Growing with Amazon
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Amazon has steadily become a retail giant, with a sales and distribution network few companies can match and revenue that is projected to continue growing. However, while Amazon’s impressive growth represents potential challenges for traditional retailers, it offers additional distribution alternatives for brands and vendors. RSM US LLP director, consumer products industry, former industry analyst Jeffrey B. Edelman, evaluates Amazon’s market dominance, and potential opportunities for retailers, vendors and global brands.
Amazon–the big market share gainer: The question is how big and how fast? Wall Street analysts estimate Amazon will displace Macy’s as the No. 1 U.S. apparel retailer by 2017. The combination of broad selection, competitive prices, increasing brand relationships and superior fulfillment represent a formidable competitor; all of which are expected to drive Amazon’s growth and market share.
To put Amazon’s position into perspective, its North American sales this year are expected to exceed $70 million, similar to Target and about one-quarter the size of Wal-Mart. Amazon’s 2015 sales are expected to increase around 30 percent compared with flat-to-up slightly for the others, reaching nearly a 6.5 percent market share compared with 5.0 percent in 2014.
The U.S. apparel and accessories market is forecasted to increase around 2.5 percent annually over the next five years, or $42 billion, to approximately $372 billion. Cowen and Company estimates Amazon’s apparel and accessory sales could increase $36 billion to $52 billion over this period, potentially accounting for 85 percent of industry growth and achieving a 14 percent market share. Off-price and fast fashion retailer sales are projected to increase around $10 billion, raising the question of what happens to everyone else. That is, assuming these estimates are correct.
Challenging the traditional distribution system: Amazon’s strategy includes self-distribution of its owned merchandise from an expanding warehouse network, as would a typical online retailer. These are classified as first-party transactions and represent the biggest challenge to the bricks and mortar retailers. The majority of these goods are the more commoditized products consumers can purchase from multiple companies, stores and websites. In this instance, both price and convenience are the main drivers to the purchase, representing the biggest challenge to commodity retailers such as Target and Wal-Mart, and a key driver of Amazon’s market share growth. It is also quickly becoming an important wholesale customer to the consumer products manufacturers.
Amazon also provides an additional channel, besides outlet malls, for retailers to sell nonexclusive and excess products in a controlled environment. It is believed Amazon can purchase on a more advantageous scale than other retailers; however, it bears the cost of markdowns and clearance, generally with no return policy to vendors.
Third-party transactions are those listed on the Amazon website, purchased through Amazon but shipped to the customer by the vendor. However, selection generally varies by brand. In these situations, pricing is set by the brand and Amazon collects a seller’s fee.
Retailers, rather than vendors, have been the largest market share donors to Amazon, particularly those selling low-to-moderate price commodity merchandise. Cowen estimates Amazon grew its market share around 160 basis points last year to 5.6 percent. By way of comparison, the 12 largest sellers (including Amazon and eBay) increased 170 basis points to 51.6 percent.
Vendors, on the other hand, appear to have the most opportunity to benefit from Amazon’s growth potential, whether it represents a first or third-party transaction.
Bricks and mortar have opportunity to grow market share: Comments by a number of retail managements have noted their ability to coexist and even grow despite the impressive growth Amazon has generated. Omnichannel efforts have been instrumental in achieving their success, catering to a more mobile-focused customer.
First of all, their own websites can often be more informative and offer better product descriptions than that of a third-party seller. An increasing number of consumers have opted to order online and pick up in the store rather than waiting for delivery. A more important factor though is ease of return and selection of another product or size. Best Buy recently noted 40 percent of its online purchases were picked up at a store. Macy’s said its net transaction was larger after a return or exchange, benefiting from the increase in foot traffic.
Pricing is always a big factor in determining where to purchase as many online sellers often have a lower price than a retailer's website. Nevertheless, service, availability and selection are generally more important to a consumer, particularly as most retailers will price match. Nordstrom has long been known for its price stability and lack of discounting; however, recent tours of its stores revealed an increased number of “price matched” signs.
The hidden cost to increased online business through Amazon as a third party or self-distribution is handling returns, similar to its own sales. Consumers have wised up to how easy it is to order several sizes in order to determine the best fit. Others are increasingly ordering multiple products, often returning many or all of them. Costs of handling returns continue to grow, in many cases offsetting the potential profit. Some retailers, such as Bloomingdales and Saks prefer returns to be handled by associates on the sales floor, hopefully leading to a higher transaction value. On the negative side, customer service is impaired, as well as potential sales.
Other retailers, such as Home Depot and Target only accept returns at their customer service counters, a practice Neiman Marcus recently established.
Benefits and risks for vendors and global brands partnering with Amazon: The biggest benefit for brands is an increased channel of distribution, including international, and Amazon’s ability to engage with consumers and fulfill orders fast. Given Amazon’s rapid growth potential, it could potentially become one of a brand’s largest customers; lower margin revenues could potentially offset return costs. A relationship with Amazon also offers an opportunity to move clearance merchandise at an advantageous price.
The third-party seller alternative could represent additional risk factors, as Amazon has the ability to set prices, at times below those of other retailers. This would especially be true for merchandise acquired by liquidators or diverters that likely have a lower-cost basis and just want to clear their inventory. Additionally, these sellers, through Amazon, often do not charge local sales tax, which is a benefit over buying direct from Amazon.
Free shipping and benefits from Amazon Prime were once key drivers to its site; however, free shipping is more often becoming the norm and less of a selling point for Amazon.
Distribution represents ongoing change: The business model will likely be affected, negatively impacting those that resist adapting to the “new world.” It will not be business as usual. One cannot do the same thing they did yesterday as that will be the fastest way down the slippery slope.
Rather, change represents an opportunity for those looking to think outside the box and reinvent themselves to cater to tomorrow’s consumer and competition.
Jeffrey B. Edelman is director of consumer products industry services for RSM US LLP, and is located in the firm's New York office. He routinely advises senior management of companies operating in the consumer and retail sectors on strategic, sourcing, financial, marketing and distribution issues. He also works closely with internal teams on matters such as new business development, transactional advisory, including due diligence and tax. Jeff can be reached at +1 212 372 1225, or via email at email@example.com.