Disruption – Part Three – Retail

I have been considering “disruption”, including what is hype and what is real.  Here is one on the cab industry where it occurred and in the electric and gas utility industry which has proven resilient in its current business model.

While “retail” is a nebulous category, it is one that touches virtually everyone in the USA. Let’s start with the definition of retail:

the sale of goods to the public in relatively small quantities for use or consumption rather than for resale.

My experience with retail has been that of a consumer, although I live in an area near Michigan Avenue which features a huge variety of stores of all types, from mass market to high end “showcase” stores. I also have a long history with e-commerce, having been involved in a variety of businesses helping them to go “online” and “digital” from the earliest days of the web. Since the primary threat to modern retail today is from e-commerce, this experience is relevant.

This chart above is from a recent Business Insider article on retail. The graph clearly shows how shopping is moving from the physical retailer to the online retailer, and it is being accelerated by the adoption of mobile technologies (which enable you to shop and research while on the move, not just when you are in front of your computer at a desk).

For years I resisted online shopping for my retail purchases, figuring that I am in the midst of so many stores that I would be able to achieve better bargains and results (less returns) if I physically inspected the goods. But with the advent of Amazon Prime, virtually anything that you’d want to buy can be delivered with free shipping and little or no hassle. Their growth has been huge, coming up on 50 million subscribers and 50% annual growth rates.

Online shopping has a large number of advantages over physical retailing, including the following:
1. Tax avoidance – in states with high sales taxes (in Chicago it is over 11%!) the shopper is able to avoid the tax by purchasing online. Theoretically there are barriers to doing this but in practical terms this remains a significant advantage of online commerce over physical commerce
2. Selection – an online store is able to offer a variety of sizes and styles that cannot be matched at the retail location
3. Lower operating costs – online retailers are able to minimize the costs of stores, managers and staff (many online retailers have some physical locations) relative to a competitor that primarily sells from physical locations
4. Ease of use – when online commerce was in its infancy sites were clunky and payment methods were difficult. The current online shopping experience via mobile, however, can be almost instantaneous and pain-free. What was once a “barrier” to online commerce is now a significant advantage vs. its retail competitor
5. Ability to customize – an emerging advantage of online retailers is their ability to customize products that must be mass produced for retail. A simple example is Apple offering engraving on their devices or Nike offering custom shoes; over time this advantage will become ever more pronounced. This could theoretically be countered by physical stores offering 3D printing but that technology and the supply chain needed to support this at scale is far behind the ability to customize from a central location and distribute via an e-commerce channel
6. Corporate tax minimization – the primarily online retailers have evolved from inception to minimize their tax payments through a variety of international strategies. The effective tax rates of the online retailers is far less than those that primarily deliver through physical retail, which is a compounding advantage over time

These “real” advantages are causing “second order” effects that accelerate this disruption even further, as follows:
1. Stock price and market value – online retailers are perceived as “growth” stocks and in turn receive higher multiples and stock values than their physical equivalents. Amazon and the Chinese online retailers have market values far and away higher than most direct-to-customer physical retailers, which in turn allows them to borrow at lower rates, make acquisitions, and hire talent which can be paid in equity. On the other hand, physical retailers are often plagued by activist investors, re-organizations, and other disruptive and negative events which make business more difficult
2. Declining store investment – as physical stores see commerce go online, they are forced to cut costs and make compromises in order to compete financially. This can be viewed in terms of run-down stores, empty shelves during peak times, and the ubiquitous self-checkout lanes which further depress customer sentiment.

While this process will take years to reach some sort of equilibrium, it is clear that mobile and ecommerce is ascendant while physical retail is declining. Given the wide variety of retail products, some will always be present and / or will evolve and thrive while many other ones will perish or be marginalized. This does not mean that “brands” aren’t important – this is a particular challenge between whether or not that brand will earn most of its money via physical stores or through e-commerce.

A physical manifestation of this shift just occurred in my neighborhood – the closure of a Wal-Mart store, the company that was once the unstoppable juggernaut of retail, sweeping up small retailers in its path. While Wal-Mart is still a giant company and will be with us for years to come, and is attempting a variety of strategies in order to compete, it remains a telling image.

To date no one has come up with a set of advantages for physical commerce that attempts to overcome the online advantages cited above. The best that has been attempted so far is to attempt to reduce those advantages by imposing barriers to the ecommerce retailers such as imposing retail taxes, attacking their lack of payment of corporate taxes, and using the press to highlight their poor treatment of employees in their warehouses. These sorts of strategies can generally only slow their erosion of market share and it is inconceivable that these trends can be significantly reversed.

Cross posted at LITGM

17 thoughts on “Disruption – Part Three – Retail”

  1. Many years ago, I worked for Sears Roebuck as a young part-time management trainee. This was largely because Sears executives had funded much of my scholarship to the University of Southern California even though they were mostly Chicago based. Robert E Brooker was then VP of Sears and heavily involved in the USC alumni of the Chicago area. The job they found for me was a way of helping me to fund living expenses as I was dependent on the scholarship and had little else behind me.

    It was interesting to see how the stores worked and was an introduction to the world of retail sales. Because I was a trainee, even though part-time, I was moved around to different departments, I sold hardware and sporting goods. I worked in the warehouse and in the inventory department. I had worked in a warehouse summers in high school and knew a bit about how they worked. The time in the inventory department gave me a clue about why Sears eventually failed.

    I had some long term connection to Sears, partly because my father was always shopping there, and partly because a long term family friend was an executive. It was sad to see them lose out on what could have been an opportunity if only they had had the vision. The catalog store had the doctrine and the infrastructure to go online. Instead, they closed the catalog the year before Amazon got going. Sears began as a catalog store and, a hundred years later, failed to see where that could lead.

  2. It is such a pity about Sears, not seeing the possibilities of internet retail sales. It’s kind of like the old saying about the buggy whip manufacturers. They thought they were in the business of making buggy whips … when they were actually in the business of making individual-transportation-unit accessories.

  3. I suspect your emphasis on taxes is over done. Does Amazon not charge sales tax in Illinois? It does in Pennsylvania because it has such a large footprint here. More important to the retailer may be the reduction in property taxes. Warehouses are located in low tax municipalities close to consumers whereas stores must be located among consumers in relatively high tax municipalities with higher property cost as well.

    Online also has disadvantages. High return rates eat up a significant portion of profits. While Amazon is now working on same day delivery, online still delays gratification. And there is a social aspect of shopping, particularly for the young. Walmart would seem to be particularly vulnerable to online except in the grocery side of the store. Peapod, Schwan’s and others have not followed in Amazon’s meteoric trail blazing and I have not found the Amazon grocery products to be competitively priced against my local store. Massive selection can be a boon when you know what you want, but bewildering when you don’t. Certain retailers will survive by offering a filtering process. Our independent bookseller continues in business despite the efforts of Borders and Amazon.

    Online represents the creative destruction that has brought more and more goods to more and more people at lower and lower cost for 150 years since the creation of The (now defunct) Great Atlantic and Pacific Tea Company. It will be interesting to watch this play out.

  4. Mrs Davis – I scrolled through my last dozen or so purchases on Amazon and they either had no sales taxes or very modest sales taxes.

    I now buy many household goods even including cleaners online through Amazon prime because they are cheaper than most local retailers (such as the drugstore) although I probably could do better if I trudged out to Costco, but then I have to take a few hours out for shopping and have to store them (they come in bulk). I’ve found that most everything from toothpaste to shampoo can be bought cheaply online with name brands through Amazon prime. Usually they don’t come in quantities of “1” – they might come in 2, 3 or 5. At a quantity of 1 it probably doesn’t make sense for the seller to offer it through Amazon prime (free 2 day shipping).

    I think many of the return problems have been fixed. Returns are a pain for both the buyer and the seller. There is far more info available for purchases now from reviews to FAQ’s to photos to better sizing diagrams. And don’t forget that returns are a huge hassle for “physical” retailers, and the physical retailers are also subject to much higher degrees of theft and shrinkage. Plus, their distributed model (each store has inventory) means that they have many more “lost opportunities” for specific sales which are captured online (i.e. I want a large in a particular color) and on the other side “stranded” inventory at each of the stores has to be sent to a central location for distribution to other discount formats (like discount malls) with additional shipping.

    Mobile commerce has exploded recently and it seriously is going to damage or obliterate many of the physical retailers. Those that survive will have specific advantages (Costco) or sell high margin unavailable goods through trophy stores (Tiffany) or just be a more efficient physical distribution method (milk for grocery stores). It is the old and those with lots of time that still physically shop.

    Much of the money that used to be spent at physical retailers by the young has moved to Starbucks, food, and movies and services. That is a totally different disruption discussion for another thread. But the retailer of physical goods to the public is generally getting slaughtered.

  5. “I think many of the return problems have been fixed. ”

    I have no problem with returns to Amazon. I have had a couple minor ones with secondary retailers with links but not enough to worry about.

  6. Sales tax liability in a state is determined by whether the seller has a “nexus,” which is generally some form of physical presence, in that state. A lot of Amazon sales are via Amazon “sellers,” who are independent parties who get to use Amazon search and payment services but are responsible for their own fulfillment. In most cases these people/companies have only a single location and hence are required to charge sales tax only in one state. There is also a category of sellers who use “Fulfillment by Amazon,” in which they ship the goods to Amazon warehouse(s) and Amazon handles outbound shipments for end-customer orders. I believe but am not that the tax nexus for these sellers includes all the Amazon WH location handling their goods, in addition to their own location or locations.

  7. I have been an Amazon customer since the 90’s when they still mostly a book seller but widening their selection of goods by the day. There are few things I’ve really liked about Amazon that have kept me remaining a loyal customer:

    1. The ability to read customer reviews of goods I’m not familiar with.
    2. They were an early insurer of safe online purchasing.
    3. They have a sterling and well deserved reputation for ensuring customer satisfaction. The ability to return problem items without hassle is a huge selling point.
    4. It’s so convenient to purchase online and have the goods delivered to my door.

    I’m sure returns make a dent in their profits. Twice in the last few years I’ve had to return items, once because what I received was not what I ordered and once because what was supposed to fit my car did not. In both cases I was told (by email) to keep what I had and replacement would be sent. Both items had a retail value of $200 or more. That should give an idea of how expensive it is for them to take an item back.

    What Amazon offers is a online marketplace where customers feel safe shopping. It is destroying the Walmart’s of the world. It will not destroy the Home Depot’s where people buy lumber or bushes or fresh flowers, then pick up all the ancillary things that go with that while they’re there. It will never destroy restaurants. It may never replace grocery stores because the profit margin is small there and fresh foods must be sold immediately. Boutique stores that specialize in selling jackets or shoes or jewelry may survive as well, since they can offer a wide range of a product line from a variety of sellers, especially if they prescreen for quality or uniqueness.

    Personally, I will not miss Sears or similar stores. I always hated shopping there since the cost was high and the selection was limited and generic.

  8. Carl,

    Interesting that Amazon does not have nexus in Illinois. Perhaps they have concentrated facilities in adjacent states with lower sales taxes. Everything I get through Amazon has sales tax, regardless of selling entity. Probably part of the settlement with PA.

    Every online vendor has problems with volume of returns and up to 80% are No Problem Found. And it’s getting worse as the average IQ of purchasers is declining. Amazon can handle it better than anyone else and is using it as a competitive weapon.

    There is no doubt online has plenty of headroom, but not all bricks and mortar will disappear. What will be interesting is to see the characteristics and tenant lists of the malls that shut down.

  9. For years Amazon had a warehouse just over the Wisconsin border and one just over the Indiana border, but last year they finally opened one in Joliet. I believe that also just added one in the city too. I see a sales tax now for all Prime orders.

  10. One thing about shipping costs: they should fall with (a) greater density of residences using the services, and (b) number of packages going to the same resident. If the Fedex or UPS driver needs to go a half mile between dropoffs, then labor costs and fuel costs are going to be higher per unit than if he only needs to go a few hundred feet. If the 3 packages get dropped off at the same location, then the more-or-less constant cost of making the dropoff will be smaller per unit than if only 1 package is going there.

    Of course, there is a point of diminishing returns; not sure how close we are to that on a national basis.

  11. Amazon charges sales tax in Florida. I assume they charge tax when there’s an Amazon warehouse or office in the same State as the customer.

    Amazon competes with specialty retailers such as Zappos by offering free returns on many shoes and clothing items. I’m guessing Amazon makes up the additional return costs by gaining market share, and by making more sales overall as some customers buy more clothing items than they otherwise would and then don’t return as many as they had planned to.

    Costco should be a natural for grocery delivery as they offer much more limited product selection than do most grocery and department stores. However, despite announcing their intent to offer online grocery shopping they have not yet done so. Perhaps online grocery shopping is more difficult to implement than they expected.

  12. As Amazon and other online retailers strive to make their process as simple as possible, most brick&mortar retailers seem to be doing the opposite…long & complex checkout processes, highly-scripted conversations, lame attempts at cross-selling, etc etc.

  13. You should be able to go to the store and optionally pay with your phone to avoid waiting at a checkout register. Stores could have fewer registers but more people to assist with service and selection issues. They should also make returns easier, i.e., for a simple return you click the return button on your phone or on an automated kiosk at the store, and then drop off the item without waiting in line.

  14. Also, the quality of self-check-out systems is generally awful: the one at Giant is like a science fair project by some kid who never got around to finishing it. Wal-Mart and Safeway are somewhat better.

    No matter how good the design, it will always take longer for the customer to check himself out than it would take for a professional checker to do the same IF there are products (produce, etc) which need to be identified. There are probably also things stores could do to further accelerate the checkout-by-employee process….the POS interface for credit cards is often sort of klutzy.

  15. “1. Tax avoidance – in states with high sales taxes (in Chicago it is over 11%!) the shopper is able to avoid the tax by purchasing online. Theoretically there are barriers to doing this but in practical terms this remains a significant advantage of online commerce over physical commerce

    Thank California for changing that after a battle with Amazon.

    I did get a good lesson over Christmas – my mother wanted a stainless-steel kitchen timer. The on line catalog at Williams-Sonoma said that they had one. I go out to the store, a 20 minute drive, wait 10-15 minutes for someone to help me, and they said that they didn’t have it at the store.

    I go home and a few days later decided to try once more – drive back (I am a slow learner, it seems) and still can’t find it.

    W-S is undercutting their pwn brick and mortar stores.

    I order it from amazon or more specifically a 3rd party vendor selling off amazon.

    When you have at your disposal an SQL data base ready to find what you need in a fraction of a second, the convenience of having it shipped, it is hard to beat.

    I keep thinking of what Mike K said about Sears, and the short sightedness of their closing up their catalog rather than putting it on the web before amazon.

    I guess they will be object lessons in business schools in the future, along with the old railroads..

  16. About the middle of last year, we decided to replace the mattress/box spring set on my daughter’s bed, and buy a box spring for mine – we went to a local Sears outlet, as the Sears website seemed to have the best prices on a particular make that we liked and would suit … but alas, it seemed that the on-line store is operated completely independently of the retail store. It was sad, really – we would have liked to have eyeballed the items in question, and ordered direct at the store for local delivery, but no. Couldn’t be done. The saleslady explained, somewhat apologetically, that she couldn’t do that. And we went away, and ordered on-line.
    It was really quite sad. The store itself was practically empty. I think there were more salespeople there than customers.
    It is the same with Best Buy – they could do very well, as a showcase for shoppers to look at the merchandise, either purchase outright if it is popular and there is a stock on hand, or order it for store or home delivery in a day or so. The particular store location could get the credit for the sale … but instead, they seem to all be wishing for the days of buggywhips to come back again.

Comments are closed.