E-Commerce: The Long and Winding Runway

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SEE LAST PAGE OF THIS REPORT Paul Sagawa / Tejas Raut Dessai

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October 29, 2018

E-Commerce: The Long and Winding Runway

E-commerce accounts for about $2.9T in revenues, addressing a global retail market of more than $24T and a B2B wholesale market that nearly doubles the worldwide TAM. In this context, the shift to on-line shopping and ordering is still in its early stages, with many trillions of dollars in revenues up for grabs. AMZN dominates outside of the closed Chinese market, with 50%+ share of US e-commerce, rapid expansion in many international markets, and likely entry to new retail and wholesale categories. While we are confident in AMZN (even after the 4Q guidance), we see opportunities for others – particularly GOOGL, which is positioned to be the partner of choice for incumbent retailers and can lever its consumer reach, user targeting/tracking, AI assistant, self-driving vehicles, and other assets. FB is expected to spin Instagram successful click-to-purchase ads into a separate e-commerce app, perhaps breaking is string of poorly received shopping features. AAPL would have potential, but thus far, remains close to home on e-commerce. MSFT has tech that could help. Meanwhile, many brick and mortar stores will suffer, but new experience-focused concepts will rise, exploiting emerging retail-tech (e.g. automatic checkout, hyper-personalized service, AR/VR, etc.) and lower friction for shoppers (e.g. store provided door-to-door robo-taxi service, autonomous delivery service, etc.). We believe tech players will be critical in developing these stores of the future, as partners (e.g. GOOGL, MSFT, etc.) or as proprietors (AMZN).

  • Ecommerce has barely scratched the surface. Global digital commerce is a $2.9T business, growing at 24%/yr. While it is often expressed as a percentage of worldwide retail activity – ~12% and growing – its real addressable market must include B2B wholesale, which nearly doubles the denominator to a TAM of nearly $50T. While we believe brick-and-mortar retail and specialized B2B distribution will remain a substantial part of a future equilibrium, e-commerce – with inherent advantages in cost, convenience and selection – can continue double-digit global growth for many years.
  • Emerging tech will enhance digital commerce. AI assistants that place orders on command and anticipate possible purchases. Autonomous vehicles that reduce costs and speed deliveries. Blockchain-like solutions that reduce supply chain friction. Customer tracking from interest to purchase. Nearly fraud-free digital payments. These and other innovations will reduce e-commerce costs while improving customer convenience, amplifying the appeal of online shopping. They will also, almost universally, favor the biggest digital platforms with the scale and technical know-how to exploit them.
  • Physical stores will have a different but substantial role. E-commerce is not a perfect substitute for traditional stores. Many consumers enjoy shopping. Many products are better evaluated in person. Often convenience is best served along the path of one’s day. Buying impulses may be stimulated by actual products. Physical retail will persist to serve these needs, also enhanced by technology. Multi-channel loyalty programs and sophisticated tracking can link online behaviors to in-store purchases, allowing retailers to make better and more timely enticements to their customers as they move from product discovery to actual transactions. Many will fail, but the best will thrive.
  • Brick-and-mortar retail will serve new use cases. Human service will be a valued feature and social interaction will be a selling point. Robotaxis will break down barriers to shopping – enabling door-to-door service (perhaps paid for by the retailer) without need for a designated driver, and delivery for unwieldy purchases – furthering the trend toward experiential and destination retail. In the store, hyper-personalized service, tech-enhanced product displays (AR/VR, etc.) and customer pleasing social environments (e.g. entertainment, product demonstrations, food/beverage options, etc.) help to stimulate purchase. Local shopping will be revolutionized by AI-driven product selection, robotic shelf stocking and automatic checkout – true “grab and go” convenience at small scale and low cost.
  • AMZN is an obvious winner. The market reacted badly to AMZN’s tepid 4Q18 guidance, but the deceleration is a blip given the size of its opportunity. It has massive scale advantage – AMZN’s gross merchandise volume is still on track to be nearly $450B in 2018, growing better than 30% YoY, ready to pass WMT’s overall sales in 2019. It is more than half of US e-commerce, increasing its lead on distant rivals EBAY, AAPL and WMT. It has opportunity overseas – strong in Europe, largely shut out of China (where BABA is king) and battling in emerging markets. AMZN is also expanding to new categories. Amazon for Business is moving beyond office supplies to more specialized products. The acquisition of PillPack portends an aggressive move into pharmacy, just as the deal for Whole Foods accompanied the push in grocery. Given the size of the opportunity, excellent execution and broad ambition, we believe AMZN’s e-commerce sales could grow to be several times larger.
  • AMZN is investing to address potential weaknesses. Prime has been a powerful competitive moat for AMZN, protecting it from price arbitrage and helping to drive acceptance as it moves to new services and product categories. We believe AI assistants will likely displace the “app model” as the primary consumer digital interface, making the big investment in Alexa and Echo hardware a key asset moving forward. It is also investing in new retail concepts – like “4 Star” showrooms, and automated grab-n-go shops – looking to blunt the advantage of its rival’s multi-channel strategy
  • GOOGL is the white knight for traditional retailers. Market growth has given the illusion of success for digital efforts by retailers, but there is a huge and widening gap vs. AMZN with big deficits in the consumer reach, data insights and infrastructure needed for online. Capitulation to AMZN’s 3rd party marketplace leaves sellers to brutal price competition, subsidiarizes their brand, and disintermediates their customer relationships. GOOGL is the primary alternative, offering reach to billions of consumers, one-click buying, payments, customer data and analytics, some local delivery support, Google Assistant integration, loyalty program management, multi-channel integration, and other support tools. WMT, TGT, COST, HD, and others have signed partnerships accessing some of these capabilities. We believe that this will be a material boost to future GOOGL sales and profits.
  • Questions for other digital players and traditional retailers. We are encouraged by FB’s one-click buying for Instagram, perhaps the right answer in e-commerce after years of trying. AAPL takes a chunk of sales made on its platforms, but its own digital sales could slow as the iPhone installed base peaks. EBAY’s role for 3rdparty sellers is being usurped by GOOGL and the AMZN marketplace. WMT is serious, buying a controlling stake in Flipkart makes them a big player in southern Asia, but will likely face erosion in its stores before digital growth can drive its top line.

It’s a Big World Afterall

Convenience, price and selection. These factors spell success and failure in retail, and historically, they demanded compromise. A conveniently located store meant high rents, and thus, either high prices, or a small shop with limited selection. The big discounters located away from the town center, worth the extra drive to get the best price on the widest selection. E-commerce broke this equation. Many millions of products are available for increasingly quick delivery, ordered right from the phone in your hand at competitive prices. E-commerce is now a $2.9T global market, still a small piece of the $46.6T spent worldwide for retail and B2B products. With the near ubiquity of smartphones and improvement in delivery infrastructure, we see many years of strong growth before we approach an equilibrium with physical stores.

AMZN, dominant in North America and much of Europe, is the big driving force. Its gross merchandise volume (GMV) will be nearly $450B in 2018 with better than 30% growth, positioning it to blow past WMT’s retail sales in 2019. AMZN is not strong everywhere – it is largely shut out of China, where BABA leads JD, and it is in a fierce battle in India with recent WMT acquisition Flipkart – but CEO Jeff Bezos is going after as much of the near $50T TAM as he can, with initiatives to extend its strength to new global territories, into new categories, like grocery, pharmacy and B2B, and to gain a foothold as AI assistants, like its Alexa, become a more important consumer interface to the digital world.

Still, future consumers will still go to stores – if they have fun, if it is for a product that really requires hands-on evaluation, or if it is truly a convenient stop as they go about their day. E-commerce will absorb much of everything else. Sales may be begun in a store and completed online or begun online and completed in a store. Self-driving robocabs with door-to-door service (perhaps paid by the retailer) and free delivery for bulky items could reduce the friction for couch potatoes to visit a store, acting as a designated driver to boot. AMZN gets this too – it bought Whole Foods, but also invests in out-of-the box retail concepts like its touchless Amazon Go stores and its planned “4 star” product boutiques that apply new tech and analytics to stores. Traditional retailers – with poor reach to digital consumers, with pedestrian data analytics capabilities, and with logistics built to serve the old-fashioned model – will have to adapt.

GOOGL may be their new best friend. The search giant has shied from a direct e-commerce play but offers an expanding range of services to retailers, including reach to consumers (search, maps, etc.), customer tracking and multi-channel loyalty, local delivery (eventually via autonomous vehicles), payments, ordering (one-click, automatic, AI assistant, etc.), and others. WMT, TGT, HD, COST, JD and others are partnering with GOOGL for some of these services. We would not be surprised to see these relationships deepen and for additional retail partnerships to be signed. This should grow to be a significant business for GOOGL.

Still, we are sanguine about the prospects for large traditional retailers – some will succeed in transition, others will fail, and most will suffer in the short run. WMT has made the most serious effort, notably with its Flipkart buy, but must improve upon its meager 3.7% share of US digital retail. Other digital-first players could find profitable roles. FB, with its mighty social presence, has struggled with commerce, but may have found a foothold with one-click Instagram ads that can use image and video to present products to their best effect. BABA and JD are powerful in China, but less so elsewhere. We believe that EBAY has missed its chance, having lost its role as the best partner for traditional retailers to GOOGL and BABA.

T is For Tens of Trillions

E-commerce addresses a staggeringly large market. Globally, consumers buy about $24T of products at retail, mostly from traditional brick-and-mortar stores (Exhibit 1). Businesses buy another $22.6T for their own use, mostly through a wildly fragmented menagerie of specialized, and often regional distributors (Exhibit 2). E-commerce – ordering products via websites and mobile apps – has captured $2.9T of this vast market. Using consumer retail as the denominator suggests e-tail at more than 12% of its global TAM and a higher percentage of many developed economies, but the e-commerce number already includes a lot of business ordering. While the highly fragmented B2B e-commerce market has not seen as much penetration by purely digital players thus far, it is no less attractive. In this context, we see a TAM of more than $46T, with a very large percentage of it directly addressable by e-commerce platforms (Exhibit 3).

Online shopping and purchasing are, and will continue to be, will keep grabbing business from traditional channels for several reasons. First, it is getting more convenient. Delivery intervals are getting shorter, with expedited delivery availability over broader geographies, as Amazon and its rival integrate forward into their own local fleets. One-click ordering is becoming commonplace, as is voice ordering via AI assistants. Returns are getting easier, with more locations to drop off unwanted shipments. Selecting products online is becoming more compelling, with better imaging, video demonstrations, and even AR tools to see the product in the shopper’s context.

Second, the already profound product selection is becoming more so, as Amazon’s marketplace continues to draw in a strong flow of new merchants. Rivals may not be able to compete with Amazon’s 3rd party powered inventory but offer a far wider range of products than they could in any store, including branded products unique to their platforms.

Exh 1: SSR Forecast for Global Consumer Retail Spending, 2017 – 2023E

Exh 2: SSR Forecast for Global B2B Sales Opportunity, 2017 – 2023E

Exh 3: SSR Forecast of Total Addressable Market for Global E-Commerce

Furthermore, Amazon continues to enter entirely new categories. The acquisition of Whole Foods accelerated their movement into grocery and the deal for PillPack portends a similarly aggressive play for pharmacy. Amazon for Business is also adding new B2B categories, beyond simple office supplies. The rest of the market will be forced to counter.

Finally, scale and automation can drive e-commerce costs lower. Integrating into delivery could accelerate this, particularly as autonomous vehicles – long haul trucking and local delivery fleets – become a realistic tool. Amazon spent $26B on shipping in the last 12 months, almost 8% of its GMV (Exhibit 4). Labor is a substantial portion of those costs, and substantial savings if shipping and delivery could be more automated. Amazon is investing to this end, with Alphabet a looming rival. Blockchain, or solutions based on some of the underlying technology advances of blockchain (hash trees that provide an inalterable chain of custody, public key encryption that securely identifies all parties to complex transactions, etc.), will ensure transaction confidence and eliminate costly and time-consuming elements within supply chains, thus reducing costs. Fulfillment added another $28B to Amazon’s cost structure and could be reduced with these technologies. AI-based fraud surveillance, biometric security, tokenized credit processes, and blockchain could combine to nearly eliminate fraud, drastically reducing payments fees, which currently add more than 2% to each credit transaction.

Exh 4: AMZN Worldwide Shipping Costs as a % of Total Revenue, 3Q14 – 3Q18

All these factors point toward digital commerce taking considerably more of this nearly $50T worldwide opportunity with time (Exhibit 5). Of course, online ordering and at home delivery will not replace all shopping or B2B trade – at some point the balance will approach equilibrium and the momentum of e-commerce will slow. We believe we are still very far from that point.

Exh 5: Inherent advantages of E-Commerce will continue to accelerate global shift of traditional retailing to online

The Brave New Store

Omnichannel marketing. Experiential retail. Hyper-personalized service. Retail industry analysts are having a field day, prescribing strategies to survive the e-commerce onslaught. Stores of the future will be integrated with e-commerce. A customer may discover a product on line, visit a store to evaluate it in person, then complete the transaction for home delivery – future retailers will look to own that process from start to finish, discouraging “showrooming”, whereby would-be buyers visit stores only to buy from another retailer from their phones in the middle of the aisle. It is unrealistic for most retailers to presume that most shoppers would begin product discovery on their own app, visit their own store, then complete the sale back on the app. Tracking consumers and keeping them focused on a specific retailer from discovery to purchase will likely require help from companies that can collect the data and analyze it. That list starts at Google and Amazon, falls off a bit at Facebook, then drops sharply thereafter.

Brick-and-mortar operators are already experimenting with new concepts to make their stores worth the trip. Virtual reality dressing rooms that let you “try on” clothing in different cuts and colors. Product demos, celebrity appearances, and other entertainment to draw crowds. Food and drink options enough to make the store a social destination. Delivery services to facilitate bag free shopping. Retailers in Phoenix have already begun partnering with Google’s Waymo robocab service to offer free rides to and from their stores – door-to-door service with no need to find parking or a designated driver. Next generation malls are levering all these concepts to deliver experiences that marry entertainment and buzz with commerce and community interaction (Exhibit 6).

Finally, tech is allowing physical retailers to get closer to their customers. Various solutions can help stores identify shoppers as they enter the store, allowing employees to address them by name and access information (e.g. recent product searches, prior orders, etc.) to help guide them. Appropriate merchandise could be waiting for the customer in the dressing room for approval. Check-out, always a bane to the shopping experience could be fully automated, with selected merchandise tracked and payments approved

Exh 6: Next Phase of Retail will be Omnichannel, Personalized and Experiential

as the customer leaves the store with simple acknowledgement on a mobile app. Products evaluated in store could be automatically added to an online shopping cart and purchases scheduled for delivery.

Some retailers may go for cost and convenience with small highly automated stores stocked with high turnover merchandise, prompting impulse purchases and easy shopping for consumers in transit. Others may augment a low-cost, high volume warehouse strategy with labor saving automation and low-cost delivery options. These approaches will look to win head to head vs. online home delivery platforms.

Where Does an 800-Pound Gorilla Sit?

Anywhere it wants to – according to the old joke. Amazon is the 800-pound gorilla of e-commerce. Considering 3rd party sales in its Marketplace, where Amazon recognizes revenues just from the service it provides to the independent vendors, the gross merchandise volume of products sold on the platform was nearly $350B in 2017 and should near $450B in 2018 (Exhibit 7, 8). The number two rival, Ebay, did just $88B in 2017, and may be less than 20% the size of Amazon this year. Walmart, the number 4 western e-tailer, did less than $25B in e-commerce sales for 2017, and its touted 40% digital growth in recent quarters will take a very long time close the gap vs. a company more than 10 times its size that is growing its own GMV’s 30%+. Amazon may have disappointed investors with a modest sales miss in 3Q18 coupled with lackluster 4Q18 guidance, but the overall story remains compelling.

Amazon’s enormous success in retail has had many well documented drivers – first mover advantage, superior logistics, service design innovation (e.g. one-click purchasing, Prime, etc.), advantaged access to capital, relentless push for scale, etc. Looking forward, these advantages have only gotten larger as the company pursues retail growth in three dimensions: 1) International expansion, 2) Category expansion, and 3) Format innovation.

Exh 7: AMZN 3rd Party Seller Services Revenue Growth, 2Q16 – 3Q18

Exh 8: SSR Estimate of Gross Merchandise Volume on Amazon, 2017 – 2023E

Amazon dominates e-commerce in North America, with more than 50% share in the US and Canada and leadership in Mexico (Exhibit 9). It is the top platform for the biggest economies in Europe – e.g. Germany, France, UK, Spain, Italy and a few others, but trails local rivals in Northern and Eastern Europe. It is neck and neck for the lead in Japan, but it just entered the South Korean market in 2017 and still faces a considerable uphill battle. China, thus far, has been a no-go, with state restrictions on foreign consumer internet platforms and the presence of indigenous leader Alibaba considerable obstacles. It has a foothold in many emerging markets – e.g. India (where it battles Walmart controlled Flipkart), the rest of Southern and Southeast Asia, South America, Africa – but contends with local rivals with strong consumer share of mind and first mover advantage – and an aggressive Alibaba. Amazon is pouring investment overseas to win where it can in economies – like India, southeast Asia, Latin America, and others – where it sees huge potential. We expect that it will win some … and lose some.

Exh 9: AMZN has nearly 50% of US E-Commerce Market Share, July 2018

Exh 10: Buyer surveys show high preference for Marketplaces like Amazon in B2B

Exh 11: Snapshot of AMZN strategic acquisition attempts since 2017