Monday, December 5, 2016

Lesson #251: U.S. Ecommerce Companies, Beware The Looming Overseas Guillotine

Posted By: George Deeb - 12/05/2016

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As many of you know, Red Rocket has been looking for an ecommerce business to buy over the last few months.  We have been doing due diligence on over 50 ecommerce companies during this time, and what an eye opening experience it has been.  My overall conclusion is: U.S. based ecommerce companies are going to see a lot of headwind in the coming years, and you better figure out how to defend yourself before the looming overseas guillotine falls.  Here are the details of what I have learned.

PHASE 1:  A QUICK HISTORY, ONLINE RETAILERS KILL OFFLINE RETAILERS

To put this topic into perspective, first a quick history on ecommerce.  After the first wave of ecommerce companies hit the market in the late 1990's, it was clearly only a matter of time before the offline brick and mortar retailers would succomb to death's grip.  Gone go Blockbuster, Borders, Circuit City, CompUSA, Linens N Things and Sports Authority, just to name a few.  Unless the retailers made quick pivots to the ecommerce channel, there was no way they could effectively compete with their huge investments in real estate, inventory and payroll, like a noose around their neck.

And, these trends still continue today.  Don't think for one minute the big chains like Wal-Mart aren't also worried about their long term future.  Why else would Wal-Mart make such a large $3.3 billion acquisition of Jet.com after only one year of launch?  To get them more formidably repositioned as a leading "ecommerce-first" company.  Especially since Jet.com was able to generate over $1BN in revenue run rate after only one year of being in business, with a lowest-price messaging, a title most covetedly held by Wal-Mart over the years.

PHASE 2:  AMAZON REDEFINES ECOMMERCE MERCHANDISING

Amazon quickly learned that there was a lot more product for sale than could possible be designed and managed by one company.  At the end of the day, they realized their core strength was marketing to a huge base of consumers and doing warehousing and distribution in mass.  So, what better to do that open up their website platform to millions of product sellers, both large and small, to basically become a "one-stop shop" for anything and everything on the web.  And, what a move that turned out to be; today, it is estimated that 40-50% of all consumer product searches on the internet now begin at Amazon.com, not Google.com.

PHASE 3:  U.S. BRANDS START TO KILL U.S. ONLINE RETAILERS

With that level of marketing and fulfillment power on Amazon.com, millions of "Amazon Only Sellers" were born in the last few years.  Now, an ecommerce startup no longer needs expensive investments in people, systems, warehouses or marketing; they simply need to design a product (typically manufactured by an overseas partner), get the product over to an Amazon warehouse, let Amazon do their magic, and sit back and collect checks for doing hardly any work.  Literally, two kids in a garage figure out best selling products on Amazon to knock off, from freely available Amazon sales data sources, and they generate $2-$4MM in revenues ($500K-$1MM in profits) in a year or two after launching.

And, that doesn't even talk about about the big national brands selling through national retailers and ecommerce sites today.  Amazon and other big online shopping platforms have embolded them into thinking they can sell products themselves, disintermediating the wholesalers and retailers they have typically relied on for sales.  And, as the product company, now they can undercut the retail price, make materially higher margins than they were before and really turn the screws on the online retailers, who are now starting to see their sales decline with this sales channel shift.

PHASE 4:  OVERSEAS MANUFACTURERS START TO KILL U.S. BRANDS

When I read this article at Internet Retailer (click through all four pages), it pretty much scared the crap out of anyone looking at investing in the ecommerce space.  What it basically said is: with a "customer first mindset" (translated: a desire to get consumers the lowest prices possible), Amazon is romancing Chinese manufacturers to start directly selling on Amazon.com in the U.S.

Why does that matter?  Remember all those U.S. brands and "Amazon Only Sellers"?  Where do you think they are sourcing manufacturers for all their products?  Most of them from China!!  So, what does that mean?  If the Chinese manufacturers start selling direct on Amazon, at the same wholesale prices they are selling to their typical U.S. brand customers, they are going to force the U.S. brands to compete with them at basically a zero percent profit margin!!  Said another way:  that was the sound of the U.S. brands' necks snapping with the fall of the guillotine.

WHAT THIS MEANS FOR YOU

For all of you ecommerce lovers, like me, sorry to sound like the grim reaper here.  But, you better get ahead of this trend, and fast!!  How do you defend yourselves here?  They are many ways:
  • Create more "brand cache" (e.g., pants from Gucci and Levi's cost the same to make)
  • Don't sell commodity products, where price is the only differentiator
  • Focus more on consumer services or consumer entertainment, as harder to replicate
  • Add value-added upsells (e.g, make your money on the popcorn, not the movie)
  • Acquire some of your vendors or manufacturers, to vertically integrate with
  • Joint venture with international manufacturers as their exclusive U.S. marketing partner

So, before investing heavily in the ecommerce space, do your homework!  Make sure the business you are in, or are considering to be in, is not a sitting duck, already starting to feel the stranglehold of your vendors starting to sell direct (e.g., see if they are already selling against you on their own websites or on Amazon).  And, if you decide to move forward, do so with a long term defense plan in place, like the ones listed above.

Each generation of selling products, tries to do it better and more cost effectively than the generation before it.  Unfortunately, for most low-price-driven U.S. consumers, that means disintermediating the U.S. middlemen in what has become a global ecosystem.  Be careful what you ask for (e.g., low prices).  It may just put the entire U.S. retail, ecommerce and brand businesses, out of business for good, with a huge impact to the U.S. economy and the resulting jobs lost. All, but for Amazon, of course . . .  the last-standing fox in the hen house.

For future posts, please follow me on Twitter at: @georgedeeb.





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