Being Remarkable · e-commerce · Strategy

Going private: Here comes Amazon’s next big wave of disruption and dismantling

While Amazon is often falsely blamed for all of retail’s woes, the “Amazon Effect” is both profound and well-documented. While the company’s overall market share is relatively low (under 5%), Amazon now accounts for nearly half of all e-commerce sales and its pricing and supply chain supremacy continues to put margin pressure across many categories of retail.

Yet, lost among the stories about the showdown between Amazon and Walmart or the impact of the Whole Foods acquisition or the company’s many stymied attempts to become a major fashion player is potentially an even bigger and more interesting narrative. What should be added to the list of things that keep both manufacturers and retailers up at night is Amazon’s rapidly evolving private brand strategy. The massive potential for a “go private” thrust to be another key component in what L2’s Scott Galloway has called Amazon’s systemic dismantling of retail and brands is huge.

Here’s why:

Private brands can have powerful consumer appeal. A well-executed private brand strategy allows for equal (or even better) quality products to be delivered at much lower prices. Store brands have moved well beyond the generic product days into being desired brands in their own right and have become significant lines of business for many retailers.

Private brands typically have greater margins. By controlling both the product design and supply chain–and avoiding the need for large marketing and trade allowance budgets–proprietary store brands can deliver a better price to the consumer and better gross margins for the retailer. Therefore the brand owner has a greater incentive to push its captive brands over national brands.

Amazon has already created a solid base of private brands. It turns out that Amazon already has a solid stable of proprietary brands. Some are more basic commodity items sold under the Amazon name. Some have their own identity, like Mama Bear and Happy Belly. Others tilt toward the more fashionable. With the Whole Foods acquisition, the company also controls the 365 Everyday Value brand which, rather unsurprisingly, is now available at Amazon. Recent reports suggest they are jumping into the athletic wear business.

Amazon’s private brands are on fire. While specific financial data is relatively sparse, most indications are that the company is thus far yielding strong performance with its own products. According to one report, many of these brands are experiencing hyper-growth.

The Amazon chokehold. Ponder for a moment the amount and quality of customer data Amazon can leverage to both design and target its own stable of higher margin products. Consider that more than 55% of all online product searches start at Amazon. Reflect on the reality that Alexa’s algorithms already give preference to Amazon’s private brands. Contemplate how easy it will be for Amazon to systematically design its website to feature the brands it wants to promote. Meditate on the freedom Amazon has to pursue the long game given its strong cash flow and Wall Street’s current willingness to value growth over profits.

Because of its sheer size, as well as the need to feed the growth beast, Amazon must both grab more market share in categories where it already has a material position, while also entering and penetrating significant new opportunity areas. At some point, Amazon will also have to demonstrate that it can make some decent money outside of its Amazon Web Services business. The opportunity in private brands serves both Amazon’s long-term revenue and margin objectives.

For the most part, Amazon’s private brand aspirations have operated under the radar. But from where I sit, it won’t be long before they reach critical mass in many key categories. And when they are ready to truly step on the gas–both from their organic efforts, as well as from what I believe will be at least one more major brick & mortar acquisition–another wave of brands (both wholesale and retail) will get caught in the wake.

For the competition, it’s time to be afraid. Very afraid.

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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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Digital · Omni-channel · Retail

Pure play e-commerce’s fantastic (and unsustainable) consumer wealth transfer

“Retail disruption” has been a popular buzz phrase for several years now. In fact, most of the retail brands that have received out-sized mentions in the business press–and commanded the adoring attention of industry conference attendees–for the past 5 years or so are somehow or other leveraging digital innovation to fundamentally re-work the consumer experience, gobble up market share and attract truckloads of venture capital.

Amidst this transformative reshaping of the retail landscape three things are clear:

  • Consumers have benefitted substantially from the introduction of new business models through more convenience, greater product access and lower prices.
  • This profound shift in the consumer value equation has put enormous pressure on industry incumbents that lack either the cost structure or agility to respond effectively.
  • A dramatic rationalization is gaining momentum as traditional players are being forced out of business or pressured to close and or shrink the foot-print of their stores, make huge investments in “omni-channel” capabilities and lower costs across the board.

Unfortunately what is lost in tales of this evolution is that most of the “disruptive” pure-play e-commerce brands have completely unsustainable business models and mostly what is happening is that venture capitalists (and other investors) are funding a transfer of wealth to the consuming public. So, on behalf of my fellow consumers, thanks venture capitalists.

Alas, this is unlikely to last much longer.

While many people think digital retail is some sort of license to print money, it’s becoming clear that e-commerce is virtually profit proof in categories with low transaction values, owing primarily to the substantial supply chains costs (particularly when brands offer free shipping and returns). Moreover, while it can be relatively easy and cheap to build an initial following online through public relations,  social media and other forms of peer-to-peer marketing, scaling an e-commerce only brand turns out to be extremely costly. Many of the buzziest pure-plays are now investing heavily in expensive branding efforts (as well as opening their own stores) in the hopes that size engenders profitability. Accordingly, initial expectations of break-evens are now being pushed out several years.

As the ROI of these efforts starts to come into sharper relief, my bet is many funding sources will lose their patience.

I’ve been an on-the-record skeptic for several years now, going back to when I called into question the sustainability of the flash-sales market well before the meltdown. More recently, I’ve been pointing out E-commerce’s pesky little profitability problem. So I’m not suprised that recent valuations of several once high flying players have collapsed. And more folks are starting to take notice. Professional smart guy (and noted wise ass) Scott Galloway agrees and has been on the “pure play doesn’t work” train for some time. Expect more to join us.

To be clear, a few digital-first brands will likely emerge as sustainable value creators. Brands with high enough average order values to overcome high delivery costs are better positioned (though Net-a-porter’s inability to make money after all these years underscores how difficult this is). Those that deftly merge online and offline experiences–think Warby Parker and Bonobos–also improve the odds (though, side-note, don’t be misled by the high productivity of their initial locations and comparisons to other brands’ productivity stats. We need to understand the four-wall profitability of these new stores and make comparisons to traditional retailers averages in like locations, not overall chain averages).

Mostly, however, we need to be careful to declare a brand successful without defining what we mean by success. If we define success as having grown revenues quickly and having been able to raise gobs of capital from investors to enable subsidizing consumers on a massive scale, than clearly Amazon and dozens of others are wildly successful. If we define success as creating enormous pricing pressure and raising the cost of doing business so as to push traditional players into a double-bind than, yes, mission accomplished.

But if we determine success as having demonstrated the ability to deliver a new and better customer experience AND earn a risk appropriate return on capital than I’m not sure any pure-play E-commerce player of any size is yet successful.

I will go on the record as saying far more pure plays will go bust in the next three years (or get sold at valuations well below their most recent funding) than will emerge as truly successful.

Until then, enjoy the low prices and the free shipping, and if you get some time, send the nice folks funding Jet.com and others a sincere and heartfelt “thank you” note.

 

 

 

 

 

Frictionless commerce · Omni-channel · Retail

A few inconvenient truths about e-commerce

It’s easy to feel like e-commerce is eating the world. It’s not.

While there can be no question of e-commerce’s continued growing importance and its often disruptive nature–particularly in categories like books and music–I’m both amused and amazed at the lack of perspective many in the industry often seem to have. So here are what I believe to be a few important, albeit at times inconvenient, truths.

Physical retail will continue to dominate. Estimates vary, but brick & mortar retail still accounts for over 90% of all sales. While e-commerce will continue to grow, physical stores will be different but not dead.

Pure-play retail is dying. Scott lays this out better than I can, but once you back Amazon out of the equation, it’s becoming ever more obvious that aside from (perhaps) a few niche exceptions, e-commerce only business models are unsustainable owing primarily to uneconomic customer acquisition costs and overly expensive logistics.

A great deal of e-commerce growth is channel shift among traditional brands. Overall growth of e-commerce will be greater than 10% for the foreseeable future, but much of this comes from major retail brands (e.g. Macy’s, Nordstrom, Walmart) transferring business from their physical stores to their improving digital channels.

Much of e-commerce remains unprofitable and economically unsustainable. Let’s remember that Amazon has never consistently demonstrated an ability to make money outside of its web service business. Let’s remember that virtually none of the massively funded pure-plays has ever turned a profit. Let’s remember that traditional brands are spending mightily to improve their omni-channel capabilities while being lucky to achieve flat overall sales. Let’s remember that many retailers experience such high returns and supply chain costs that a large percentage of e-commerce transactions are profit proof. Let’s remember that just about every omni-channel retailer has had to cut prices and offer free-shipping to try to keep pace with upstart competitors who are subsidized by often irrational investment.

Of course even while accepting these truths, many brands find themselves in a real bind. As long as investors are willing to irrationally fund certain companies, consumers are the big beneficiaries and traditionally funded brands are either forced to respond to remain competitive or get pummeled in the markets by not playing the game, however self-destructive.

The good news is that reality is slowly creeping into the market. Some bubbles have burst–witness the recent deflation of the once ridiculously hyped flash-sales market. Perhaps even today’s hammering of Amazon’s stock suggests investors’ patience is beginning to wane. But it’s difficult to predict and count on the vicissitudes of either the public or venture capital markets. But there are a few things to do right now.

First, don’t blindly pursue all things omni-channel. With consumer demands and expectations changing no brand can possibly remain idle. But a disciplined approach to investing is essential. Conducting a friction audit is a great way to uncover and to prioritize the areas of leverage and greatest near-term ROI.

Second, understand marginal unit economics. Averages aren’t very helpful, yet many companies rely on them for decision-making all the time.  At any kind of basic scale, e-commerce is mostly a variable cost business. Brick and mortar is mostly a fixed cost one. If you don’t understand the differences–and the interplay–you’re going to do something dumb. Don’t be that guy or gal.

Lastly, go deep on the customer insight and customer profitability analysis. It’s one thing to have a few unprofitable transactions within a mix of purchases for a customer that has overall great lifetime value. It’s another to have your customer portfolio laden with high cost-to-serve, low margin, low average transaction value customers who return stuff all the time. Do the math. Don’t chase your tail. Rinse and repeat.