The Death of Traditional Retail?

The Rise of Ecommerce

There is no question that the rise of ecommerce and the likes of Amazon have changed the way consumers shop. Online stores have a huge advantage in fixed rent costs as their dollar per square foot is much lower. Fulfillment centers in suburban neighborhoods are much cheaper than retail space in urban city malls for example. Combined with fast shipping, what’s the need for traditional retail? Covid further bolstered this belief as retail stocks dropped and online companies continued to perform.

Covid

So coming out of 2020 and 2021, would you expect a further shift in consumer spending patterns to online or a rebound in traditional brick-and-mortar retail? Most would say covid expedited that secular shift with a slight rebound in traditional retail as consumers ventured out to shop as part of the “great reopening” post lock down. Presumably that “yolo” phase has passed in 2023, and retail stocks should continue their downward trend. Surprisingly not been the case.

Return of Brick-and-Mortar Retail

Many online brands such as Rhone and other online startups say one of their biggest regrets was waiting too long to sell their goods in department stores and other traditional retailers. What brands are realizing is that cutting out the middle man is much harder than anticipated. Wholesale, the practice of selling goods through a third party such as a department store, is profitable. Ecommerce takes much longer to become profitable and some brands may never become profitable because they spend too much money on acquiring customers and the unit economics just don’t make sense. Brands that believed traditional retailers were relics of the past are now becoming fixtures in those stores that they had left for dead.

What’s Changed?

After the 2008 financial crisis, interest rates became extremely low, in fact near zero. This encouraged venture capital firms to pour significant money into digital startups that prioritized growth over profits. For many startup companies, as long as revenue grew at double digit rates year over year, it was ok to be unprofitable. Investors bought into the idea that brands such as Harry’s (razors), Blue Apron (meal kits), and Casper (mattresses) understood their customers better than retailers and would make money over the long run. Arguably possible, the miscalculation was the rising expense of acquiring customers online. For example, marketing costs went up. Startups that bought advertisements online through Facebook ads, Snap, Google, Twitter, and other digital marketing pushed up costs. Additionally, privacy changes such as Apple’s App Tracking Transparency made it harder for app makers and advertisers track user behavior, leading to far less efficiency per marketing dollar spent (Facebook said Apple’s privacy change has cost it $10bn in revenues in 2022). Finally, as interest rates rose, the cost of shipping each item increased (One solution was to open physical stores. Ie. Allbirds and other brands raced to build brick-and-mortar footprints but that too is expensive).

Those brands have since turned back to department stores and other traditional retailers, which carries lower costs and instantly exposes brands to thousands of customers. Nike for example in 2021 abandoned some of its retail partners (i.e. Macys) to focus on selling online and its own retail stores. Just this month, on June 1st, 2023, Nike signed a long-term agreement with Macys to sell at its retail partner again. Macys has over 40 million customers, making acquisition costs much lower for companies like Nike.

Conclusion

No doubt that ecommerce has shifted the way consumers shop and took a significant piece of the pie from traditional brick-and-mortar retail. Not all online retail is the same and one must scrutinize closely the unit economics to see if a high growth company will eventually be profitable (basically a company needs to obtain critical mass to cover its fixed costs).

As for traditional retail, it’s not completely dead and can be surprising. For example, Dick’s Sporting Goods stock price is up 6x since Covid! (a bit surprising, happy to chat for why that is and the potential risks involved in that name).

Appendix – Here’s some quick math in traditional retail vs online direct-to-consumer

Assume a brand’s product sells for $100 and the cost to make it is $50. If the brand goes through a retail partner, they may sell it to the retailer for $75 and the retail partner marks it up to $100. To a customer, it will always be $100 but through the retail partner, they take a piece of that markup. Brands believe that if they go direct to consumer, they can cut out the middlemen and take the full $50 margin. But, once marketing, shipping, and other costs are factored in, brands may actually make less than going through a retail partner. This may or may not be the case but should be factored in to any investor’s analysis.

Note – Other factors to consider… Data is quite important in this day and age. When a retailer sells a product, that department store owns the data, not necessarily the brand. Retailers may decide to share selling data to brands or may require brands to purchase that data. Furthermore, product liability can be another factor. For example, when selling on consignment, the brand still owns the product while it is under the care of the store until the item is bought by a buyer.