Despite a booming stock price, Wayfair is no Amazon

Wayfair.com, the leading purveyor of home furnishings online, recently delivered what many on Wall Street saw as a blockbuster quarter, reporting sales growth of more than 40%. Of course they also lost $144 million for the quarter, which about doubled the loss from the year earlier. For the entire year they lost a cool half a billion dollars, despite being at this whole e-commerce thing for over 15 years.  Seems like selling at a loss and making it up on volume is now back in vogue. Despite the seemingly deteriorating economics, Wayfair’s stock is up 70% in the past year and the company is now valued at nearly $15 billion.

At one level, Wayfair can certainly be applauded for having gone from a fledgling start-up to a major retail brand with revenues trending at more than $7 billion per year. And having thrown many millions at broadcast media of late, their jingle (“Wayfair you’re just what I need”) is rapidly turning into an annoying earworm. There is only one eensy-weensy little problem with all of this : their business model, at least as presently executed, is deeply flawed and, well ladies and gentlemen there is no nice way to say this, those bidding up the stock might do better to short it.

While some may see Wayfair as the “Amazon of home furnishings” there are many reasons why those comparisons are largely specious (though their ability to lose lots of money for more than a decade is certainly an apt parallel). Yet unfortunately Wayfair doesn’t have an AWS to subsidize its losses, so eventually they will have to make money the old fashioned way–or hope to be acquired.

Here are four significant underlying issues with Wayfair’s business model, supporting why I predicted earlier this year that Wayfair’s stock is due to crash back to earth.

  1. Customers are expensive to acquire at scale. I’ve written many times about the challenges of scaling e-commerce businesses given the high cost of marginal customer acquisition. Wayfair is pretty much the poster child for this “reverse economies of scale” phenomenon. The last few earnings reports suggest that Wayfair’s acquisition costs remain extremely high and they are getting little leverage despite their growing scale. To keep sales growth booming they will almost certainly need to keep paying Facebook, Google and the rest of the toll-booth marketing industrial complex dearly to stand out in a highly competitive sector. And as Peter Fader and Dan McCarthy’s work illuminates, despite these pricey bounties many new customers will have insufficient lifetime value to be worth adding.
  2. Supply chain costs are big barriers to profitability. E-commerce may work really well in the search and discovery piece of the furniture shopping process but it does very little when it comes to a big piece of the value chain, namely the cost of (and complications associated with) home delivery of big and bulky items. So far nobody has figured out how to have delivery trucks get from point A to point B much faster. Nobody has figured out how to get a sofa into a house and up a flight of stairs without two guys going along for the ride. Amazon has its own challenges in dealing with spiraling fulfillment costs. While Wayfair is investing a lot to build better supply chain capabilities there are many daunting fundamental challenges inherent to home furnishings that will not be easy to overcome.
  3. Product returns are a killer. As I’ve written about previously, returns & exchanges are a ticking time-bomb for retail as online shopping grows. It’s particularly bad in the furniture business. Not only does buyers’ remorse tend to be higher in the home furnishings category, but the nature of the product often means items are more prone to damage. So when a product needs to come back it can be hugely expensive to handle the reverse logistics and refurbishing and/or liquidation cost. Want some evidence that this is a growing concern? Wayfair’s first physical store is an outlet.
  4. And what’s the deal with gross margin? There was a lot of excitement about Wayfair getting to 24% gross margin. Need I remind everyone that better is not the same as good? This might be an acceptable margin for a retailer with a low cost structure like Walmart or Best Buy. For a brand like Wayfair that isn’t close to sufficient. A better comparison is Williams-Sonoma–and their margin is around 34%. As Wayfair grows they can develop further efficiencies. They can also shift their product mix and obtain lower product costs–yet they already have a very high penetration in private label. What this low margin suggests to me more than anything is that their pricing is consistently too low. That may help explain the rapid customer growth, but it is hardly a recipe for long-term profitability.

While Wayfair has done many admirable things–and there certainly is room for a sizable digitally-driven home furnishing brand of some scale, should we continue to be impressed with a business that only seems to drive outsized growth with unsustainable pricing and crazy high levels of marketing, while offering free shipping in a business with notoriously high supply chain costs? If you don’t find this more than a bit crazy please contact me about investing in my new highly disruptive business model selling $20 bills for $15.

This likely doesn’t end well. Unless of course Amazon, Walmart, Target or some other huge player decides to acquire them in a “strategic move.” If things don’t start to improve much more dramatically in the near future that may be the best and only hope.

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

Sorry, Alexa: Voice shopping is still mostly hype

Voice-activated shopping—and Amazon’s anticipated dominance of the platform via Alexa-enabled devices—has been touted as one of the next big things in retail. In fact, a simple Google search with any combination of the relevant keywords reveals a large number of bold predictions about the revolutionary nature of the technology. Go ahead and give it a try. I’ll wait.

So, given the large number of pundits, publications and consultancies reveling in the future thrill of a world dominated by voice-driven shopping, should we believe the hype? Well, as it turns out, maybe not so much. At least not yet.

In a report released last week by The Information, it appears that only about 2% of Alexa owners have ever used the device for shopping. Even more startling is the finding that of those that had bought via voice, a mere 10% did so again. As you probably know, repeat purchase rates are often a good indication of customer delight and can provide valuable insight into future sales momentum. So, if true, this doesn’t bode well for rapid adoption.

To be fair, a study by Narvar suggests higher adoption rates and considerable customer interest. Amazon has also disputed the numbers in the report, responding that “millions of customers use Alexa to shop.” Of course, when you do the math, given the installed base of Alexa devices, that’s not definitive proof that purchase incidence is a whole lot greater than 2%. Whether the actual data reveals a considerably different picture or Amazon is simply obfuscating a disappointing outlook is anyone’s guess. And just because momentum might be relatively slow right now doesn’t mean the rate won’t pick up considerably as the technology improves and consumers become more familiar. But I’d be cautious. Here’s why.

First, there is an aspect of the technology that is solving a problem I’m guessing relatively few customers have. Shopping on Amazon (and most other sites) via a mobile device, laptop or desktop is pretty easy, fast and well optimized. At the margin, in some instances, Alexa can save a little time and solve an immediate need. But it’s not like it’s a step function in improved convenience.

Second, voice-activated commerce, at least as it’s currently delivered, can involve significant experiential comprises. While I have not seen specific data, my own personal and industry experience suggests that visual cues are central to many purchases, and the ability to see options—and navigate through them—is highly useful for many purchase occasions. In these situations “regular” online shopping is clearly superior.

Third, as Scott Galloway from New York University and L2 humorously illuminated, Alexa does not always present most of the available product options and, shockingly, might have a bit of a bias towards Amazon’s own private brands. While it would take a large study to really understand how prevalent this pattern is, it strikes me that voice-activated shopping can work quite well when you know exactly what you want and aren’t especially open to considering alternatives. In all the other situations (which might well be the vast majority), it’s far from clear it’s meeting consumers’ needs in a highly relevant, compelling and unbiased manner.

Fourth is the trust factor, which extends beyond voice-activated commerce in particular to the general adoption and use of Alexa and similar devices. Some of the things I’ve mentioned already speak to the trust of shoppers getting the experiential outcome they desire. The other aspect is whether some of the suspicions about how these devices invade privacy get adequately addressed over time. Stories like the one about a woman’s conversation being recorded by Alexa and then being sent to a random contact don’t exactly inspire confidence. Whether these concerns are all that profound and whether a significant number of customers remain cautious about using such devices remains to be seen. Certainly the technology will continue to evolve, if only because of Amazon and Google’s massive commitment to their adoption.

As I don’t possess a working crystal ball, I’m reluctant to predict that voice-activated commerce won’t someday be retail’s next big thing. Right now, however, it seems much more of a cool technology still in search of addressing a real customer need at scale.

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

Is Amazon finally getting serious about retail profitability?

There seems little doubt that Amazon.com AMZN -0.27% is crushing it and Macy’s is flailing. So who has the best profitability? Well, it’s not even close.

Macy’s operating margin is just over 6%. In recently reporting what was widely seen as a blowout quarter, Amazon is just now approaching a whopping 2% in its non-Amazon Web Services business. By just about any comparison, in most categories, Amazon’s margin performance appears to be anywhere from lousy to lackluster, despite its vast capabilities and more than 20 years of working hard at most of it.

One particularly disturbing trend is rising shipping and fulfillment costs. With Amazon’s massive scale, you might think this would be a growing source of profit leverage. You’d be wrong. Logistics costs continue to rise faster than revenues.

This is not terribly surprising. The structure of Amazon’s Prime program (which recently surpassed 100 million members) essentially encourages customers to overuse “free” shipping for frequent small orders—which generally have low (or non-existent) profits. Amazon also continues to aggressively push same-day delivery, which, at current scale, has terrible marginal economics.

Amazon’s growing success in apparel may be great for the top line, but returns and exchanges tend to be much higher than average, pushing supply chain costs further in the wrong direction.

Before anyone quibbles with my high-level analysis, I will state that I know the company has been making substantial investments for the long term. I realize that there are many instances where Amazon could make more money but it continues to prioritize market share gains over decent (or any) near-term returns. And I understand that Wall Street clearly values growth over profits. Yet against this backdrop, it does seem as if there is a subtle shift in focus.

Given the significant headwinds from growing logistic costs, the fact that profits improved dramatically suggests that both product margins and non-logistics operating costs are starting to be leveraged in more powerful ways. Moreover, in what some see as a risky move—but I see fundamentally as an acknowledgement of customer loyalty, pricing power and a growing need to offset spiraling delivery costs—Amazon is raising the price of Prime membership by $20. Despite customer protestations, I am willing to bet that Amazon comes out way ahead on this move.

Another sign of Amazon’s seriousness toward pursuing profitability is its growing investment in private brands. Amazon already has more than 70 proprietary brands, and more are sure to follow. Done right, increasing the mix of its own brands can further drive market share gains by offering strong additional value to its customers and drive gross margins higher. Expect to hear more about the significant contributions these new brands are making within the next few quarters.

When it comes to buying versus shopping, Amazon holds more and more of the cards. More than 50% of all online product searches start at Amazon. Amazon is fast closing in on owning nearly 50% of the U.S. e-commerce market and is racking up significant share in many global markets. Prime membership tends to lock consumers into a virtuous shopping cycle where, at the margin, Amazon becomes the default choice for a growing basket of stuff. As Amazon gets deeper into physical stores (organically or through another major acquisition), even the “shopping” side starts to come more seriously into view—much of which should actually help expand margins. And personally I think Amazon has yet to take anywhere close to full advantage of its powerful customer data and insight assets.

Given the complexity of its operations—and the overlapping cycle of major investments in the next wave of growth—it’s often hard to discern the underlying dynamics of Amazon’s retail operations in any given quarter. Yet a few things seem clear.

First, Amazon likely never gets to decent operating margins without addressing the supply chain cost issue. Second, private brands will soon become a more important part of the story. Third, in the not too distant future, a more aggressive brick-and-mortar strategy is likely needed to continue to drive outsized growth. Lastly, Amazon still has a lot of levers to pull to leverage its data and take advantage of its growing customer loyalty. For the most part, improved profitability can likely come at a time and date of Amazon’s own choosing.

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

On May 17 I will be keynoting Kibo’s 2018 Summit in Nashville, followed the next week by Retail at Google 2018 in Dublin.

Here’s who Amazon could buy next, and why it probably won’t be Nordstrom

Since the Whole Foods deal, more than a few industry analysts and pundits have weighed in on which retailers might be on Amazon’s shopping list.

Various theories underpin the speculation. Some say Jeff Bezos wants to go deeper in certain categories, so Lululemon or Warby Parker get mentioned. Foursquare (is that still a thing?) crafted its own list from analyzing location data. The Forbes Tech Council came up with 15 possibilities. The always provocative, and generally spot-on, Scott Galloway of L2 and NYU’s Stern School of Business believes Nordstrom is the most logical choice.

Obviously no one has a crystal ball, and Amazon’s immediate next move could be more opportunistic than strategic. Given Amazon’s varied interests, there are several directions in which they could go. And clearly they have the resources to do multiple transactions, be they technology enabling, building their supply-chain capabilities out further, entering new product or service categories, or something else entirely. For my purposes, however, I’d like to focus on what makes the most sense to expand and strengthen the core of their retail operations.

Before sorting through who’s likely to be right and who’s got it wrong (spoiler alert: Scott), let’s briefly think about the motivating factors for such an acquisition. From where I sit, several things are critical:

  • Materiality. Amazon is a huge, rapidly growing company. To make a difference, they have to buy a company that either is already substantial or greatly accelerates their ability to penetrate large categories. This is precisely where Whole Foods fit in.
  • Fundamentally Experiential. There is an important distinction between buying and shopping. As my friend Seth reminds us, shopping is an experience, distinct from buying, which is task-oriented and largely centered on price, speed and convenience. Amazon already dominates buying. Shopping? Not so much.
  • Bricks And Clicks. It’s hard to imagine Amazon not ultimately dominating any category where a large percentage of actual purchasing occurs online. Where they need help is when the physical experience is essential to share of wallet among the most valuable customer segments. They’ve already made their bet in one such category (groceries). Fashion, home furnishings and home improvement are three obvious major segments where they are under-developed and where a major stake in physical locations would be enormously beneficial to gaining significant market share.
  • Strong Marginal Economics. We know that Amazon barely makes money in retail. What’s not as well appreciated is the inconvenient truth that much of the rest of e-commerce is unprofitable. Some of this has to do with venture-capital-funded pure-plays that have demonstrated a great ability to set cash on fire. But unsustainable customer acquisition costs and high rates of product returns make many aspects of online selling profit-proof. An acquisition that allows Amazon access to high-value customers it would otherwise be challenged to steal away from the competition and one that would mitigate what is rumored to be an already vexing issue with product returns could be powerfully accretive to earnings over the long term. Most notably this points to apparel, but home furnishings also scores well here.

So pulling this all together, here’s my list of probable 2018 acquisition targets, the basic rationale and a brief word on why some seemingly logical candidates probably won’t happen.

Not Nordstrom, Saks or Neiman Marcus

Scott Galloway is right that Nordstrom (and to a lesser degree Saks and Neiman Marcus) has precisely the characteristics that fit with Amazon’s aspirations and in many ways mirror the rationale behind the Whole Foods acquisition. Yet unlike Whole Foods, a huge barrier to overcome is vendor support. Having been an executive at Neiman Marcus, I understand the critical contribution to a luxury retailer’s enterprise value derived from the distribution of iconic fashion brands, as well as the obsessive (but entirely logical) control these same brands exert over distribution. Many of the brands that are key differentiators for luxury department stores have been laggards in digital presence, as well as actually selling online. Most tightly manage their distribution among specific Nordstrom, Saks and Neiman Marcus locations. If Nordstrom or the others were to be acquired by Amazon, I firmly believe many top vendors would bolt, choosing to further leverage their own expanding direct-to-consumer capabilities and doubling down with a competing retail partner, fundamentally sinking the value of the acquisition. While Amazon might try to assure these brands that they would not be distributed on Amazon, I think the fear, rational or otherwise, would be too great.

Macy’s, Kohl’s or J.C. Penney 

Amazon has its sights set on expanding apparel, accessories and home but is facing some headwinds owing to a relative paucity of national fashion brands, likely lower-than-average profitability (mostly due to high returns) and a lack of a physical store presence. Acquiring one of these chains would bring billions of dollars in immediate incremental revenues, improved marginal economics and a national footprint of physical stores to leverage for all sorts of purposes. All are (arguably) available at fire-sale prices. Strategically, Macy’s makes the most sense to me, both because of their more upscale and fashion-forward product assortment (which includes Bloomingdale’s) and because of their comparatively strong home business. But J.C. Penney would be a steal given their market cap of just over $1 billion, compared with Macy’s and Kohl’s, which are both north of $8 billion at present.

Lowe’s

The vast majority of the home improvement category is impossible to penetrate from a pure online presence. Lowe’s offers a strong value proposition, dramatic incremental revenues, already strong omni-channel capabilities, and a vast national network of stores. The only potential issue is its valuation, which at some $70 billion is hardly cheap, but is dramatically less than Home Depot’s.

A Furniture Play

Home furnishings is a huge category where physical store presence is essential to gaining market share and mitigating the high cost of returns. But it is also highly fragmented, so the play here is less clear as no existing player provides a broad growth platform. Wayfair, the online leader, brings solid incremental revenue and would likely benefit from Amazon’s supply chain strengths. But without a strong physical presence their growth is limited. Crate & Barrel, Ethan & Allen, Restoration Hardware, Williams-Sonoma and a host of others are all sizable businesses, but each has a relatively narrow point of view. My guess is Amazon will do something here — potentially even multiple deals — but a big move in furniture will likely not be their first priority in 2018.

As I reflect on this list (as well as a host of other possibilities), I am struck by three things.

First, despite all the hype about e-commerce eating the world, the fact remains that some 90% of all retail is done in physical stores, and that is because of the intrinsic value of certain aspects of the shopping experience. For Amazon to sustain its high rate of growth, a far greater physical presence is not a nice “to do” but a “have to do.”

Second, the battle between Amazon and Walmart is heating up. While they approach the blurring of the lines between physical and digital from different places, some of their needs are similar, which could well lead to some overlapping acquisition targets. That should prove interesting.

Lastly, the business of making predictions is inherently risky, particularly in such a public forum. So at the risk of stating the obvious, I might well be wrong. It wouldn’t be the first time, and it surely won’t be the last.

But why not go out on a limb? I hear that’s where the fruit is.

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

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Department store quarterly performance: Better isn’t the same as good

Last week we had five major department stores report their quarterly earnings: Macy’sKohl’sNordstromDillard’s and JCPenney. It was a decidedly mixed bag relative to both expectations and absolute performance. Yet many observers seemed encouraged by the overall improvement in sales trend. Yet the overall sector is still losing market share, just not at quite as fast a rate. Which begs the question, is less bad somehow good?

It’s clear that one must pull out of a dive before an ascent can begin. It’s also obvious that reducing the rate of descent is no guarantee of a resurrection. Better is simply not the same as good. So to understand whether recent results provide a dose of optimism or are merely noise, it’s worth looking more closely at a few key considerations.

More rationalization must occur. The sector has been in decline for two decades–and not because of Amazon or e-commerce. The main reason is that department stores failed to innovate. They focused on expense reduction and excessive promotions, instead of being more remarkable and relevant. That won’t be fixed easily or quickly. So, in the meantime, there is simply too much supply chasing contracting consumer demand. Sector profitability isn’t going to improve much until Sears goes away and additional location pruning on the part of remaining players occurs.

Yet physical retail is not going away. Brick & mortar retail is becoming very different, but it’s far from dead. There is no fundamental reason why any given department store cannot not have a viable operation with hundreds of physical locations, particularly when we realize that some 80% of all products in core department store categories are purchased offline.

You can’t shrink to prosperity. Wall Street seems to think that store closings are a panacea. They’re wrong. It’s one thing to right-size both store counts and individual store sizes in response to overbuilding and shifting consumer preferences. It’s another thing to make a brand’s value proposition fundamentally more relevant and remarkable. Department stores must spend more time working on giving consumers reasons to shop in the channels they have (note: excessive discounting doesn’t count) and abandon the idea that shuttering scores of locations is a silver bullet.

Same-store sales are an increasingly irrelevant metric. Wall Street needs to let go of its obsession with same-store performance as the be-all-end-all performance indicator. Any decent “omni-channel” retailer should be on its way to–or as is already true with Nordstrom and Neiman Marcus well past–more than 20% of its overall sales coming from e-commerce. So unless a retailer is gobbling up market share most of that business is coming from existing stores. The reality is that shifting consumer preferences are going to make it nearly impossible for many retailers (of any kind) to run positive store comps. That does not mean a brand cannot grow trade area market share and profits. And it doesn’t mean that a given store is not productive even if sales keep trending down. Stores drive online, and vice versa. Smart retailers understand this and focus on customer segment and trade area dynamics, not merely individual store performance in isolation.

It is going to take more than a couple of quarters to fully understand whether the department store sector has stabilized, much less turned the corner. As we look ahead, of the five that reported, Nordstrom is clearly the best positioned, both from the standpoint of having relevant and differentiated formats and possessing physical and digital assets that are the closest to being “right-sized” for the future. And call me crazy, but I sense that JC Penney is actually starting to gain some meaningful traction. Dillard’s is a mess and Macy’s and Kohl’s remain very much works in progress.

Regardless, with tepid consumer demand and over-capacity, no department store brand (and I’d include Neiman Marcus and Saks in the mix as well) does especially well until we see further consolidation. And even when that occurs, if department stores keep swimming in a sea of sameness and engaging in a promotional race to the bottom, they have zero chance of getting back to a sustainable, much less interesting, level of performance. Better is nice. Encouraging even. But it is simply not the same as good.

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