The future of e-commerce could come to a mall near you.
Wayfair Online Furniture Seller,
which saw a drop in the number of active customers last year, places new hopes in this physical world: it plans to open three physical stores in Massachusetts this year. In an earnings call on Feb. 24, Wayfair chief executive Niraj Shah said the stores would be “valuable avenues for discovery, visualization and marketing.”
The adjustment for Wayfair – and a number of other online sellers – is due in part to a slowdown in e-commerce since the early months of the pandemic. The online share of US retail sales peaked at 15.7% in the second quarter of 2020, falling to 12.9% in the fourth quarter of last year, according to the US Census Bureau. Meanwhile, shoppers are heading to malls again: In March, foot traffic in indoor malls was up 16.6% from a year earlier, according to Placer.ai.
These slow growth prospects have caused online pet retailer Chewy to lose an estimated $80 billion in combined market value.,
Wayfair and Etsy’s online craft marketplace from their respective heights. That’s about four times the combined value of Macy’s department store mainstays,
Nordstrom and Kohls.
E-merchants have other challenges to overcome. It is becoming increasingly expensive to attract new customers online as advertising costs rise and organic search visits for purchases decline. Google’s organic search visits to retail and consumer goods sites fell 14% in Q4 2021 from a year earlier, while travel search visits increased 41% , according to marketing agency Merkle.
This puts pressure on retailers to spend more to ensure their ads appear in front of consumers. Facebook parent company Meta Platforms said the average price per ad rose 30% year over year in its first quarter.
Chewy faces these obstacles. In fiscal 2019, it spent approximately $148 in sales and advertising costs per net new customer. By 2021, that number had jumped to $424 per net new customer, and by 2022 it’s expected to hit $505, based on consensus estimates polled by Visible Alpha.
The so-called customer acquisition cost looks less daunting if you exclude “retention” marketing expenses for existing customers and consider gross additions of new customers, not net numbers. But even after factoring in those nuances, the big picture remains the same: Chewy acquisition costs were around $120 per customer in 2021, a 44% increase from 2019, according to estimates by Seth Basham, equity analyst at Wedbush Securities.
“The cost of customer acquisition has become quite high online because e-commerce has already selected the customers most likely to shop online,” Basham said. “There is this natural limit.”
Compare that with Petco,
an animal retailer who generates most of his turnover in his stores. Petco spent about $170 on advertising per net new customer in 2019, but that figure fell to $64 per net new customer in 2020 and then to $60 last year. Petco said in its recent Investor Day presentation that because of its in-store footprint, it is able to offer same-day delivery which is cheaper and faster compared to pure e-commerce. It is remodeling its stores to expand convenient services such as veterinary care and grooming services, which cannot be provided online.
There are many more examples of brick-and-mortar retailers adding e-commerce than the reverse. But the track record for profitability isn’t great for e-commerce, as variable expenses like shipping and processing returns can quickly add up. While retailers’ online sales penetration more than tripled between 2012 and the first three quarters of 2021, margins based on earnings before interest, taxes, depreciation and amortization shrank by half, according to research by AlixPartners on publicly traded retailers with annual revenues exceeding $1 billion.
Since online retailers have already attracted many online shoppers, stores could serve to attract a different type of customer. As Bank of America analyst Lorraine Hutchinson puts it, “many different people walk past stores.”
Of course, if the intention is to acquire new customers, these stores will need to be located in prime retail corridors, which is not cheap. Yet, as online advertising costs have risen, retail rents have fallen. In New York, for example, asking rents in key retail corridors fell an average of 11% in the first quarter from a year earlier, according to data from Jones Lang LaSalle..
Some direct-to-consumer brands that started out as online sellers have continued to add physical stores, citing better profitability. Eyewear brand Warby Parker plans to open 40 new stores this year, while shoemaker Allbirds plans 16 to 17 new locations. Although neither company is profitable on an overall basis, both reported strong margins at their stores. Ms. Hutchinson, for example, noted in a November 2021 report that physical Allbirds stores have earnings before interest, taxes, depreciation and amortization, or Ebitda, margins of 20% to 25%. Warby Parker said it was on track to meet its 35% Ebitda margin target for its stores.
When the company opens a new store, that geographic market sees revenue growth of more than 250% on average in the store’s first year of launch, Warby Parker co-chief executive Dave Gilboa said during the the company’s last earnings call in March. This echoes what Macy’s found: Macy’s CFO Adrian Mitchell previously said digital performance was stronger in markets where the company has stores. The department store giant delayed most of the remaining store closures it had planned in 2019 to maintain a physical presence in many markets.
The success of online retailers in the physical world may, in part, depend on how much of the consumer wallet they already capture. After all, small, direct-to-consumer brands have plenty of room for growth, whether online or in stores.
which already has a high market share, the foray into bricks-and-mortar retailing hasn’t done much. Revenue from its brick-and-mortar stores, which include bookstores, as well as grocers such as Whole Foods and Amazon Fresh, fell last year from 2018.
In any case, for Amazon, physical stores serve a broader function: they are also ways in which Amazon tests new services, such as “just out” technology, which the company can license to retailers. third. Its new clothing store slated to open in California, Amazon Style, will use technology that allows customers to add items to the fitting room through an app.
Going from a business based on variable costs to one that adds fixed costs will of course add different kinds of pressures. This could involve more capital expenditure, so capital returns could suffer in the short term, notes Mr. Basham, who also says operational challenges could be greater in brick-and-mortar retail. Since many brick-and-mortar retailers are experiencing persistently depressed valuations, they could enter into more partnerships, business combinations or other types of tie-ups such as real estate deals with online players in the coming years.
In short, retail is about to become much less bifurcated. Some of the most successful merchants will be those who understand how to connect the worlds of bricks and clicks.
Write to Jinjoo Lee at [email protected]
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