Much of what gets written about the retail industry centers on the notion that e-commerce is changing everything and that traditional retailers and malls will soon be obliterated in a tsunami of disruption. Alas quite a bit of this is just flat out wrong or widely misunderstood.
The seismic forces being felt throughout most sectors of retail are undeniable. While the overall retail apocalypse narrative is nonsense, a harsh reckoning is befalling those retailers that failed to act in the face of significant change and shifting demographics. The ridiculous overbuilding of retail space during the past decade or so is finally being corrected. And, to be sure, the rapid growth of e-commerce — and Amazon in particular — continues to transform consumer behavior and wreak havoc with many legacy brands’ boring value propositions and challenged underlying economics.
It’s also true that a lot of commonly held beliefs — and what is put forth as “futurist” prognostication — ranges somewhere between rank hyperbole and outright distortion. So here’s my take on the five big things many often get wrong about e-commerce in particular — and the impact of digital disruption more broadly.
E-commerce will soon represent 50% of all retail
Forever is a long time, so it’s impossible to say definitively that e-commerce will never represent half of all industry sales. But I’m absolutely willing to take “the under” from those that are predicting it will get to 50% within the next decade. That’s not to say that certain categories won’t make it — books and music are already there. Certain retailers might grow to (or maintain) that penetration level as well; the most obvious being brands that started as pure-plays but are rapidly expanding into brick and mortar (e.g. Warby Parker, Indochino). Well differentiated brands with a strong legacy in direct-to-consumer that wisely invested ahead of the curve and that operate relatively few physical stores (e.g. Williams-Sonoma, Neiman Marcus) can get or stay there as well.
The reason it won’t happen is two-fold. First, you don’t have to be a mathematician to see that we are not on a glide-path to make it. To achieve 50% share would require a far different growth rate than current trends suggest. Rates are moderating, not accelerating. Indeed there remain large categories with comparatively low e-commerce penetration (home furnishings, grocery, home improvement, et al) but there are inherently sound reasons for this, mostly tied to the experiential nature of the vast majority of these purchases. When the customer is inclined to see, touch and feel the product, brick and mortar is likely to stay overwhelmingly favored. This is a prime (heh, heh) reason why Amazon bought Whole Foods, why Wayfair is struggling and why so many once online only brands find themselves rapidly (and rather ironically) opening stores.
It’s all about new disruptive models
With all the hype surrounding the brands the cool kids like — and the VCs seem to enjoy pouring money into with reckless abandon — you might think they are big contributors to e-commerce’s massive growth. Turns out, not so much. First of all, when we say e-commerce we mostly mean Amazon, as it accounts for nearly half the entire sector. But here are the leaders that come right behind them, in rank order: №2 Walmart, №3 Apple, №4 Home Depot, №5 Best Buy, №6 Macy’s, №7 Target, №8 Kohl’s, №9 Costco. №10 is Wayfair, which I doubt will stay much longer in the top ten, but that’s another story.
So despite the bright and shiny nature of the latest brand to “disrupt” the sock, lingerie or luggage market, when you add them all up they don’t account for all that much market share. Instead the $100 million plus e-commerce club is filled with old school brands like Lowe’s, Staples, Nordstrom, Neiman Marcus and (shudder) Sears.
Online shopping is easy to scale
Among the key reasons that investor dollars flooded into pure-play e-commerce over the past decade was the belief that these new and innovative brands could scale quickly and efficiently. While it’s turned out that the technology is generally quite scalable — and that impressive numbers of customers could be acquired far faster than a typical brick and mortar roll-out strategy — the path for many, if not most, has been far more difficult than anticipated. Much of this can be traced back to the ridiculously high (and generally unsustainable) costs of customer acquisition, as well as what often turn out to be expensive and/or complicated issues stemming from the high rate of customer product returns. Pure-play e-commerce can be extremely capital efficient. Until it’s not. See One Kings Lane, Gilt.com and a growing list of pure-play flameouts.
Online shopping is more profitable than brick & mortar
Amazon has barely made any money in retail in its more than 20 year history. In its most recent earning quarter report (which delivered record profits), Amazon’s margins remained below industry averages (fun fact: Apple made more money in its recent quarter than Amazon has made in its entire history, and that includes AWS). When you consider that Amazon represents nearly half of all e-commerce, and the majority of hyper-growth digitally-native brands (Wayfair, Bonobos, et al) lose money, it’s hard to believe the sector is more profitable. For traditional brick-and-mortar-dominant retailers with fast growing e-commerce businesses we can reasonably infer from publicly available information that for many the growth of e-commerce is dilutive to earnings. It’s not surprising, particularly for low average ticket online purchases, where order fulfillment costs eat up a large percentage of margins.
Many have criticized brands like Walmart, Pier 1 and H&M for being slow to develop their online capabilities. And they did get some things wrong, mostly around not understanding the role of digital in the overall customer journey irrespective of the purchase channel. But it’s also likely true they were slow because they knew that given the characteristics of their product lines they were signing up for deteriorating margins.
The focus on transaction channel is important
Retail industry folks like to talk about channels. There is little evidence that customers care. Wall Street likes to know how fast e-commerce is growing and what’s going on with same-store sales. The fact is those channel-centric metrics are increasingly useless. Many retail brands are organized by channel, allocate inventory by channel and analyze customer behavior exclusively by channel. Many still have separate marketing budgets, performance indicators and incentive schemes based upon purchase channel. In almost all cases this is not only wrong but dangerously misleading as it encourages behavior that is not customer-centric, while undermining overall brand objectives.
While there are customers who are literally online-only shoppers, the vast majority of customers are regularly active in digital and physical channels. They think brand first and channel second (if at all). To them it’s all just shopping — and for brands it should be seen as all just commerce. One brand, many channels. Digital influences brick and mortar and vice versa. In fact, both Deloitte and Forrester studies indicate that digitally-influenced physical store revenues are far bigger than e-commerce sales, suggesting anyone who attributes all digital spending to online channel revenues is likely to widely miss the mark on their investment strategies. Except for the few brands that remain online only (which is a rapidly dwindling number), the focus on e-commerce versus brick and mortar is fast becoming a distinction without a difference.
Clearly shopping behavior continues to evolve rapidly. Short-term strategies that look to be burning cash today may turn out to be wildly profitable tomorrow. Amazon obviously has the potential to improve profitability if they choose to focus on margins over growth. A shakeout of profit proof business models is likely in its early days. Much more of this history is yet to be written.
Nevertheless, when we advance click-bait worthy stories as real analysis, we do a disservice. When we broad brush industry trends, rather than dig deep into the idiosyncrasies and nuance of particular sectors and categories, we are likely to miss what’s really going on. And understanding the dynamics of a complicated, ever-changing industry is hard enough to do without getting confused or distracted by the hype cycle.