Retailing in a Digital World

Assessing Which Companies Are Positioned to Win

Monday, May 1, 2017

Nearly 20 years ago William Blair’s consumer research team issued its Perspectives on Electronic Commerce report, which noted that the “impact of the Internet on retailing is profound”; today, virtually every investor would agree with that statement. However, perhaps too few retailers paid attention and adapted their business models for the then emerging new reality.

Clearly, the consumer landscape has fundamentally altered, and retailers need to serve consumers wherever, whenever, and however they wish to interact and transact. In the words of our consumer team predecessors, the internet’s “low cost of communication, deep search and informational capabilities, and increasingly ubiquitous presence in consumers’ homes and offices suggest a permanent, meaningful alteration of the retail landscape.” “What they did not know,” according to consumer analyst Sharon Zackfia, “was that the ubiquity of the internet would become even more pronounced with the advent of smartphones in 2007, providing customers near-constant access to e-commerce purchasing power at the touch of a finger.” Indeed, last year e-commerce sales topped over 10% of all retail sales in the United States (excluding auto and gas), more than doubling its penetration from 2007, with Euromonitor projecting e-commerce penetration in the U.S. to reach 17% of sales by 2021. Moreover, while growth in e-commerce sales has been relatively range bound at 11% to 15% per year since 2010 (and actually down-ticked somewhat in 2016), it is growing at roughly triple the pace of retail sales excluding e-commerce, restaurants, and gasoline stations.

Retailers and brands have had to adjust their business models to deal with this new reality, although many retailers perhaps realized the transformation too late to effectively evolve. Amid a landscape that has nearly 10 times the retail saturation of Europe (as measured by square feet per capita), the United States will undoubtedly continue to see store rationalization, particularly for retailers that built too many boxes that are too big. This issue is further compounded by potential disenfranchisement by pure-play e-commerce players for retailers that rely heavily on non-proprietary products. Still, not all categories have proved to be well disposed to e-commerce, with categories such as beauty and personal care, home improvement, and food/drink at below-average penetration rates.

Zackfia views omnichannel as a winning strategy, and expects companies with rational retail footprints, strong e-commerce capabilities, and seamless fulfillment across channels to emerge stronger. In addition, she believes companies with strong proprietary product and/or an experiential nature can thrive in the current environment.

Despite outsized growth and share gains in online sales and accelerating declines in mall traffic, the physical retail channel has been slow to react. Only in the last year have operators begun to announce large store closures, which we expect is just the beginning. The pace of bankruptcies has also increased, with a growing number of full liquidations as opposed to restructurings. We believe all of these measures are needed in an oversaturated market, with estimates that the U.S. has some 25 square feet of retail space per capita, nearly 10 times the saturation level of Europe. The biggest headlines on store closures belong to retail dinosaurs—companies that built too many boxes that are too big while failing to quickly adapt to the rise of e-commerce (e.g., department stores). For some retailers, this issue has been further compounded by disenfranchisement by pure-play e-commerce players, particularly for retailers that sell non-proprietary product (e.g., sporting goods retailers).

However, even with the major paradigm shift at play in the industry, retail stores are by no means dead and should continue to play a central role in the retail landscape, supporting indispensable needs around awareness and service, and from a finance perspective, operating leverage. Just as important as rationalizing physical supply is understanding how the remaining stores will interact with online operations as customers continue to use both channels.

At present, the retail industry is facing margin pressure as demand shifts from the retail channel (with high fixed costs) to the online channel (with high variable costs). This suggests that even if operators are successful at replacing lost in-store demand through its online operations (though evidence supports that many are not), they may be doing so at overall lower profitability. On the other end of the spectrum, pure-play e-commerce companies, while largely noted for capturing outsized traffic share, face an uphill battle leveraging at scale given the variable nature of some of the largest-cost items, including fulfillment and customer acquisition. As a result, we believe both channels can be better served through greater integration.

For a copy of this report or for more information on the consumer companies covered by Sharon Zackfia, Jon Andersen, Daniel Hofkin, Ryan Domyancic, and Dylan Carden, please contact your William Blair representative.

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