Retail Tech: The New “App-and-Mortar” Era of Retailing
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Robert Campagnino/Howard Mason
Thursday, April 23, 2015
Retail Tech: The New “App-and-Mortar” Era of Retailing
“We tend to overestimate the effect of a technology in the short run and underestimate the effect in the long run.” Amara’s Law
“I think eCommerce businesses are out of business; there is not going to be a pure-play retail play within two to three years … Amazon will make a transformative [brick-and-mortar] acquisition in 2015” Scott Galloway, Clinical Professor of Marketing, NYU Stern School of Business, March 2015
- The view of bricks-and-mortar retailers has tracked the sentiment expressed by Mr. Amara, with a premature assessment that the internet was the death knell for the physical and that AMZN, in particular, represented a broad existential threat. While retailers have made an initial adjustment, it is only to the extent that their products are now offered on the internet (with free shipping!). Mobile commerce will lead to more far-reaching changes as offline retailers mount an “app-and-mortar” challenge to online brands. WMT, for example, notes “the possibility of bringing the web to the store is incredibly disruptive… we have 140mm shoppers in the US and that is internet scale in the offline world”.
- As physical and digital commerce converge around mobile, offline retailers have forgotten their concerns about showrooming and looked to engage customers through mobile apps and prevent leakage of the resulting data to third-parties. There is measurable sales-lift from app-engagement with WAG, for example, reporting that customers who use mobile for shopping spend 4x the amount of non-internet walk-ins, and those using both mobile and walgreens.com spend 6x. Meanwhile, in its own omni-channel push, WMT plans to match AMZN for online product-range and shipment-speed in 2016. The omni-channel advantage works both ways:
- Physical stores that have an online presence can see a 40% lift in conversion rates because of “reverse showrooming” where a consumer researches a product online but completes the purchase in-store. There is therefore competition to engage consumers as early in the shopping journey as possible and this has motivated WMT’s investment in its online channel, COST’s participation in Google Shopping Express, and Amazon Dash-Replenishment-Service or DRS (which automates the purchase of repeat items sometimes based on an IoT signal from an appliance such as a Brother printer running low on ink).
- Online stores that have a physical presence can offer customers “click-and-collect” pick-up options and improve the ROI on direct marketing because of brand effects which improve both response and, through retention, the lifetime value of customers. These brand-effects become more important as costs-per-click increase so that previously online-only retailers such as Warby Parker are now exploring innovative approaches to creating a brand experience (by selling eye-wear in converted school buses). Using the vernacular of the digital ad-platforms, we think of Warby Parker, Apple or Starbucks stores as immersive content and the optician, genius, or barista as native advertising.
- In digitizing the in-store experience, retailers must: (i) install smart (often in the sense of iOS-enabled) infrastructure including beacons (for in-store navigation and location-sensitive services) and point-of-sale terminals (to integrate payments and loyalty so that, for example, rewards can be earned and redeemed in the main payments stream); (ii) safeguard the resulting data (from thieves and from third-parties who may use it to steer the retailer’s customers to competitors); and (iii) leverage these data to personalize the shopping experience and generate targeted ads and offers. COUP makes the point: “if you look at the desire of retailers and CPGs for more efficiency in their [coupon and trade] spend, it is a core strategy of all of them to be able to target specific offers for specific customers”.
- We see the winners as companies that can support retailers in this shift to more digitally-enabled models including, in particular, NCR and PAY (as they develop point-of-sale payments software), PayPal (as it provides the “gateway” middleware to connect this software to core acquiring processors like First Data that support the back-end clearance and settlement of transactions), and FIS (as it supports retailers, particularly members of the MCX consortium, in developing mobile wallets and by-passing the V and MA networks).
- As consumers turn to digital channels and either complete their shopping journey online (driving down foot traffic in stores) or arrive in-store with more established purchase intentions, we see the losers as firms relying on in-store checkout for impulse-oriented purchases such as HSY (although HSY is attempting to establish its products at click-and-collect points) and class B&C malls whose anchor brands (such as JCP and SHLD) cannot provide an immersive brand experience that draws traffic. Conversely, retailers that can provide this traffic-drawing experience (such as AAPL, RH and WSM) are winners in that their shopper-appeal allows them to negotiate increasingly favorable leases with class-A malls that need to attract destination-stores. Finally, as physical and digital commerce converge, the business models of WMT and AMZN will move closer (albeit from very different starting points), and it is hard to believe that their capital models and valuation will not do the same.
Retailing is at a crossroads – the death of the physical store has been greatly exaggerated and the rise of e(lectronic) Commerce will yield to the growing trend of e(verywhere)Commerce. Online and mobile are no longer existential threats to the physical, but rather key partners in the effort to build an immersive brand experience that represents a more relationship-based retailing experience. Paid-search advertising, pioneered and dominated by Google (and accounting for ~$50bn of global ad spend of ~$550bn) created a wave of e-commerce innovation by providing a low-cost channel for customer acquisition by small online brands. However, per-click costs, which were pennies when AdWords launched in October 2000 and are now nearer $1, have risen to levels that are prohibitive for small brands. Established CPG and retailer brands have bid up these costs with their larger budgets and rosier ROI assumptions (sometimes to the point of indifference when the use-it-or-lose-it portions of marketing budgets are dumped online) around conversion of clicks to customers and retention, hence lifetime value, of these customers.
However, because of synergies across clicks and mortar, brand-scale does not end online. Stores with digital franchises have a marketing performance advantage (leveraged through reverse showrooming which can lift in-store conversion rates by 40%) over store-only franchises; and digital franchises with store distribution have product-delivery advantages (leveraged in click-and-collect models, for example) and branding advantages (think of Apple or Starbucks stores as immersive content and the genius or barista bar as native advertising) over digital-only franchises. These advantages, and hence omnichannel synergies across online and offline storefronts, are increasing: digital advantages as more in-store sales are influenced by digital channels (36% in 2013 vs. 14% in 2012) and store advantages as free-shipping becomes a table-stakes for eCommerce (for 68% of eCommerce deliveries in 2014Q3 versus 44% in 2013Q4) and as media budgets shift from customer acquisition to retention (and hence in-store branding).
As a result, long-time brick and mortar retailers (such as Costco and WMT) have seen eCommerce growth outpace that of AMZN (from admittedly smaller bases, of course) and rival that of some of the larger web only retailers (NFLX grew revenue 25.8% in 2014, for example). Obviously, some smaller web-only retail concepts such as Dollar Shave Club (+242% in 2014) are growing quite quickly off of very small bases. Clearly, a brick and mortar legacy isn’t an impediment to growth and, in February 2015, Amazon opened its first ever brick-and-mortar store at Purdue University and will, according to Scott Galloway, Professor of Marketing at NYU Stern, “make a transformative [brick-and-mortar] acquisition in 2015”.
Exhibit 1: eCommerce Growth in 2014
Mobile is increasingly the lynch-pin of both online and offline store fronts as mobile-influenced sales are expected to reach $700bn in 2016 (approximately double expected eCommerce sales) and as it allows app-and-mortar retailers to combine the convenience of a digital shopping experience with the immediacy of a store-based shopping experience. Indeed, retailers are increasingly aggressive in enrolling customers into mobile loyalty-and-payments programs so as to generate an accumulating digital transaction record for each customer and hence enable a personalized shopping experience in both channels along with targeted ad and offers. Gibu Thomas, Senior VP of Digital and Mobile at WMT (which reported that 70% of Walmart.com sales last holiday were app-driven), put it well in April 2014: “Online there have been a lot of innovations using technology and data to give you a personalized, relevant experience that makes it easy for you to find the products you are looking for or even the products you are not looking for … we were not able to bring those disruptions into the store because a customer did not carry a laptop … but now we have the opportunity to transform the [in-store] experience and create a personalized shopping assistant for them using their smartphones”.
One consequence of the convergence of digital and physical channels is that customers are arriving at stores better informed about product choices and price-points; they browse more at online than physical storefronts but arrive at store with more conviction so, that while foot-traffic was down over the last holiday period, average sales per shopper, and conversion metrics increased. In this environment, potential losers include manufacturers of impulse-purchase products, such as those on display at checkout, unless they are able to develop impulse-conversion solutions (at click-and-collect points, for example, as Hershey (HSY) is attempting) as consumers shift to digital channels. Winners will be stores, such as Apple (AAPL), Restoration Hardware (RH) and Williams-Sonoma (WSM), that can create an immersive brand experience that is compelling enough to be a traffic-draw for malls and hence leverage to reduce per-square feet rents. The flip side of the fact that customers are arriving at stores with better information is that the store experience can be constructed so as to drive value as well – a consumer can spend hours surfing through webpages and still not get the same impression of the retailer that can be gained by a couple of minutes of walking through a store that is a truly immersive brand experience. The store remains the physical manifestation of the brand.
As a consequence of these developments, “showrooming” will transition from a concern (for a company like BBY, for example) to a desired outcome whereby the in-store experience is sufficiently unique so as to be accretive to the sale process, eliminating the need/desire to browse the physical store and then shop online for price.
We are entering a new era of “app-and-mortar” retailing as the only viable model versus either pure.com or legacy brick-and-mortar plays. The reasons are: (i) an increasing proportion of in-store sales are being influenced by digital channels (14% in 2012 and $1.1tn or 36% in 2013) and mobile, in particular, is driving both online and offline sales; and (ii) the economics of eCommerce are changing with rising shipping and customer acquisition costs which a physical store network can mitigate through providing eCommerce customers with the option of in-store pick-up (in “click-and-collect” models) and through providing the opportunity for brand support. Walmart (WMT) illustrates the catalytic effect of mobile on convergence of online and offline channels; the firm reports that nearly 70% of Walmart.com traffic in the US during the last holiday period came via mobile and expects that mobile-influenced retail sales in the US will reach $700bn in 2016 or approximately double eCommerce sales. The result is symbiosis across online and offline channels with mobile as the lynch-pin of both: without consumer engagement in a branded app, a large retailer loses important scale in both online and offline environments and, without brand-scale in both online and offline channels, a retailer is competitively disadvantaged in the data and marketing investment necessary for a successful mobile platform.
In short, business economics are driving industry-migration to omnichannel strategies so that retailers with a brick-and-mortar legacy are growing eCommerce sales faster than AMZN, and digital-only brands are either going out of business (e.g. Fab.com) or building physical infrastructure (e.g. Warby Parker). For retailers with a store legacy, the immediate business case for digital, and particularly mobile, capabilities is that app-engaged customers spend more; as an example, WAG (which, in 2014Q1, had the third most popular app ranked by downloads from iOS app store and Google Play after Amazon and Groupon with Target, Etsy, and Walmart occupying the next 3 spots) reported as early as 2013 that customers who shop across stores, website, and app spend 6x more than those are in-store only and over 1.5x more than those who shop in-store and online but not in-app. As traditional brick-and-mortar retailers build out their online presences, using mobile apps to drive traffic and store networks for fulfilment (through services like Walmart Pickup in the US), digital-only brands are pressured to build out physical infrastructure, such as Amazon Lockers, to offer customers the opportunity for pick-up on their schedule. Furthermore, given that free-shipping is increasingly a table-stakes offering for eCommerce merchants (with 68% of US e-commerce purchases being freely-shipped in 2014Q3 versus 44% in the year-ago quarter), eCommerce merchants face rising incentives to replace the variable cost of third-party shipping services with the more fixed-costs of a delivery-infrastructure including warehouses and stores. Like investment in a mobile platform, the investment in that delivery-infrastructure is scale-able, and therefore must as a competitive matter be scaled, across online and offline storefronts. This leads Scott Galloway, Professor of Marketing at NYU Stern, to conclude that “in 2015, Amazon will make a transformative [brick-and-mortar] acquisition”.
In fact, there are nascent industries emerging around this concept of “clicks to bricks”. For example, Kimco Realty (KIM – Shopping Center REIT) has an initiative dedicated to attracting web-based retailers to small-shop, mall-based locations throughout its portfolio of shopping centers. These smaller locations have the advantage of being built from scratch by the web-based retailer, unencumbered by long-standing retail doctrine, allowing for the creation of a very different shopping experience from the “typical” bricks and mortar store – essentially reinventing traditional retail. Warby Parker makes for an interesting case study – the company’s product (eyewear) is such that it begs for a more sensuous consumer experience and, indeed, from the very beginning, customers were looking for a way to see and touch the product. The industry is dominated by Luxottica (LensCrafters, among other stores) but Warby-Parker’s initial eCommerce offering appealed to consumers on the basis of price ($95 uniform pricing), style, social consciousness, as well as the usability and functionality of its website. That said, a bricks and mortar offering would very likely create a large number of new customers for the company – but at what cost?
Warby Parker went so far as to retrofit an old school bus to look like an old-style library (Exhibit 2), with eyeglasses instead of books. Consumers can get their eyes checked in the “library”, and the prescription products can be shipped or picked up in the “store”. The end result is a highly experiential, interactive and sensuous quality that simply can’t be replicated by a web-only retailer. Moving beyond the school bus, Warby Parker has also opened up a number of bricks and mortar locations throughout the country (New York, Boston, Dallas and Los Angeles among them) that are generally on the smaller side (~2,000 square feet). Of further interest to investors should be the fact that Warby Parker doesn’t just sell eyeglasses in its physical locations – the company also sells a selection of books, mostly from independent publishers, adding to the uniqueness of the shopping experience and also representing interesting opportunities for co-branding.
Exhibit 2: Converted School Bus now Warby Parker Store
In similar fashion, Hershey (HSY) is trying to expand beyond its traditional purchase points and take advantage of additional points of contact with the consumer that are emerging as a result of the migration of web-based retailers to physical locations. The company is experimenting with product placement at those locations (curbside pickup, for example) where consumers go to pick up their online purchases. The opportunity certainly exists for these “click and collect” points to extend the reach of certain brands outside the brick-and-mortar store. Contrast the Warby Parker and HSY cases with Fab.com, a company whose product offering was initially geared to “flash sales” – a limited number of items at a limited price. That model is an easy one to grow, but a difficult one to maintain. The company then moved toward a more traditional ecommerce model, but its product offering wasn’t sufficiently differentiated enough, and competing solely on the basis of cost is generally a losing proposition. While Warby-Parker’s price point is generally less than its primary competitor, the price isn’t the sole point of differentiation and likely does more to focus the consumer on other aspects of the company’s offering.
The Role of In-Store Branding: Part 1 – The Role of Branding
Google enabled the pure.coms because AdWords campaigns (where advertisers place text ads at the top or side of a consumer’s browser screen with targeting based on the keywords used in the consumer’s search to land at that website or the more general relevance of the website content) provided an approach to customer acquisition that suited small businesses. Small-business advertisers paid only when consumers clicked, could set a budget for AdWords campaigns, and deliver quality traffic to their website at a workable cost. However, cost-per-clicks (CPC) have increased over time from pennies when Google launched AdWords in October 2000 to well over a $1 in 2010 although that has been some moderation since then (see Exhibit 2) as more supply has entered the paid-search market (including from sites such as Yahoo and Bing) and as other acquisition channels, including the mobile platforms (such as Facebook and Twitter), have built their advertising capabilities. However, per-click costs are nonetheless at uneconomic levels for many small brands as they are crowded out of the AdWords channel by large brands with large budgets, advertising research staff, and return-on-investment (ROI) assumptions to support (sometimes just rationalize) high CPC rates.
Exhibit 3: Average CPC in $ or Google AdWords
Source: Hochman Consultants; Adgooroo for 2014
A first reason that large brands can make more aggressive ROI assumptions for paid-search is that it can be integrated into other digital campaigns and supported by in-store branding. As an example of the benefits of multi-channel digital marketing (so leaving stores aside for a moment), one study quantified a significant increase in paid-search performance through running parallel Facebook campaigns: specifically, Kenshoo found a 19% increase in conversions (i.e. clicks turning into purchases) among consumers who saw Facebook advertising compared with those who saw just paid-search advertising without Facebook ads. A second reason that large brands can make more aggressive ROI assumptions is that they are likely enjoy higher lifetime value per customer: they can amortize the acquisition cost over a broader suite of products and services, and typically count on less customer churn. Indeed, as customer acquisition costs increase, online brands are shifting marketing intention from customer acquisition to retention and loyalty: for example, one survey of 1,000 digital marketers found that 40% responded in 2014 that they were more focused on acquisition than retention versus 44% in 2013; the same study found that 83% of respondents viewed paid search as more geared to acquisition while ~70% viewed social media, mobile apps, and personalized messaging (e-mail, SMS, or MMS) as more-or-equally geared to retention.
The Role of In-Store Branding: Part II – The Role of Stores
The broad conclusion is that returns-to-brand-scale increasingly drive paid-search performance just as they drive that of other forms of marketing. A March 2014 study commissioned by Nielsen quantified this in finding that brand content lifted purchase intent for low-price items in the $50-399 range by 125% (more than expert content at 113% and user reviews at 75%). While Google is looking to evolve its model to broaden from direct-response advertising to brand advertising, the dominance it enjoys in paid-search (where it accounts for over two-thirds of the global market of ~$50bn) does not extend to advertising formats lending themselves to branding (accounting for most of global ad spend of over $500bn). For example, half of senior marketing executives report using owned media channels for brand videos and these include, in addition to You Tube channels, Facebook brand channels and corporate web-sites. Furthermore, the algorithmic skills (involved in the targeting, measuring, and auctioning of impressions) that drive successful direct-response advertising can be less important in brand advertising relative to creative editorial and immersive content.
Brand advertising, of course, has been a mainstay of the TV industry but the idea of native advertising (in the sense that the ad is immersed in core content like a TV commercial or radio jingle) is being extended to digital channels (in Twitter streams or Facebook newsfeeds for example) and into stores through the integration of brand-content into commerce. For example, purchasing an iPhone at an Apple Store or a cup of coffee at Starbucks (but unlike, say, buying a pair of Levi’s at Sears) immerses the customer in an in-store brand experience. In other words, stores are evolving as delivery vehicles for brand-content as well as physical product and, as such, improve the performance of digital marketing. This completes the circle where digital marketing, in turn, improves offline conversion (with Deloitte Digital reporting consumer use of a digital channel before or during a store visit lifts conversion rates by 40%). This immersive brand experience will be the hallmark of the online retailer migration to the physical store, where the store itself transforms from being a storage facility for inventory to becoming a showroom and brand-accretive sensory experience that leverages the best qualities of the physical store (holding a product in your hand, interacting with the sales staff and other customers, the immediate gratification of walking out with the product) with the convenience of the digital shopping experience.
The Mall Gap Widens
Indeed, the notion of an immersive brand experience can be extended from a single-store to the community of stores that comprise a mall. That said, and despite our view that the death of the physical store has been exaggerated, we don’t believe that the situation will be much improved for Class B&C malls (definitions vary, but generally below $350 in sales per square foot for the shop tenant). Not every retailer will have the ability to create an immersive brand experience and similarly, not every mall will be the appropriate venue for showcasing a brand. Ideally, the stores in a mall should feed off each other and complement each other, creating a shopping experience that is greater than the sum of its parts. The imperative, over time, for what are generally highly entrepreneurial, smaller, web-only retailers to inhabit a physical space will not be the saving grace of Class B&C malls whose anchors (JCP and SHLD, as examples) may continue to struggle. Instead, the rich will likely get richer as Class A malls move toward becoming a more dynamic shopping destination with the addition of more unique retail experiences.
To begin with, smaller, internet only retailers that lack for capital won’t be able to able to migrate to a bricks and mortar location – the cost of entry and price of failure (wrong concept, wrong location, etc.) may simply be too high. Similarly, not every brand or product can be suitably transformed into an experience, and some products are indeed well-suited to be sold solely online – CD’s, books, as examples. Bulky replenishment items such as diapers or paper towels without significant brand equity are not exactly conducive to creating an immersive brand experience, and are easily shipped and sold primarily on the basis of cost; they are also low-engagement repeat purchases which can be sold on the basis of minimizing the need for customer involvement (which is the strategy of Amazon Dash). The criteria for those products that will be best positioned to succeed being sold as a combination of the digital and the physical includes:
- Sensory component –product benefits from being seen or touched;
- Complexity – product requires some explanation/demonstration from a competent sales representative;
- Fashion – style, look and fit matter;
- Vanity – being seen and seeing other customers has some positive value;
Investors will likely gravitate toward luxury items, but Warby Parker’s $95 price point doesn’t necessarily scream “luxury” and limiting the opportunity set to only “expensive” items misses the point. The bottom line for retailers is that the trip to the mall needs to have some positive utility for consumers. We mentioned earlier that a company (HSY) that is leveraged, in part, to impulse purchases is going to need to rethink that piece of its business. This would include vending as well (Coca-Cola, KO and Pepsi, PEP), which has in recent years expanded its presence near checkout. Companies need to expect that consumers will enter stores with better information, more focused, and, with the aid of mobile, spend less time (if any) at checkout. That is to say nothing of the almost complete disintermediation that order online and pickup in store represents for impulse oriented purchases.
In retailing, data generate competitive advantage: what to stock, how much to price, and which customers to target. Online retailers gained market share because of technology-solutions that gave them a data advantage over brick-and-mortar competitors: online brands could use paid-search to acquire customers cheaply (and without the higher table-stakes of TV advertising) through targeted and measured marketing, and the transactions of these customers were digitized and linked to personally-identifying information (because of customer log-in) so that online businesses generated a rich dataset for marketing retention and cross-sell offers.
Offline retailers suffered as passing trade declined with falling foot-traffic and because in-store transactions are not intrinsically digitized. However, mobile has upended this trend by providing offline retailers with the “app-and-mortar” opportunity to combine the convenience of digital shopping with the branding and immediacy of physical stores. The result is that pure-play retailers are now converging around “omni-channel” strategies involving both online and offline channels. A contributing factor is that CPGs and other brands have bid up the costs of paid-search stemming the flow of new online start-ups that can viably acquire customers.
Digitizing physical stores requires large retailers to create smart (i.e. software-enabled) infrastructure, whether point-of-sale terminals or in-store “beacons”, that can support the rich data-flows of an app-to-app exchange between customer and merchant. At the same time, there is an emerging ecosystem of players to support offline retailers in leveraging the resulting data including demand-side platforms for programmatic media buying (that will be delivered to retailers in SaaS format), payment platforms such as PayPal that can position their gateway services as data hubs, and hardware manufacturers such as PAY and NCR that integrate their products into merchant data-strategies. Of course, most retailers do not have the predictive modeling capabilities of online incumbents but they have the unique advantage of access to offline purchase data.
©2015, SSR LLC, 1055 Washington Blvd, Stamford, CT 06901. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein. The views and other information provided are subject to change without notice. This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results.
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