Monday, March 6, 2017

AMAZON AND THE FUTURE OF RETAILING


The Bad News and the Really Bad News for Retailers Fighting Amazon.com

Amazon.com’s ability to sustain its retail growth rate will determine the fate of the rest of the retail industry


Even modest growth at Amazon.com could bruise Target Corp. and other big-box retailers.
Even modest growth at Amazon.com could bruise Target Corp. and other big-box retailers. Photo: Alan Diaz/Associated Press
Here is a thought that should make investors in U.S. retailers tremble: Amazon.com could inflict roughly the same amount of cumulative pain on its competitors over the next three years as it did over two decades as a public company.
Revenue for Amazon’s North America segment—the bulk of its retail business—was $79.8 billion in 2016, marking the second consecutive year of 25% growth. Back in 1997, revenue was below $200 million for its U.S. business. If its now massive North America segment continues to grow at 25% a year, it will take only three more years for Amazon to add another $76 billion in annual revenue. That could deliver a swift blow to a U.S. retail industry, already wilting from Amazon’s aggressive expansion.
Investors must ask how big Amazon’s retail business can get. Its North America sales already represented 3% of 2016 U.S. retail sales, excluding car dealers, gasoline stations, stores selling building and garden materials, food-service vendors and bars and well as grocery stores.
That is still considerably smaller than Wal-Mart Stores, but Amazon won’t be able to put all its bricks-and-mortar competitors out of business. Analysts predict the growth rate for Amazon’s North America segment will slow to 16% in 2018 and decelerate in each of the following years.

Created with Highstock 2.1.5Retail ReckoningAmazon's North America segment sales (millions)THE WALL STREET JOURNALSource: the companyFigures for 2017-2019 assume a 25% growth rate. Figures for 1997-2000 represent Amazon's U.S. retail sales.


Retail ReckoningAmazon's North America segment sales (millions)THE WALL STREET JOURNALSource: the companyFigures for 2017-2019 assume a 25% growth rate. Figures for 1997-2000 represent Amazon's U.S. retail sales.

Created with Highstock 2.1.519982000’02’04’06’08’10’12’14’16’18025,00050,00075,000100,000125,000150,000$175,000
Created with Highstock 2.1.519982000’02’04’06’08’10’12’14’16’18025,00050,00075,000100,000125,000150,000$175,000

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Amazon’s shares slumped 22% in 2014 when its North American retail business posted sales growth of only 14% versus the previous year’s 28%. For the rest of retail, however, even modest growth at Amazon could inflict serious pain.
Defending their turf against Amazon already comes at a steep cost. Wal-Mart managed to return to minimal sales growth in fiscal 2016, but operating margins fell to 4.7% from 5% the previous year. Conversely, Target Corp.’s operating margin climbed to 7.2%, but its sales tumbled. Amazon’s own North America operating margins were 3% in 2016.
Target, whose shares fell 12% last Tuesday when it reported fiscal fourth-quarter results, said it will spend $7 billion over the next three years to improve its stores, launch exclusive brands and enhance its digital capabilities while sacrificing $1 billion in potential profit in order to keep prices competitive.
Even when Amazon stops expanding, the damage to industry margins may be irreversible. Online sales come with significantly lower margins, primarily because companies can’t reduce shipping costs by selling more stuff. The willingness of Amazon investors to tolerate low margins has enabled a shift in retail to this high-cost distribution method from having customers visit physical stores.
There are a few retailers that have managed to chart a strategic path away from the Amazon steamroller and their shares should continue to command a premium to peers. For the rest of the industry, Amazon’s growth rate will determine whether things get bad or really bad.