The End of the Pure Play? - fbicgroup.com Global Retail And... · July 27, 2015 DEBORAH WEINSWIG Executive Director – Head of Global Retail & Technology Fung Business Intelligence

July 27, 2015

D E B O R A H W E I N S W I G E x e c u t i v e D i r e c t o r – H e a d o f G l o b a l R e t a i l & T e c h n o l o g y F u n g B u s i n e s s I n t e l l i g e n c e C e n t r e d e b o r a h w e i n s w i g @ f u n g 1 9 3 7 . c o m N e w Y o r k : 6 4 6 . 8 3 9 . 7 0 1 7

The End of the Pure Play? What Internet Retailers’ Move into

Brick and Mortar Tells Us • We’ve seen a surge in the number of pure plays moving into physical stores, but there are

several caveats: some of these pure plays are more akin to brands, some of the stores are short-‐lived pop-‐ups and others are flagships, few in number.

• A large store network can give retailers—particularly fashion retailers—advantages: it makes it less necessary for retailers to offer free delivery and returns, cutting out some of the cost of doing business online, and the rate of returns tends to be lower among fashion retailers with stores. As a consequence, store-‐based apparel retailers often see higher margins than their

pure play rivals do.

• To gain these advantages, fashion pure plays need to open substantial store networks: a few flagships or a handful of pop-‐ups won’t be enough to drive down the rates of product returns

or slash delivery costs.

• We doubt that we’ll see a wave of mass store openings by pure plays, not least because the

2 Fung Business Intelligence Centre (FBIC) publication: Pure plays move into b&M

Copyright © 2015 The Fung Group, All rights reserved.

July 27, 2015

Big Names Are Opening Stores A slew of Internet-‐only retailers have opened physical shops in recent years, and the trend appears to have accelerated recently. The move into brick and mortar (B&M) is particularly prominent in fashion, as top names in fashion from Europe, Asia and the US have opened stores. Bonobos, Zalando and Simply Be are among the companies that are no longer pure plays in the purest sense.

Here’s a rundown of some of the names that have followed this pattern:

Some commentators have argued that pure plays will need to open stores in the same way that physical stores needed to sell online. We disagree, and we point to three counter-‐indicators:

• Many of the retailers noted above have pushed into B&M with only a limited number of stores or with short-‐term pop-‐ups, whose contribution to the top line is likely to be minimal.

• Big names such as Amazon and ASOS (aside from its short-‐lived Australian pop-‐up store experiment) have been holdouts against the move to physical stores.

US menswear retailer Bonobos plans to operate a total of about 40 stores (or “guideshops,” as the company calls them) in the US by mid-‐2016; as of July 2015, it already has 17 stores in the US. In 2015, the company opened a new, 4,000-‐square-‐foot flagship on Fifth Avenue in New York City.

Young-‐fashion brand ZALORA, from Singapore, moved into B&M with a pop-‐up store at the ION Orchard shopping mall that was open from October 2014 to January 2015. The company opened another pop-‐up at the Bugis+ mall in April 2015.

British fashion pure play Missguided launched a concession in Nordstrom stores in the US in April 2015 and followed that with a pop-‐up store in the Manchester Selfridges in June 2015.

German clothing and footwear retailer Zalando opened its first B&M store, an outlet shop in Berlin, in 2012. The company opened a second outlet shop in Frankfurt in February 2014. The stores sell discounted stock that includes goods that were returned by shoppers.

American fashion rental brand Rent the Runway opened its first store in September 2014, a 1,700-‐square-‐foot New York City flagship, having already trialed shops-‐in-‐shops in upmarket clothing store Henri Bendel and at The Cosmopolitan hotel in Las Vegas in later 2013. As of July 2015, the company has one store in Washington, DC, one in Chicago, and two in New York, as well as the Las Vegas hotel store.

US eyewear brand Warby Parker opened its first physical store, a showroom, in Manhattan’s SoHo neighborhood in April 2013. As of July 2015, the company has four stores in New York, two in Los Angeles, and one each in San Francisco, Miami, Atlanta, Chicago, New Orleans, Boston and Dallas.

Australian footwear brand Shoes of Prey opened within Sydney’s David Jones department store in January 2013 and has since launched in six US Nordstrom stores. It also opened a pop-‐up store in the Westfield Bondi Junction mall near Sydney.

UK plus-‐size fashion fascias Simply Be (for women) and Jacamo (for men) opened a joint flagship store on London’s Oxford Street in September 2014. The brands, owned by catalog group N Brown, had previously sold goods only through paper catalogs and online.

Back in October 2012, British fashion pure play ASOS opened short-‐lived pop-‐up stores in Australia to showcase its country-‐specific range.

And, further back, eBay launched a London pop-‐up in Soho prior to Christmas 2011. The short-‐lived store showcased 350 products tagged with QR codes that consumers could scan in order to view the products on eBay.co.uk.



July 27, 2015

• Finally, not all ventures into B&M prove suitable. British baby products pure play Kiddicare is one name that tried B&M before deciding it wasn’t right for the company. British grocery chain Morrisons acquired Kiddicare in February 2011, when it was an online-‐only retailer, and promptly began opening stores for the brand. After Kiddicare posted a loss for three years, Morrisons sold it in July 2014. Its new owner, restructuring specialist Endless, pulled out of stores to focus on online retailing. Kiddicare retains just one shop, located within its headquarters building, out of its previous total of 10 stores.

In short, it’s far from certain that opening B&M stores is necessary or appropriate for all pure plays, and we think it’s far too simplistic to forecast a wave of mass store openings by pure play retailers.

Are They Really Pure Plays? When is a pure play retailer really a pure play retailer? There’s a case to be made that some of the names listed above are closer to brands than retailers. Bonobos, Warby Parker and Shoes of Prey, for instance, look more akin to brands, so a move into B&M retail is simply a diversification of the distribution network, a move that is to be expected for nascent brands.

It’s no surprise that a number of these brands opted for concessions or shops-‐in-‐shops within department stores as part of their move into physical retail; they’re following the traditional multichannel route adopted by brands from luxury to midmarket.

What Functions Are Stores Serving? What are the attractions of physical space for e-‐commerce retailers? We think they’re several, and that they vary by the type of store opened:

• Pop-‐ups have been opened by many of the pure plays noted above. These stores principally serve a marketing and PR function, drawing media coverage that may help push a particular range (for instance, ASOS’s Australian line) or promote a retailer during a particular period (such as eBay at Christmas). These kinds of stores are much less about selling product than they are about publicity.

• Flagship stores serve a brand-‐building function. Again, the marketing value outweighs the potential sales value, but the marketing here is direct to customers rather than to the media. Retailers such as Simply Be have opened a very limited number of flagship stores that focus on a quality experience in order to build their brands.

• Collection points are another function some physical stores provide. As “buy online, collect in store” (or click-‐and-‐collect) options gain traction, pure plays’ lack of space can start to look like a weakness. But pure plays would need to open a large number of stores in order to serve demand for collection in a comprehensive way—and there are easier ways to offer collection, such as via automated lockers or third-‐party retailers (convenience stores, newsagents and the like).



July 27, 2015

So, it’s not quite accurate to say that pure plays need to open stores to sustain growth. Different retailers are looking for different gains from physical stores, and few of them appear to be opening outlets purely for the cash taken through the till.

Do Pure Plays Need Stores? We think Internet retailers can flourish without a physical presence. Zalando and Zulily are among the names that continue to post storming sales growth without any significant store network. In 2014, Zulily reached annual sales of $1.2 billion, while Zalando posted revenues of €2.2 billion (US$2.9 billion). It’s our view that online-‐only retailers can thrive, and we think these retailers’ performance shows that.

How Are Pure Plays Losing Out? There’s a solid argument that Internet-‐only retailers lose out by not being able to offer some of the marketing and collection functions their store-‐based counterparts can. Pure plays can’t provide a physical, brand-‐building experience, which can negatively affect customers’ value perceptions of them and limit these retailers’ ability to move their positioning beyond price. But are there other inherent disadvantages to being an online pure play?

There’s strong evidence that Internet retailers are less profitable than stores. Data from a handful of leading apparel retailers in the UK suggest that pure plays such as boohoo.com and ASOS see lower operating margins than high-‐street stalwarts such as Next and Primark.

Figure 1. Operating Margins, Selected UK Retailers: 2014

*Marks & Spencer total, which includes its food division; the company does not split out operating profit by division. Source: S&P Capital IQ and FBIC Global Retail & Technology

20.1

17.7 16.9

13.4 11.7

8.5 7.5

4.5

Next Inditex H&M Primark Arcadia Group boohoo.com Marks & Spencer*

ASOS

Percen

t



July 27, 2015

For many pure plays, scale is a disadvantage that can hit margins: Internet-‐only retailers remain the upstarts competing against long-‐standing, large-‐scale chains. But there are other disadvantages that can hit margins, too: • Pure plays tend to see higher rates of product returns than multichannel players do. At ASOS, around 30% of purchases are sent back by shoppers, while at German rival Zalando, the rate has tended to be closer to 50%. For multichannel fashion retailers, return rates tend to be lower, only 15%–20% of online purchases, as we note in our new Quick Take report, Fit for Purpose? Online Fitting Tech and the Boom in Internet Apparel.

• Returns add cost, not just in terms of postage, but also in processing at dedicated centers and loss of stock through returned products that can’t be resold either because they’re out of season or damaged.

• With no option of distributing through physical stores, there’s greater pressure for pure plays to offer free delivery and returns, which heaps extra costs onto their business. Store-‐based retailers have greater freedom to push customers toward in-‐store collection by charging for home delivery (or even charging for click-‐and-‐collect, as John Lewis plans to do for orders under £30).

Figure 2. Standard Delivery Charges, Selected etailers

Marks & Spencer* 3.50

Zara* 3.95

H&M 3.90

Next 3.99

Topshop/Topman* 4.00

ASOS** Free

boohoo.com 3.99

*Free on orders over £50 **On orders over £20 Source: Company reports and FBIC Global Retail & Technology

So, can store networks help limit these costs? Possibly. Giving customers greater opportunities to try on products (which results in fewer returns) and more options to collect and return orders in store could help push operating margins for pure plays closer to those of stores. The big caveat here is that online retailers would need a very substantial network of stores to reach a majority of their customers and so make substantial margin gains.



July 27, 2015

What Are the Alternatives to a Big Store Network? For Collection Given that there’s a major investment required to build a comprehensive store network, are there other options for midmarket Internet retailers seeking to reach a broad consumer base?

Third-‐party collection locations are one possible solution. Amazon Lockers are an established format here, but there are others, too. In the UK, the CollectPlus network allows shoppers to pick up or return purchases from one of thousands of local stores such as newsagents and convenience stores.

In a similar vein, Britain’s Doddle chain is a network of collection-‐only stores focused on high-‐footfall locations such as railway stations. As with CollectPlus, shoppers can opt to collect from Doddle stores when they shop online from a retailer that has signed up for the service.

There’s scope to launch similar services in other markets, in order to deliver real convenience to shoppers. And we think these kinds of services are likely to be far more efficient means of improving collection options than opening a big network of stores will be.

For Brand Building Although it’s convenient, picking up an order from a local newsstand doesn’t build brand loyalty on the part of the customer; it’s simply a functional experience. So, there’s a case for complementing these kinds of collection services with flagship stores in big cities. Glossy flagships can build perceptions of value among customers, helping to reduce price as the defining characteristic of pure play retailers. In a less direct way, then, flagships can play a part in strengthening margins among Internet-‐only retailers, to bring them closer to the levels enjoyed by their store-‐based rivals.

What We Think • We’ve seen a surge in the number of pure plays moving into physical stores, but there are several

caveats: some of these pure plays are more akin to brands, some of the stores are short-‐lived pop-‐ups and others are flagships, few in number.

• A large store network can give retailers—particularly fashion retailers—advantages: it makes it less necessary for retailers to offer free delivery and returns, cutting out some of the cost of doing business online, and the rate of returns tends to be lower among fashion retailers with stores. As a consequence, store-‐based apparel retailers often see higher margins than their pure play rivals do.

• To gain these advantages, fashion pure plays need to open substantial store networks: a few flagships or a handful of pop-‐ups won’t be enough to drive down the rates of product returns or slash delivery costs.

• We doubt that we’ll see a wave of mass store openings by pure plays, not least because the investment necessary to yield major gains would be huge. So, despite typically lower margins, it’s clear that pure plays can thrive without stores.



July 27, 2015

Deborah Weinswig, CPA Executive Director—Head of Global Retail & Technology Fung Business Intelligence Centre New York: 917.655.6790 Hong Kong: +852 6119 1779 [email protected] Cam Bolden [email protected] Sunny Chan [email protected] Tal Dor [email protected] Marie Driscoll, CFA [email protected] John Harmon, CFA [email protected] Aragorn Ho [email protected] John Mercer [email protected] Charlie Poon [email protected] Kiril Popov [email protected] Stephanie Reilly [email protected] Lan Rosengard [email protected] Jing Wang [email protected]

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The End of the Pure Play? - fbicgroup.com Global Retail And... · July 27, 2015 DEBORAH WEINSWIG Executive Director – Head of Global Retail & Technology Fung Business Intelligence