How bricks can save clicks

The future of e-commerce may come to a local mall near you.

Online furniture seller Wayfair,

W -8.08%

which experienced a decline in active customers last year, puts new hopes in the physical world: It plans to open three physical stores in Massachusetts this year. In a earnings call on Feb. 24, Wayfair CEO Niraj Shah said the stores will be “valuable avenues for discovery, visualization and marketing.”

The adjustment for Wayfair – and a number of other online sellers – is due in part to a slowdown in e-commerce from the first months of the pandemic. The online share of U.S. retail sales peaked at 15.7% in the second quarter of 2020, falling to 12.9% in the fourth quarter last year, according to the U.S. Census Bureau. Meanwhile, shoppers are hitting the malls again: As of March, pedestrian traffic in indoor malls had increased by 16.6% from a year earlier, according to Placer.ai.

These declining growth prospects lost about $ 80 billion in total market value from online pet store Chewy,

Wayfair and online craft marketplace Etsy since their respective peaks. That’s about four times the total value of the department store’s skilled Macy’s,

Nordstrom and Kohl’s.

E-commerce vendors have other challenges to overcome. It is becoming more expensive to lure new online customers in as advertising costs rise and organic search visits for shopping fall. Google’s organic search visits to retail and consumer goods sites fell 14% in the fourth quarter of 2021 compared to a year earlier, while travel search visits have increased 41%, according to marketing agency Merkle.

This puts pressure on retailers to spend more to ensure that their ads appear to consumers. Facebook’s parent company Meta Platforms said that the average price per ad increased 30% year over year in its first quarter.

Chewy faces these obstacles. In fiscal year 2019, it spent about $ 148 in sales and advertising expenses per year. net new customer. By 2021, that number had risen to $ 424 per share. net new customer and is expected to reach $ 505 in 2022, based on consensus estimates from Visible Alpha.

The so-called customer acquisition cost looks less daunting if one excludes the cost of “retention” marketing for existing customers and takes into account the gross inflow of new customers, not the net figure. But even after taking in those nuances, the big picture remains the same: Chewy’s acquisition costs were around $ 120 per customer in 2021, a 44% increase over 2019, according to estimates by Seth Basham, equities analyst at Wedbush Securities.

“The cost of acquiring customers has become quite high online because e-commerce has already selected the customers who are most likely to shop online,” said Mr. Basham. “There is the natural limit.”

Compare that to Petco,

a pet store that generates the majority of its revenue in its stores. Petco spent about $ 170 in advertising per year. net new customer in 2019, but that number dropped to $ 64 per. net new customer in 2020 and then to $ 60 last year. Petco said in its recent investor day presentation that because of its store footprint, it is able to offer same day delivery that is cheaper and faster compared to pure e-commerce. It is in the process of remodeling its stores to develop practical services such as veterinary care and care services that cannot be provided online.

There are far more examples of physical retailers adding e-commerce than vice versa. But the broad track record for profitability is not great for e-commerce, as variable expenses such as shipping costs and processing returns can increase rapidly. As online penetration of retail sales more than tripled between 2012 and the first three quarters of 2021, profits were halved on the basis of earnings before interest, tax, depreciation and amortization, according to an AlixPartners survey of listed retailers with an annual turnover of over 1 USD billion.

Because online retailers have already attracted a lot of online shoppers, stores could serve to attract a different type of customer. As Bank of America analyst Lorraine Hutchinson puts it, “a lot of different people walk past stores.”

If the intention is to acquire new customers, these stores must of course be located in first-class retail corridors, which is not cheap. Still, while the cost of online advertising has risen, retail rents have fallen. In e.g. New York City fell rental prices on premium retail corridors by an average of 11% in the first quarter compared to a year earlier, according to data from Jones Lang LaSalle.

Some direct-to-consumer brands that started as online sellers continue to add physical stores, citing better profitability. Spectacle brand Warby Parker plans to open 40 new stores this year, while shoe manufacturer Allbirds plans 16 to 17 new locations. Although neither company is profitable on an entire corporate basis, both have indicated that margins are strong in their stores. For example, Ms Hutchinson noted in a November 2021 report that Allbird’s physical stores have earnings before interest, taxes, depreciation and amortization or Ebitda margins of 20% to 25%. Warby Parker has said it is on track to reach its targeted 35% Ebitda margin for its stores.

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When the company opens a new store, the geographic market sees revenue growth of over 250% on average in the first year of the store debut, Warby Parker CEO Dave Gilboa said at the company’s last earnings call in March. This is in line with what Macy’s has found: Adrian Mitchell, Macy’s CFO, has previously said that digital performance is stronger in markets where the company has stores. The department store giant has delayed most of the remaining store closures it had earmarked in 2019 to maintain a physical presence in many markets.

The success of online retailers in the physical world may depend in part on how much of consumers’ wallets they are already capturing. After all, small brands directly to the consumer have plenty of room for growth – whether it is online or through stores.

To Amazon,

which already has high market shares, the entry into the brick-and-mortar retail trade has not made the big dent. Revenue in its physical stores – which includes bookstores as well as grocers such as Whole Foods and Amazon Fresh – fell last year compared to 2018.

In any case, the physical stores serve a greater function for Amazon: They are also avenues through which Amazon tests new services – such as “just walk out” technology – that the company can license out to third-party retailers. Its new clothing store, scheduled to open in California – Amazon Style – will use technology that allows customers to add items to the fitting room through an app.

Moving from a variable cost-based business to one that adds fixed costs will obviously add various forms of pressure. It could involve more capital expenditures so that capital gains can suffer in the short term, notes Mr Basham, who also says that operational challenges could be more significant in physical retail. Given that many physical retailers are experiencing persistent depressed valuations, they may enter into multiple partnerships, business associations or other forms of bonding such as real estate deals with online players in the coming years.

In short, retail is becoming much less divisible. Some of the most successful resellers will be those who understand how to bridge between bricks and clicks.

Write to Jinjoo Lee at jinjoo.lee@wsj.com

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