Mark Hawtin and Amanda Lyons
Despite being able to shop at the mere press of a button, online apparel shopping rates are far from rocketing. Digital challenges from stock logistics to selection criteria are restricting pure online sales, while offline growth is actually benefiting from the additional exposure. Mark Hawtin and Amanda Lyons of the GAM Tech Team look at the investment case around online apparel retail.
Online clothes shopping is starting to lose momentum as companies post lower growth rates. Berlin-based Zalando has shifted from revenue growth in excess of 30% in 2015 to under 25% this year, while the Chinese VIP Shop has gone from 55%-98% growth last year to 36% this year. This slowdown can be attributed to a variety of factors, some more concerning for investors than others.
In the US, 14% of apparel retail sales take place online, but growth seems to have stagnated. Sales have only grown by 2% since 2012, despite the increased number of websites and brand presence online. Conversely, the real area of expansion has been web-influenced offline sales, which have grown from 23% in 2007 to 66% in 2016.
Online benefits offline
Consequently, retailers have been investing in their omni-channel experiences (where shopping may start online and have several touch points before being completed in-store). Bernstein estimate that by 2025 there will no longer be a differential between offline and online as the omni-channel experience becomes the norm. For example, the Australian company 'Shoes of Prey' originated online as a design-and-buy site. As the company grew, they saw a huge demand for a physical store as customers wanted to try shoes on before customising and buying - they now have seven bricks-and-mortar shops.
Similar to offline, online apparel is a highly fragmented, competitive market. As many traditional offline players try and move elements of their business online, the space becomes more contested. The online shopper has never had as much choice, and this is only likely to increase.
Retailers have to offer free shipping and expedited delivery to be able to compete in this space effectively, making profitability an ever-increasing challenge. Retailers must understand how to market, advertise and re-target efficiently online (Facebook, Google and Criteo all benefit from this) - a very different skillset to the physical store equivalents.
They must also understand how to manage their logistics to reduce the returns rate (a serious problem in the apparel space as consumers buy multiple items in different colours and sizes with the aim of returning items that do not fit - the home becomes the changing room). If this is not managed efficiently, online can be very costly for a retailer. All of these elements have resulted in low margins as retailers compete for dominance, with no one key player.
The Amazon effect
This is compounded by Amazon investing in the space. While to-date the giant hasn't had a huge amount of success, it is stepping up its efforts. A key issue is curation - there basically isn't any and they seem to rely predominantly on search, which is not effective. They also lack focus, with women's dresses ranging from GBP 0.01 to GBP 14,000. These are real issues, but also not difficult to solve.
Amazon has the advantage of having a superior logistics network to competitors, as well as having a highly engaged consumer base, particularly Prime members. It is only a matter of time before Amazon becomes a major player in this space (remember the days when Amazon only sold books and people laughed at the thought of it expanding into other products). Research by Cowen estimates that Amazon apparel in the US will grow from USD 11bn in 2014 to USD 52bn in 2020.
Cost of the customer
In Europe, Zalando is arguably the largest online apparel retailer but has less than 1% market share. This highlights how fragmented the market is. Although the small market share also provides great opportunity for growth, their recent progress has been a lot more measured than historic numbers. The cost of getting each new customer is increasing as more retailers compete for exposure. Zalando definitely has the advantage of building its own platform and getting traditional bricks-and-mortar retailers, such as TopShop, to use it as their online strategy. However, this is not enough to get back on a faster growth path.
We are seeing a similar problem in China. Both Alibaba and JD now operate in the online apparel space; electronics used to be the largest category for JD, it is now apparel. And while VIP Shop operates in the discount sector, it is still competing for share of apparel spend and has recently expanded into cosmetics. There is also pressure to reach critical mass for China as a whole, which is no small task. All of the Chinese online retailers are increasing their exposure to second-tier cities as they strive for growth - this puts pressure on marketing spend and requires significant investment in logistics and to-date has not boosted top-line growth dramatically.
The tough macro environment is a compounding issue impacting growth for all players within the space. It has been a particularly prominent topic on Chinese companies' earnings calls, and appears to be a greater concern in the region. Online apparel is not as attractive a tech investment as it once was, although select names look set to benefit as industry players clammer to find dominance in the space.