Why adapting to e-commerce is crucial for brick and mortar shops

March 08, 2019 16:50
Online now comprises about 7 percent of Home Depot’s sales and is the fastest-growing part of the business. Photo: Reuters

To find hidden gems in the retail sector, investors need to be selective. While an attractive offer is critical, other factors like headroom for space growth, good control over brands and distribution, and the ability to adapt well to e-commerce are becoming more important.

E-commerce is becoming an increasingly important channel for retailers and comprises 10 to 20 percent of retail sales in most developed markets.

One of the key elements that determine whether a retailer can benefit from e-commerce is if it owns the key brands it sells. Multi-brand distribution formats like department stores or even specialty sportswear formats tend to be more at risk from e-commerce, as the brands they distribute can go directly through those e-commerce channels. Hence, e-commerce often becomes cannibalistic.

The key is to ensure that e-commerce can be done in a way that is neutral or incremental to returns, and that it integrates well with the brick and mortar store base.

An important part of the strategy is that retailers must be able to offer click-and-collect and effectively handle returns both online and through the stores.

Players with off-line stores have an advantage over pure online players in that the in-store pickup option encourages repeat business, adding opportunities for customers to interact with staff.

To do this, inventory systems must be integrated between offline and online stores, which has been a challenge for a number of retailers.

In apparel, Inditex and Nike have made the transition well, generating a meaningful percentage of faster growing sales online, and at margins which are at least the same as, if not better than offline.

Although less threatened by e-commerce, a good example of a company that is adapting well to it is Home Depot, a major American home supplies store.

The predominance of big, bulky products which often require technical knowledge has enabled the home improvement market to withstand the disruption that e-commerce has posed for retailers.

Even so, Home Depot formulated its own online strategy, developing a strong consumer interface and integrated fulfillment capability. Online now comprises about 7 percent of sales and is the fastest-growing part of the business (at 20 percent plus) – with around half of the online orders picked up at the store.

We have a strong preference for companies that own brands, as opposed to those that distribute brands.

However, TJX, the leading player in discounted retail in the United States, is a notable exception as a distributor of other brands. Its consumer proposition is compelling as it offers attractive brands at significant discounts, as retailers need to clear excess inventory.

TJX achieves this through its leading store network, strong merchandising capabilities, and relationships with a diverse merchant base.

Buying scale is a crucial factor, and TJX has an unparalleled lead versus the competition, with two and a half times the purchasing scale of the number two player Ross Stores, and nearly seven times that of the number three player Burlington.

This scale allows TJX to pay a larger amount upfront to its suppliers (i.e., the retailers), thereby attaining access to higher-quality inventory.

TJX also competes effectively in an online world since brands prefer that discounted products not be sold nationally online. So, TJX faces less direct online competition. Rather, TJX’s near 3,000-strong store base in the US allows brands to distribute off-price products without damaging brand image or creating channel conflicts.

While the retail space is littered with names that have fallen by the wayside, we see great potential from physical stores for the right franchises as the market changes.

Companies with a strong brand and product lineup are providing their customers with the opportunity to see, try out and discuss the products with well-trained sales people and are amenable to how the customer chooses to buy or return, whether in-store or online.

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Portfolio Manager, Vontobel Asset Management