When Walmart enters a new city, it’s only a matter of time before a lot – if not all – competitive local merchants are out of business. There are basically two reasons for this phenomenon – economies of scale and loss-leader pricing.

"Economies of scale" simply means that Walmart can purchase in bulk, ship in bulk, package in bulk, and sell in bulk – getting discounts and cost savings all along the way. "Loss-leader" pricing refers to when a merchant sells products at below cost as an incentive to get customers in the door to buy high-margin products. Some, of course, have accused Walmart of using loss-leader tactics as a way of literally bankrupting local competitors, but the point of this blog isn’t to focus on Walmart’s ethics.

The point, actually, is to talk about how the online lead generation industry will soon be filled with a few Walmarts, while the small mom-and-pop shops will be out of business. And just as with the ‘offline’ Walmart, the same two causes will apply – economies of scale, and loss-leader pricing.

First, let’s discuss economies of scale. As Jay Weintraub adeptly pointed out on his blog, there is no "bulk discount" for lead buyers; in fact, the more leads a buyer wants, the more he will likely pay for each lead. So a lead seller who is able to deliver huge volumes of leads will actually get more per lead than a small shop that can only delivered a limited supply (as an example, lead generation companies that go through a middleman like Commission Junction will always get paid less than a big lead gen company that negotiates directly with the buyer).

Moreover, top lead sellers are able to reinvest their returns in top technology, top people,and the best media placements. When you combine superior back-end economics, increased efficiency, and resources unavailable to small fry, things look bleak for small lead gen shops.

You might rightly counter that there are plenty of small companies making a killing right now in lead generation, which I accept as fact. The problem for these companies, however, is that the gap between the small guys and the big "Walmarts" is becoming larger and larger. At a minimum, this means that the big guys can enter any market (CPC, Email, SEO, etc) and push out the little guys simply because of superior economics. The fact that they haven’t yet simply proves that this is a developing market. Over time, as the market develops, there will be less and less "arbitrage" opportunities for small players.

Which leads me to the second point, loss-leader pricing. I am seeing a lot of lead generation companies trying to develop multi pronged revenue strategies at the moment. This can be anything from creating ad networks, buying domain names, or even trying to launch consumer portals. The reason for these forays into non-lead gen, in my opinion, is that they serve as a margin cushion against the volatility of the lead gen market. Perhaps more importantly, they also present a strategic opportunity to crush any one-trick pony lead gen players.

Consider this scenario. Let’s say there is a lead generation company that is really, really good at online education leads. Perhaps they are able to charge $50 per lead and can buy the leads on search engines for $40 – a 20% margin, not bad.

Now let’s say a new competitor comes into this market. Because the competitor is new to the game, he can only negotiate $40 a lead from the education companies. But, this competitor has a war chest of revenue that it generates through another business (for example, let’s say the competitor has millions of domain names, like Marchex.com). This competitor is actually willing to pay $50 per lead on the search engines, in part to grow it’s margin-share of the industry and get the online education companies to pay it more per lead, but also as a competitive way (and potentially illegal, but hey, anti-trust really doesn’t mean much these days!) to force the other lead gen company out of the market.

The existing lead gen competitor – not having an alternative revenue stream – has no choice but to retreat, or maybe even go into another vertical entirely. As soon as the coast is clear, the new competitor can lower bids down to the margin of the old player and effectively become the new leader in the space.

Thus, as economies of scale grow and margins decrease, it’s not just the small lead gen shops that are in trouble – you could say that all lead gen-only shops are in trouble. As Walmart has proven, it’s tough to beat a competitor with superior economics and deep pockets.

Tags: lead generation, walmart, competition, loss-leader, economies of scale

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David Rodnitzky
David Rodnitzky is founder and CEO of 3Q Digital (formerly PPC Associates), a position he has held since the Company's inception in 2008. Prior to 3Q Digital, he held senior marketing roles at several Internet companies, including Rentals.com (2000-2001), FindLaw (2001-2004), Adteractive (2004-2006), and Mercantila (2007-2008). David currently serves on advisory boards for several companies, including Marin Software, MediaBoost, Mediacause, and a stealth travel start-up. David is a regular speaker at major digital marketing conferences and has contributed to numerous influential publications, including Venture Capital Journal, CNN Radio, Newsweek, Advertising Age, and NPR's Marketplace. David has a B.A. with honors from the University of Chicago and a J.D. with honors from the University of Iowa. In his spare time, David enjoys salmon fishing, hiking, spending time with his family, and watching the Iowa Hawkeyes, not necessarily in that order.