Retailing on the World Wide Web has alerted the general public to the Internet’s potential for transforming business and everyday life. Yet so far, the financial performance of most Web-based retailers has been dismal. Their experience provides an object lesson for the new economy: businesses have to make money.

As the Web continues to transform retailing, can retailers hope to generate profits on-line? The evidence is sobering. Our recent research into the underlying economics and competitive dynamics of Web retailing shows that it will be structurally impossible for most pure Web retailers—unless they hit Amazon.com-like scale—ever to turn a profit, let alone to take a dominant position. The clear advantage in retailing goes to big, highly skilled traditional retailers that use the Web to extend their already potent physical presence. So though pure plays may indeed be doomed, the demise of e-tailing has been greatly exaggerated for multichannel players.

The problem

Most e-tailers lose money on every transaction. Even the flagship e-tailer, Amazon, is losing about $7 an order on its nonbook sales after taking into account product, shipping, and fulfillment costs. (Its book sales generate about $5 an order.) Fogdog Sports, a sporting-goods outlet, loses $5 an order....