Date
17 October 2017
Technology has enabled Amazon to establish direct relationships with its customers, build an online marketplace offering hundreds of millions of goods and guarantee two-day delivery on millions of the items. Photo: Reuters
Technology has enabled Amazon to establish direct relationships with its customers, build an online marketplace offering hundreds of millions of goods and guarantee two-day delivery on millions of the items. Photo: Reuters

New ways to make the consumer connection

Disintermediation of the value chain and personalization of products and services will change everything about the customer’s experience of buying. This will fundamentally alter what it takes to be profitable in the consumer sector and influence the types of companies investors should consider.

Amazon is king of the hill now. When it comes to selling standardized goods out of centralized distribution centers, we would argue that no one — not even Wal-Mart — offers greater choice and convenience at lower cost, which are by far the primary reasons that shoppers go online.

Growing from an online bookseller to the largest supplier of cloud services, Amazon has captured market share across a vast array of products and services that consumers are now looking to buy online. This is especially remarkable in the everchanging retail landscape, where yesterday’s prince has become today’s pauper — think Sears.

What could challenge Amazon’s dominance? In an industry characterized by constantly shifting consumer preferences, we see rapidly evolving technology amplifying three forces that are likely to determine tomorrow’s leaders: disintermediation, personalization and customer experience. In our view, other firms will be able to challenge Amazon’s leadership position if they are as good or better at anticipating the future state and adapting their business models to master these trends.

Disintermediating the value chain

The consumer value chain has conventionally been broken down into product branding/intellectual property, manufacturing, logistics and retailing. Technology has allowed many firms to consolidate these multiple functions into their businesses, creating advantages over traditional models.

For instance, technology has enabled Amazon to establish direct relationships with its customers, build an online marketplace offering hundreds of millions of goods and guarantee two-day delivery on millions of these items. The company has invested large amounts of capital to internalize many logistics functions typically provided by third parties. Amazon has done this at a scale whereby the company can deliver goods to customers with shorter shipping windows and at a lower cost versus the competition. To date, companies with more traditional models have lost share to Amazon, as they have had difficulty combining new technologies with existing bricks-and-mortar assets.

Brands have been able to partially disintermediate Amazon and the traditional consumer value chain by using technology to interact directly with customers, rather than depending on market research or retailers for consumer feedback. Owned e-commerce sites and social media, for example, have let brands get feedback from current or potential customers. Learning about what consumers really want can streamline product development and inventory management, avoiding the potential miscues derived from the limited sampling and longer lead times of traditional market research approaches. Through such connections, decision-making can be more effective, helping brands stay relevant in their fast-moving end-markets.

Looking ahead, in an extreme but plausible disintermediation scenario, a producer could merely supply raw materials or blueprints to a customer. From these inputs, the consumer would create a customized end-product using technologies like three-dimensional (3D) printing or computer numerical control (CNC) cutting machines. In this case, traditional intermediaries in the value chain would be completely eliminated.

Personalizing products

As long as Amazon’s value proposition depends on wide selection, low price and fast delivery of mass-produced goods, we think personalization may prove to be an area where competitors can make inroads. Again with technology facilitating the link between brands and consumers, firms could engage with market segments as small as one individual.

Digital connectivity enables two-way information sharing so that products can be customized to meet the explicit tastes of consumers — think of Nike and Converse inspiring buyers to design their own unique footwear, L’Oréal blending makeup to match a particular skin tone, Modern Tailor or Proper Cloth making a custom shirt to measure.

Brands offering this degree of personalization may be able to differentiate themselves from the mass-selling business model and build deeper emotional bonds with consumers. And we are already seeing advances in manufacturing technology helping to ring in an era of mass personalization and local production, as more versatile automated factory equipment can accelerate retooling and make small batch sizes economically viable.

Enhancing the customer experience

Owners of intellectual property also have the potential to leverage their brand equity by exercising more control over the sales process and creating a better buying experience. Through e-commerce data analytics, brand websites can track browsing activity to learn what interests shoppers, then suggest related products and extend discounts to tempt reluctant buyers. When a desired item is out of stock, this can be an opportunity for upselling to a more expensive alternative, rather than losing the sale to a competitor.

Brands can add value through product education and services offered both before and after purchases, such as free shipping and returns. But for brands to outperform aggregators on experience outside of personalized products, they have to provide brand-specific opportunities — for example, early access to new releases, exclusive invitations to events and interactions with brand ambassadors.

When the exchange of information between buyers and sellers is viewed as mutually beneficial, the direct-to-customer model allows brands to be more responsive, enabling them to maintain a deeper knowledge of their markets. This trend creates space for niche players to defend or expand market share against low-cost competitors by connecting and resonating with their customers, building even more brand equity in the process.

Positioning to fend off competitive challenges

For the time being, Amazon is still the dominant force in retail, taking a 36 percent share within e-commerce, which accounted for 11.5 percent of retail excluding food service, autos and gas in 2016. But even with Amazon’s supremacy, we have found opportunities as global investors in select luxury and mass affluent brands, like athletic footwear, which have been able to defend their franchises through customer loyalty and their reputations for quality.

We are also interested in categories that are more immune from the current challenges posed by Amazon, such as home improvement, convenience stores and restaurants.

Going forward, we are looking to invest in companies with strong brands that can offer personalized and unique customer products and experiences, while controlling manufacturing and delivering those products directly to consumers.

– Contact us at [email protected]

RC

The writers are analysts at State Street Global Advisor

EJI Weekly Newsletter

Please click here to unsubscribe