Is logistics the future of retail?

On a recent flight to Beijing for a China technology, media and telecommunications conference, I read The Everything Store by Brad Stone, a book on Amazon’s early history and its transformation from an online bookstore into the retail behemoth it is now. As I read, a thought occurred to me: is retail the future of retail, or is logistics the future of retail? This thought was further reinforced at the conference, where one of the two key themes was e-commerce logistics (the other being online education).

Since the advent of money, retailing has been about buying things for one price and selling them for a higher price. Sam Walton revolutionised retailing when he opened his first Walmart store in 1962, and for half a century, successful retailing entailed the leveraging of scale to generate slightly more sales using the same selling space at slightly less cost, coupled with rapid geographical expansion to achieve said scale. However, over the last two years, the traditional retail model has been turned on its head by Amazon and the everything store.

The thing that struck me most while reading The Everything Store was just how early Jeff Bezos formulated that vision. We often think of Amazon as an online bookseller that expanded into other retail categories over time. The reality is that Amazon was the everything store from Day 1, but Bezos had to choose one category to start with, which happened to be books. The importance of this distinction cannot be stressed enough – from Day 1, Bezos was solving a logistics problem, not a retailing problem. For traditional retailers, the problem was how to get customers into their stores, and how to sell at a higher gross margin; for Amazon, the problem was how to get the long tail of goods to customers.

This begs the question – if “the everything store” concept has been around for two decades, why has the seismic shift in the retail industry only occurred over the last two years, and what does the future hold for traditional retailers? Two important concepts may help us answer this question (or at least tackle the question with more mental flexibility).

Firstly, the internet, particularly the mobile internet, has enabled the elimination of friction. We see this in search, social, payments, entertainment, and now retail. Typical sources of friction associated with e-commerce are delivery fees, waiting times, returns and payments. Amazon eliminated or mitigated these frictions through innovations such as 1-Click ordering, 2-day free shipping, free returns, and the Fulfilment By Amazon (“FBA”) program. Importantly, these solutions didn’t pop up overnight – Amazon spent two decades investing in its logistics capabilities to ensure that Prime and FBA could deliver what was promised to consumers and merchants.

In my opinion, once Amazon eliminated these frictions of online retailing, the biggest friction of traditional retailing was laid bare for all to see – that is, the friction of physically going to a store to buy things. Until the e-commerce frictions were eliminated, this was a non-issue because consumers had no choice – if they wanted to buy something without paying delivery fees for the privilege of waiting a week for it to arrive, they had to go to a store. If one retailer didn’t carry the item, the consumer had to go to another retailer, or go home empty handed. Brick-and-mortar retailers as a group monopolised supply, and that allowed them as a group to maintain positive comparable sales growth and attractive margins.

But now, Amazon has created a sufficiently frictionless logistics network (from the customer’s perspective) to provide an almost infinite selection of items to the customer. Working out how to turn a selection of 50,000 or 100,000 SKUs consistently is a retailing problem; offering a catalogue of hundreds of millions of items, many with same-day or two-day delivery, is a logistics problem. And solving this logistical problem has led to a fundamental shift in retailing – the aggregation of demand.

This second concept is what Ben Thompson of Stratechery calls “aggregation theory”, which in the retailing context describes how retailers integrate up or down the value chain to maximise value to themselves. It is very difficult for a traditional retailer to aggregate consumers (integrating down the chain) – it can grow its store base to increase geographic penetration, but it doesn’t have the logistics infrastructure to be ubiquitous to the consumer. The limitations on selection associated with operating physical stores also mean the consumer relationship is necessarily spread across numerous retailers. The best that traditional retailers can do is integrate with suppliers and monopolise supply.

Amazon, on the other hand, does have the logistics infrastructure to reach consumers wherever they are, and is on a path to monopolising demand. The aggregation of consumers is much more valuable than the aggregation of supply, because it ultimately allows Amazon’s ecosystem – the platform and the logistics – to become the infrastructure upon which retail trade is conducted. As much as suppliers and brands may resist, they will ultimately go where the consumers are, as Nike has recently shown. Bezos’ foresight to go all-in on FBA at a time when it was an unproven concept was perhaps the catalyst for this retail revolution, because it elevated logistics to the most important aspect of retail, and perhaps threatens to disintermediate retailers altogether by enabling suppliers and brands to serve customers directly over Amazon’s logistics infrastructure.

Traditional retailers are over-invested in “old” retail, characterised by “getting customers to come to us”, and under-invested in logistics, or “getting our goods to the customer”. It won’t be enough for these retailers to invest in e-commerce and omni-channel capabilities, because they lack the underlying logistics infrastructure and selection required to aggregate demand. Not only would shipping costs pressure margins, online sales would also cannibalise in-store sales. Aside from perhaps Walmart, no other retailer has sufficient scale to justify investing in their own logistics infrastructure. This means that over the long term, retailers without compelling private labels or exclusive distribution agreements with sought-after brands will become share and margin donors to Amazon and the logistics service providers.

From this logistics perspective, it is easy to see why Amazon’s acquisition of Whole Foods Market is a fundamental threat to the incumbent grocers. For Bezos and Amazon, grocery is a solvable logistics problem. Not only does Whole Foods give Amazon a premium grocery brand, it also gives Amazon a network of 460 distribution points from which to tackle its logistics problem. The incumbent grocers, on the other hand, face a nigh-unsolvable retailing problem – that is, invest in grocery e-commerce and risk cannibalising their stores and margins with no guarantee of success (or survival), or ignore e-commerce and hope that Amazon can’t solve its problem. Either way, it is likely that the shakeout of the traditional retail industry is still in its early innings.

Montaka owns shares in (Nasdaq: AMZN)

DH5_2155Daniel Wu is a Research Analyst with Montaka Global Investments. To learn more about Montaka, please call +612 7202 0100.

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