30 Jun 2017
“Amazon Web Services launched an Australian region in 2012, we launched a Kindle Store on Amazon.com.au in 2013, and we now have almost 1,000 employees in the country. The next step is to bring a retail offering to Australia, and we are making those plans now.”
These brief words in an Amazon press release from 20 April 2017 wiped $2 billion off the value of ASX listed Australian retailers in the following month. It also put an end to months of speculation about Amazons potential entry - which had already weighed heavily on retailing share prices. So what exactly is Amazon and is this the death knell for Australian retailers?
In this research insight we take a look at the rise of Amazon globally, its impact globally, its potential impact to domestic retailers and how they can combat Amazon’s entry into the Australian market. We also identify one Australian retail company that we believe is well positioned to weather the Amazon storm.
What is Amazon?
Amazon is the 7th largest retailer in the US, and the 12th largest in the world with revenue of over US$140billion. Moreover it dominates the e-commerce landscape, accounting for almost 40% of total online retail sales in the USA.
Amazon revenue US$bn
Amazon US Share Online Retail
Source: Amazon, US Census, Macquarie Group Limited
While impressive in itself these statistics don’t capture the weight Amazon carries in the world of retailing. Amazon’s market disruption is unique. In its relatively short 23 year history, it has evolved from an online book store, to an “everything store” – selling a mind boggling 480 million products across consumer electronics, clothes, cosmetics and groceries to name a few. Interestingly, some argue that Amazon is more of a technology company than a retailer given the array of hardware products it manufactures including the Kindle e-reader and Fire tablet, as well as the impressive automation it uses throughout its supply chain.
The key to Amazon’s success is its overwhelming focus on the customer - with a goal to be “Earths most consumer centric company”. In fact, profits appear to be a secondary objective in the short-term with the business operating on razor thin margins - and seemingly willing to lose money on products at times to ensure it remains competitive.
Amazon continually innovates and adapts to make shopping easier for customers. Amazon Prime is perhaps its most successful offer, where for an annual membership fee customers get unlimited free 2 day delivery, irrespective of order size. This removes shipping costs as a consideration in the purchase decision, which is a major obstacle for “off-line” shoppers. Illustrative of this success, Amazon now has an incredible 80 million Prime members in the US – each of which spends on average double that of non-Prime Amazon customers.
Amazon’s impact internationally
Amazon disrupts traditional retail business models in a number of ways. Firstly, it causes incumbent retailers sales growth to slow or decline, as Amazon steals volume share. Secondly, Amazon’s focus on low prices often forces incumbents to reduce their prices, which acts as a compounding negative force on the sales line. This action also squeezes gross profits – or the amount of profit a retailer earns on each item sold. The third blow comes in the form of increased costs, as existing retailers are forced to invest in their store service and fitout to keep customers engaged. At the same time retailers often need to invest in their online offering, including free shipping, to try and neutralise Amazon’s advantage.
Amazon’s impact in Australia
We believe that in order to rationally evaluate the likely impact in Australia, its critical to employ a structured and objective framework. In particular we consider the Amazon impact by answering the following questions.
1. What is the online penetration of retail sales?
Amazon is an online retail offer. For it to capture a sale, the customer has to be willing to shop online. Internet penetration, internet speed, logistics, delivery infrastructure, existing retail offerings and cultural differences will all influence how much share Amazon gains. In Australia 5% of retail sales are already online. We expect this online market to double by 2025, but this still represents the upper limit of Amazons potential market.
eCommerce share of retail sales
Source: eMarketer Inc, Citi Research, MQG
2. What is Amazon’s share of online?
Amazon’s success at capturing online share has varied significantly by market - as illustrated below. While the Amazon offer appears to be compelling on the surface, online competition varies by market. Interestingly in Australia, eBay has a particularly strong position with over 20% share of online sales. This will act as an obstacle for Amazon. Nevertheless, by comparing and contrasting its success overseas, including the time taken, we believe Amazon will gain 16% share of Australian online retail sales by 2025.
Amazon share of eCommerce retail sales
Source: Practival e.Com, eMarketer, BOAML estimates, Citi estimate, MQG
3. What is Amazon’s sales mix?
Amazon has extended from books into a huge number of product categories. However its success in each has varied. It has been particularly successful in consumer electronics, in part due to the relative comparability of products, high value of items and small package size making transportation simple and cost effective. We estimate that the consumer electronics category represents 30% of Amazons sales. By contrast, furniture has been more difficult for Amazon, partly due to the bulkiness of items for shipping.
4. Can incumbent companies defend themselves?
It is important to consider each company’s relative position, and its individual ability to compete with Amazon. A key learning from offshore markets is that whilst Amazon’s entry has been detrimental to the retailer on average, this is not true for all companies. Some companies have continued to prosper, while others have gone out of business. This is evident in the consumer electronics category in the US and the UK, per the charts below.
US Electricals market share
UK Electricals market share
Source: Company reports, US census, MQG
Are there opportunities in the Australian retail landscape?
Amazon’s entry into markets around the world has had a significant impact on the profitability of incumbent retailers. Using the US as an example retailer margins have fallen, and with it the profitability and share prices of incumbent US retailers.
Given the international experience, it is somewhat understandable that Australian investors have seemingly chosen the path of least resistance and sold retail stocks.
Share Price Change – 1 month from Amazon entry into Australia announcement (19 April 2017)
However as fundamental investors, we see this kind of reaction as a potential opportunity. With a rational framework like the one outlined above, we can assess the impact of Amazon and try to identify strong retail companies’ that have been oversold as a result of market sentiment.
One opportunity we have identified is Super Retail Group (owner of Rebel Sport, Super Cheap Auto and BCF), which we believe is well positioned to combat the arrival of Amazon through its:
- Category exposure: with its leisure categories proving more resilient than many in offshore markets
- Strong brand franchise: with each of its retail banners being the leader in their categories
- Engaged customer base: reinforced by its large loyalty program
- Integrated online and in-store offering (Omni Channel): with informative and easy to use websites, click and collect, or delivery capabilities.
- In-store experience: With new store formats designed to add excitement and increase the service offering
- Brand and private label combination. Offering the latest products, as well as a value range – and increasing the uniqueness of its range
- Relatively efficient supply chain: with amongst other things a new nationally optimised warehouse network
Super Retail will inevitably need to continue to invest in these areas to combat the arrival of Amazon in the Australian market. However, we believe it has a number of levers to defend earnings – and following the recent sell off, we believe Super Retail has the opportunity to beat expectations over the medium term.
Is Amazon the end of retail as we know it? Following the $2bn fall for ASX listed Australian retailers following the announcement that Amazon is bringing its retail offering to the Australian market it seems many believe this is the case. However, looking at the impact of Amazon entering international markets, we believe it is clear that Amazon will disrupt Australia’s retail market, however:
- strong Australian retailers will be able to combat the arrival of Amazon through brand, investing in Omni Channel and enticing store experiences and optimising their store footprint; and
- there are opportunities in the retail market for those that can identify strong retail businesses that have been oversold on market sentiment
In our view, Super Retail Group represent one of these potential opportunities and it remains a key holding in the Macquarie High Conviction Fund.