An inconvenient truth about e-commerce: It’s largely unprofitable

The disruptive nature of e-commerce is undeniable. Entirely new business models are revolutionizing the way we buy. The transformative transparency created by all things digital has revolutionized product access, redefined convenience and lowered prices across a wide spectrum of merchandise and service categories. The radical shift of spending from brick & mortar stores to online shopping is causing a massive upheaval in retailers’ physical footprint, which looks to continue unabated.

But the inconvenient (and oft overlooked) truth is that much of e-commerce remains unprofitable–in many cases wildly so–and many corporate and venture capital investments have no prospect of earning a risk-adjusted ROI.

While it was once thought that the economics of selling online were vastly superior to operating physical stores, most brands–start-ups and established retailers alike–are learning that the cost of building a new brand, acquiring customers and fulfilling orders (particularly if product returns are high) make a huge percentage of e-commerce transactions fundamentally profit proof. Slowly but surely the bloom is coming off the rose.

Despite the hype–and a whole lot of VC funding–it’s increasingly clear that most of pure-play retail is dying, as L2’s Scott Galloway lays out better than I can. We have already seen the implosion of the flash-sales sector and the collapsing valuations of once high-flying brands like Trunk Club and One King’s Lane. Just the other day Walmart announced it was acquiring ModCloth, reportedly for less than the cumulative VC investment. A broader correction appears to be on the horizon and I suspect we will see a number of high-profile, digitally native brands get bought out at similarly discounted prices. And, ironically, we will continue to witness a doubling down of efforts by many of these same brands to expand their physical footprints, some of which is certain to end badly.

The challenges for traditional retailers and their “omni-channel” efforts are even more vexing. Walmart, Pier 1, H&M and Michaels are among the many retailers that have been criticized for their slowness to embrace digital shopping. Yet I suspect their seemingly lackadaisical approach owes more to their understanding of e-commerce’s pesky little profitability problem than corporate malfeasance. Alas, more and more retailers are increasing their investment in online shopping and cross-channel integration only to experience a migration of sales from the store channel to e-commerce, frequently at lower profit margins. Moreover, this shift away from brick & mortar sales is causing these same retailers to shutter stores, with no prospect of picking up that volume online. The risk of a downward spiral cannot be ignored.

Given the trajectory we are on it’s inevitable that more rational behavior will creep back into the market. But with Amazon’s willingness to lose money to grow share and investor pressure on traditional retailers to “rationalize” their store fleets, I fear it will take several years for the dust to truly settle.

In the meantime, e-commerce continues to be a boon for consumers and a decidedly mixed bag for investors.

A version of this story appeared at Forbes, where I am a retail contributor. You can check out more of my posts here.

 

Should Hudson Bay Buy Neiman Marcus? The Case For And Against.

Tuesday morning the Neiman Marcus Group reported another quarter of disappointing financial results and announced that it was going to “explore strategic alternatives.”

To be sure, some of Neiman’s problems are idiosyncratic, largely owing to a botched systems implementation and a now crushing debt load taken on in a 2013 private equity buyout. Yet the brand’s continuing struggles also underscore how luxury retail has hit the wall and how it now seems increasingly likely that the storied company may need to run into the arms of yet another owner.

Recent reports have suggested that the Hudson’s Bay Company was hot on the trail of Macy’s. Yet to many, the notion that HBC would acquire a badly wounded company several times its size, seemed a bit crazy. But the rationale for HBC–the owner of Saks Fifth Avenue and Gilt–to acquire Neiman’s seems, at least at face value, more strategically sound and (perhaps) more easily financed.

When I worked for Neiman Marcus as the head of strategy and corporate marketing we took a hard look at acquiring Saks. Years later, many of the pros and cons of combining the #1 and #2 luxury department stores remain the same.

The Case For

It seems increasingly obvious that the luxury department store sector is quite mature. While e-commerce is growing (now representing 31% of Neiman’s total revenues), most of that is now merely channel shift. Moreover, there are virtually no new full-line store opportunities for either Saks or Neiman’s, and the jury remains out whether or not US brands can find a meaningful number of store openings outside their home markets. Shifting demographics also do not bode well for long-term sector growth.

Faced with this reality, consolidation makes a lot of sense. If Saks were to merge with Neiman’s there would be considerable cost savings from combining many areas of operations. Rationalization of the supply chain would yield material savings as well. Managing the two brands as a cohesive portfolio would allow for optimization of marketing spending and promotional activity. There might even be some benefits from combining buying power to extract greater margins from vendors. Less tangible, but potentially meaningful, is the ability to cascade best practices from each organization.

The more interesting benefits could come from addressing store overlaps. As the market matures and more sales move online, there will be a growing number of trade areas (and specific mall locations) where Saks and Neiman’s going head-to-head only waters down the profitability of each respective location. Selectively closing stores and redeploying that real estate could drive up the remaining locations’ profitability dramatically, while unlocking the underlying real estate value of certain locations. All of which certainly plays into Richard Baker’s (HBC’s Chairman) strengths.

The Case Against

By far the most challenging element of any buyout of Neiman’s by HBC (or by anyone for that matter) would be the price and the related financing. Neiman’s was sold in 2013 for $6 billion dollars and still carries about $5 billion in debt. Since the buyout the company’s EBITDA has gone south, with no prospect for an imminent major turnaround. Given the maturity of the sector and the company’s recent weak operating performance, it’s hard to see why anyone would pay the sort of multiple that would make the current equity and/or debt owners whole.

Unless the real estate value can be unlocked in a transformative way, the only rationale for a merger hinges on the ability to generate operational efficiencies and optimize trade area by trade area market performance. With regard to the former, this isn’t trivial. The Saks and Neiman’s cultures are very different. To say one is very New York and the other is very Texas merely hints at the challenges. It’s easy to sketch out the synergies on paper. Making them actually happen is another thing entirely.

With regard to the latter, the fact is that Saks and Neiman’s are very similar concepts (though Neiman’s historically has been operated far better). When I was at Neiman’s we struggled with how we would operate two virtually identical brands often operating in the same mall–or in places like San Francisco, Beverly Hills, Boston and Chicago–just down the street. Even if we could get out of a lease (or sell the store), would closing a shared location actually be accretive to earnings? If we continued to go head-to-head could we shift the positioning of each brand enough to actually grow market share and profits. Ultimately, other issues trumped this particular concern, but this issue isn’t trivial either and the degree to which it is important mostly comes back to the ultimate price to get a deal done.

Without access to proprietary data it’s impossible to completely assess the likelihood of an HBC/Neiman’s deal. But it seems increasingly likely that something dramatic needs to happen with Neiman’s capital structure and it’s difficult to imagine how another leveraged buyout gets done with private equity sponsors. And it’s hard to see another strategic buyer that makes much sense. More and more, HBC looks like the only game in town.

A version of this story appeared at Forbes, where I am a retail contributor. You can check out more of my posts here.

The fault in our stores

Last week Target became the latest retailer to report weak earnings and shrinking physical store sales. They certainly won’t be the last.

As more retail brands disappoint on both the top and bottom lines–and announce scores of store closings–many may conclude that brick-and-mortar retail is going they way of the horse-drawn carriage. Unfortunately this ignores the fact that roughly 90% of all retail is still done in actual stores. It doesn’t recognize that many retailers–from upstarts like Warby Parker and Bonobos, to established brands such as TJMaxx and Dollar General–are opening hundreds of new locations. It also fails to acknowledge the many important benefits of in-store shopping and that study after study shows that most consumers still prefer shopping in a store (including millennials!)

Brick-and-mortar retail is very different, but not dead. Still, most retailers will, regardless of any actions they take, continue to cede share to digital channels, whether it’s their own or those of disruptive competitors. To make the best of a challenging situation, retailers need a laser-like focus on increasing their piece of a shrinking pie, while optimizing their remaining investment in physical locations. And here we must deal with the reality that aside from the inevitable forces shaping retail’s future, there are many addressable faults in retailers’ stores. Here are a few of the most pervasive issues.

The Sea Of Sameness

Traditionalists often opine that it all about product, but that’s just silly. Experiences and overall solutions often trump simply offering the best sweater or coffee maker. Nevertheless, too many stores are drowning in a sea of sameness–in product, presentation and experience. The redundancy in assortments is readily apparent from any stroll through most malls. The racks, tables and signage employed by most retailers are largely indistinguishable from each other. And when was the last time there was anything memorable about the service you received from a sales associate at any of these struggling retailers?

One Brand, Many Channels

Too many stores still operate as independent entities, rather than an integral piece of a one brand, many channels customer strategy. Most customer journeys that result in a physical store visit start online. Many customers research in store only to consummate the transaction in a digital channel. The lines between digital and physical channels are increasingly blurred, often distinctions without a difference. Silos belong on farms.

Speed Bumps On The Way To Purchase

How often is the product we wish to buy out of stock? How difficult is it to find a store associate when we are ready to checkout? Can I order online and pick up in a store? If a store doesn’t have my size or the color I want can I easily get it shipped to my home quick and for free? Most of the struggling retailers have obvious and long-standing friction points in their customer experience. When in doubt about where to prioritize operational efforts, smoothing out the speed bumps is usually a decent place to start.

Where’s The Wow?

As Amazon makes it easier and easier to buy just about anything from them, retailers must give their customers a tangible reason to traffic their stores and whip out their wallets once there. Good enough no longer is. Brands must dig deep to provide something truly scarce, relevant and remarkable. Much of the hype around in-store innovations is just that. For example, Neiman Marcus’ Memory Mirrors are cool, but any notion that they will transform traffic patterns, conversion rates or average ticket size on a grander scale is fantasy. Much of what is being tested is necessary, but hardly sufficient. The brands that are gaining share (and, by the way, opening stores) have transformed the entire customer experience, not merely taken a piecemeal approach to innovation.

Treat Different Customers Differently

In an era where there was relative scarcity of product, shopping channels and information, one-size-fits all strategies worked. But now the customer is clearly in charge, and he or she can often tailor their experience to their particular wants and needs. Retailers need to employ advanced analytical techniques and other technologies to make marketing and the overall customer experience much more personalized, and to allow for greater and greater customization. More and more art and intuition are giving way to science and precision.

Physical retail is losing share to e-commerce at the rate of about 110 basis points per year. While that is not terribly significant in the aggregate, this erosion will not be evenly distributed and the deleveraging of physical store economics will prove devastating to many slow to react retailers. This seemingly inexorable shift is causing many retailers to reflexively throw up their hands and choose to disinvest in physical retail. The result, as we’ve seen in spades, is that many stores are becoming boring warehouses of only the bestselling, most average product, presented in stale environments with nary a sales associate in sight.

The fault in our stores are legion. But adopting an attitude that stores are fundamentally problems to be tolerated–or eliminated–rather than assets to be leveraged and improved, makes the outcome inevitable and will, I fear, eventually seal the fate of many once great retailers.

PurpleCow

A version of this story appeared at Forbes, where I am a retail contributor. You can check out more of my posts here.

Sears: Is The End Finally In Sight For The World’s Slowest Liquidation Sale?

When I left Sears in 2003, I was quite pessimistic about the company’s long-term prospects. Some initiatives we had put in place during a two-year strategic re-positioning effort were gaining traction, but most key metrics were alarming. The apparel business was well below a sustainable productivity level. The appliance and home improvement segments–which accounted for roughly 50% of our enterprise value–were losing market share to better positioned competitors, mostly notably Home Depot and Lowes. And the one strategy that might have saved us was no longer a feasible option. My fear was that Sears’ slow death was inevitable.

The following year Eddie Lampert put two failing retailers together and promptly made a bad situation even worse. While Sears and Kmart both suffered from challenges driving revenue, Lampert focused on cutting costs. As leading brands realized that retail was moving to an era of greater customer experience and shopping integration, Lampert set up merchandise categories as warring factions. Next came the idea of starving the stores further to focus on making Sears more digitally savvy. Then he became enamored with an emphasis on making Sears “member-driven” by launching “Shop Your Way,” a frequency shopping scheme that only served to lower margins without restoring necessary sales growth.

After witnessing nearly a decade of flailing, in 2013 I publicly declared Sears “the world’s slowest liquidation sale” and suggested that they were a dead brand walking.

I have to admit that Sears has hung in there longer than I would have thought. The degree to which Lampert has been able to extract value from Sears assets has been surprising and remarkable. But he is rapidly running out of rabbits to pull out of his hat.

First, and most importantly, Sears has never laid out any realistic strategy to reverse a nearly perfect string of comp store declines for both the Sears and Kmart brands extending back to 2004. Sears cannot possibly cut enough costs to restore positive operating cash flow without growing top-line sales significantly.

Second, most store closings only make things worse. Contrary to popular belief, stores are needed to drive online sales, and vice versa. Sears’ fundamental problem is not too many stores, it is that is has become a brand that is no longer relevant enough for the assets and operating scale it has in place.

Third, with massive operating losses assured for the foreseeable future, Sears must raise a lot of cash to stay afloat. And it has already sold almost all the good stuff.

Yes, the presumably imminent sale of the Kenmore and DieHard brands may fetch in excess of a billion dollars. Yes, there is some real estate left to unload. Yes, the Home Services and Auto Centers retain some meaningful value. But don’t let the financial engineering strategies gloss over the fundamental point. There is no viable operating strategy to restore Sears to a profitable core of any material size. And unless the company can generate cash from operations before running out of assets to fund its staggering losses, it is not, in any practical sense, a going concern.

The company has been liquidating for many years now. It’s just that some of us are finally starting to notice.

 

This post originally appeared on Forbes where I recently became a contributor. You can check out more of my writing by going here.

Working on the wrong problem

When we see a brand struggling–or we find ourselves working within a flailing or failing organization–the first order of business should be clear. We need to understand the root causes. Once we’ve become keenly aware of what’s driving our problem–and accepted the reality of the situation–we are then ready to move into developing and launching a course of action.

So if the path is clear and obvious, why do so many retailers–and scores of other types of organizations, for that matter–get it so very wrong, so very often?

We regularly see retail brands hyper-focused on cost reductions when by far the bigger issue is lack of revenue growth (I’m looking at you Sears).

We see brands falling prey to the store closing delusion when often it turns out that closing stores en masse only makes matters worse.

We see brands blindly chasing the holy grail of all things omni-channel when, in most cases, they are merely spending millions of dollars to transfer sales from one pocket to the other–often at a lower margin.

We brands engaging in price wars they can never possibly win or without regard to the possibility that their customers aren’t even interested in the lowest price.

We see brands chasing average, the lowest common denominator, the one-size-fits-all solution because it seems safe. Yet it is precisely the most risky thing they could do.

Far too often we fail to pierce the veil of denial.

Far too often we fall victim to conventional wisdom, what we’ve always done or what we think Wall Street wants.

Far too often we ascribe wisdom to shrewd salespeople or charismatic and clever charlatans.

Far too often we fail to do the work, to ask for help, to dig deep to understand what’s really going on.

We can work really hard. We can focus our energies and those of our teams we great alacrity and intensity. We can pile on the data, build persuasive arguments and rock a really slick PowerPoint presentation. We can tell ourselves a story that convinces us we must be right.

But if we aren’t working on the right problem that’s all a colossal waste of time.

 

 

Retail’s great deleveraging

Over the past several quarters an awful lot of retail brands have reported disappointing earnings. Expect that to continue.

Some of this is because of tepid overall consumer demand in certain categories. Apparel comes to mind. But it goes far beyond simple macro-economics.

We are going through the great deleveraging of retail. And for many brands this will end badly.

When retailers operate a fleet of strong brick & mortar locations with growing revenues, small increases in sales typically convert powerfully to greater profits and return on invested capital. Yet when revenues are headed in the other direction the converse is true. The high fixed cost nature of physical stores can quickly make a given location financially untenable when sales sag. This is the primary reason we are seeing a virtual tsunami of store closings.

But store closings typically cause deleveraging as well.  Many marketing, supply chain, administrative and other costs are relatively fixed. Pull volume out of the system through massive store closings and other types of deleveraging occur.

A lot of folks seem to think that aggressive investments in digital channels and omni-channel integration are the silver bullet answer. But that’s often not true. There is also a relatively fixed cost nature of fulfilling and shipping a direct-to-consumer order. Shift sales from a physical store where the marginal cost of filling an order is comparatively low to e-commerce, where the marginal cost is higher and, once again, the financial leverage gets worse, not better.

Most retailers are investing heavily in omni-channel integration capabilities. Many of these investments are necessary, but not sufficient. If all we are doing is adding a lot of cost to the system without gaining market share and becoming meaningfully more customer relevant, we are once again deleveraging our underlying economics.

Therefore, it should not surprise us that retailers experiencing relatively flat sales overall through a combination of minor declines in physical store sales, but strong increases online are seeing profits erode. Deleveraging is to blame.

Ultimately, the greatest long-term leverage comes from being more remarkable and more intensely customer relevant in ways that grow share of wallet and engender true loyalty, not by squeezing out operating costs and closing stores.

Show me a retailer that is all about cost-cutting and “rationalizing” its real estate and most often you’ve shown me a brand that is out of ideas. Far too often that merely confirms that the downward spiral has begun. Dead brand walking.

Does e-commerce suck?

Well it certainly isn’t bad for consumers. In fact, it’s been a bonanza.

The advent and enormous growth of e-commerce has dramatically expanded the availability of products, making nearly anything in the world readily accessible, 24/7. Product and pricing information that was previously scarce and unreliable is now easily obtainable. Prices are down, in many cases, dramatically. Digital tools and technologies have ushered in a new era of innovation making shopping far more convenient, easy and personalized.

For retail brands and investors the picture is much less clear and increasingly bleak. The fact is e-commerce is mostly unprofitable–and that’s not about to change anytime soon.

Amazon, which is both far bigger than any other retailer’s web business and growing faster than the overall channel, has amassed huge cumulative losses. The high cost of direct-to-consumer fulfillment and so-called omni-channel integration has made virtually every established retailer’s e-commerce business a major cash drain. And more and more, it’s becoming clear that most of the “disruptive” venture capital funded pure-plays are ticking time bombs. Quite a few major write-downs have already occurred (e.g. Trunk Club, Nasty Gal and just about every flash-sales business) and more are surely on the way (I’m looking at you Jet.com and Dollar Shave Club).

Investors have been throwing money at business models with no chance of ever making money for years. Analysts and pundits regularly excoriate traditional brands that are slow to “invest” tens of millions of dollars in all things digital and omni-channel while spewing nonsense about physical stores going away. Much of this is incredibly misguided.

It’s time for everyone to be more clearheaded and, dare I say, responsible.

Industry analysts and the retail press need to stop with the breathless pronouncements about the demise of physical stores. They need to back off the notion that retailers can cost cut their way to prosperity. They also need to quit labeling disruptive businesses as “successful” merely based upon revenues and rapid growth and take the time to really understand the economics of e-commerce and omni-channel (hint: it’s mostly about supply chain and customer acquisition costs).

More established retailers need to stop chasing all things omni-channel and prioritize investments based upon consumer relevance, long-term competitive advantage and ROI. They also need to realize that if they feel the urge to close a lot of stores or drastically cut expenses they are probably working on the wrong problem.

Venture capital investors need to start caring more about building a business based upon fundamentals, not just pricing everyone else out of the market and/or hoping that some idiot big corporation will come along and write a huge check. Also, have we forgotten that selling at a loss and making it up on volume has never been a viable strategy?

Of course, by far the single biggest thing that would restore an element of sanity to the overall market would be if Amazon were to decide to not treat most of their e-commerce business as a loss leader. Sadly, that doesn’t seem likely to happen anytime soon.

So if you are a consumer, enjoy the ride and the subsidies.

If you are retailer, yeah, that definitely sucks.