why they should continue to buy from us at the store. On a local level, it's all about maintaining relationships."
Officially launched in June 2006 as a full-line e-tailer, Instrumental Savings offers a wide range of products, everything from accordions to French horns to world percussion instruments — all geared toward the entry-level musician. The company's no-frills website, instrumentalsavings.com, has basic photos and descriptions, along with external links directing customers to more product information. There are also links for customers to "connect" products to their online social networks. Some product pages feature embedded YouTube videos for a pseudo-"touch" component, as is the case with the page for Yamaha band and orchestral products. Each product page also has a list of related accessories customers can add to their carts.
It's not a flashy, high-concept design, but Nguyen said that's not the point, explaining that functionality is key to converting visits to sales.
"When it comes to online, there are two questions you have to answer," he said. "One is how do you get traffic? No. 2 is how we convert the traffic into customers. Those two things [have a lot to do with] design. One design may look phenomenal, and the other one may be plain but it converts. You have to have a balance."
According to Nguyen, great design and intricate pages that take a long time to load aren't worth the wait for today's customer. If customers have to wait, he said he believes they'll more than likely leave the site. This dovetails with Nguyen's original strategy of targeting the entry-level market to penetrate the music industry — he's banking on customers not needing tons of high-res photos with zoom capability. It's the dollar-store concept: When you're paying a dollar for shampoo, you usually don't expect it to have the same bells and whistles as salon shampoo in the $20–$30 range. Plus, you don't need to spend a lot of time comparing the two because you know intuitively what you're getting.
"After we earned our spot in the marketplace as a trusted source for musical equipment for aspiring musicians, we had to develop a completely different approach to attract the more advanced musicians," Nguyen said. "The more experienced customer we target, the more they expect from their instruments, and the more they want to inspect the instrument before they buy. Because of that, online becomes very difficult for their risk decisions. So we said, 'If that's the case, we need to lower their caution level by providing more rich media of our product offerings.'"
Don't Rent, Buy
Nothing is more low-caution for a customer than renting an instrument, at least that's the conventional wisdom among school music retailers. Nguyen, however, argues that parents are actually doing themselves a disservice by renting rather than buying. He feels so strongly that buying a low-cost student instrument is a smart investment for parents that he devotes an entire Web page on instrumentalsavings.com to explaining the finances behind retail rental programs.
"The only benefit to a consumer when they rent is if the child is not really sure if he is going to continue," Nguyen said. "Renting is the worst thing you can do if you know your student is going to stick with it because it's just wasted money."
It's a controversial strategy, especially as rentals account for a large percentage of school music dealers' revenue. Nguyen acknowledged that having a large rental pool can yield fantastic returns. Still, he said the initial capital investment and the length of time before dealers start reaping financial returns are too significant for an e-commerce business. It takes at least three years, he said, to realize a profit with rentals. During that time, a retailer continues to carry increasing debt, as it has to buy more instruments to expand its rental pool. So, his strategy is: Why not source low-cost instruments that let parents capitalize on their investment?
"We are the bridge for parents to say, 'Honey, we can afford it,'" he explained. "Years ago, the off-brand instruments were few and a dime-a-dozen in terms of quality. But now, student-model instruments are actually good quality at a very affordable price. Because of that, it makes buying much more advantageous. We look at the best vendors that will give the best quality at the best price to help the musicians get started."
That said, students often progress past their entry-level instruments. It raises the question: Is Nguyen, who has a robust student instrument business, worried about constantly having to go after new customers?
"To grow with the market is a great strategy theory-wise, but it is an uncertainty," he said. "The loyalty question is quite high for e-commerce. If you're a local store, you can bet on [loyalty] because geographically [that family is] going to be with you. For online retailers, we can't bet on the fact that customers will remember us for anything. We're not there to coach them through the process. We're just there to make them feel great for the purchase. The only thing we can do is constantly be the champion for our customer's experiences shopping with us and hope they will remember us next time."
When Instrumental Savings launched in 2006, Nguyen said the company invested $500,000 in online marketing (specifically, in search engine optimization and keyword searches) to start generating enough traffic and sales to make the site profitable. For the first three years, all profits were reinvested back into the business, according to Nguyen, who added that an online business model differs substantially from that of a brick-and-mortar in terms of budget allocations.
"Typically, we would budget 15 percent or more of our revenue into marketing for online, whereas bricks-and-mortar stores [often] budget about 3–5 percent for marketing at most," he said. "Conversely, a physical store would invest more in their rental location to drive foot traffic. If you want to have foot traffic, you have to focus on spending on the rental space. However, online you buy traffic that comes through your store. So is it cheaper to start an online store versus a real store? The answer is that it's not. That's contrary to what people think."
An online business, he said, has to reinvest continually in marketing. In some ways, it's a losing proposition, as the e-commerce business model is getting more complicated and the online market more saturated.
"If you don't keep investing, what you have currently will be lost and gone because there will always be a new and better [website] coming out," Nguyen said. "In reality, a bricks-and-mortar store's competition is another bricks-and-mortar store. For that market to change, a store has to close. Online, you never know who is going to be your next competitor. You never know who's taking traffic from you. The new guy might put you out of business, and you won't even know it."
The huge start-up cost and online marketplace's volatility are the biggest reasons why Nguyen recommended that smaller independent dealers focus their websites initially on serving local clients. It's not as risky, and it lets dealers grow at a more measured pace without investing large sums of capital into an unpredictable business. He suggested that stores spend no more than $5,000 for their initial investment — $3,000 on the site itself and $2,000 on marketing it.
"That should allow you to get something going," he said. "That cost should be all-inclusive and allow you to start a site that can re-engage your local customers and allow them to critique the site. From there, once the site starts breaking even, you can start to reinvest and grow."
Nguyen pointed out the importance of existing technologies for startup sites. He recommended using a programming company that's already familiar with your type of business and also cautioned retailers from using brand-new software, as it usually has bugs that need to be worked out. Plus, he suggested having hosted solutions. For example, instead of buying a full shopping cart system when you don't fully understand how it works with PCI (payment card industry) compliance, go with something like PayPal's existing merchant solutions. "They've done it for years, and they can integrate into your site with no problem," he said.
"Once you have figured out that you have customers, then you can play around with reinvesting in certain areas. You need to build a local website first for your local customers. If you jump into nationwide retailing online, you're going to spend so much money on marketing and so much money in infrastructure. And you're going to find out that you're going to make pennies, and you're going to be really upset."
After five years as an online retailer, about the only constant for Nguyen has been change. Instrumental Savings is set to launch a redesigned website within the next few months, something that's been in the works for more than a year. He also plans to launch a resource for brick-and-mortar stores interested in starting an online division. The site, pioneeringcompanies.com, will provide the nuts and bolts on issues to consider when starting an online business, including details on how to best utilize available resources.
Nguyen's coming off what he called "possibly the best year we've had." He credited much of his success to mentors, staff, customers and such key vendors as Yamaha that have helped him along the way. Now, he said he feels a sense of responsibility to share his knowledge and give back.
"It goes back toward the way I was brought up," said Nguyen, who immigrated to the United States from Vietnam with his family when he was 5 years old. "My dad told me that one of the biggest gifts you can give on this earth is to create employment. My dad was a major in the Vietnam War and says that if we would have won the war he would have looked for ways to create jobs for people in Vietnam. It's one of the poorest countries where a lot of people don't have jobs, and jobs are what stimulate the economy."
Still, success for Nguyen hasn't come cheaply — neither in terms of reinvestment or the pace that's required to stay on top of an ever-shifting online marketplace.
"The honest truth is that if I knew how difficult it would be, I would have never started," Nguyen said with a laugh. MI