Digital experiences and the ‘Amazon’ effect

Share prices in the US retail sector have declined by around 7% on average since the beginning of May compared with an advance of 1.4% for the S&P 500 (see following table). Some commentators have suggested this is an indication of weakness in the underlying health of the US consumer, which would be particularly worrying for the US economy as personal consumption expenditure (PCE) accounts for close to 70% of GDP.  However, the share-price action is at odds with the latest retail sales data (excluding the volatile auto and gas components), which showed year-on-year growth of 3.5% – in line with the long-term average (see following chart).

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So what is really going on?

We feel fairly confident about the health of the US consumer, as PCE continues to grow at around 3.5% per annum, in line with the post-financial crisis average. However, spending habits are changing, as a result of consumers moving online, and this is impacting the share prices of some, more traditional retailers.  Of particular interest to us are two spaces where consumers’ adoption of digital is impacting profit pools: we call these ‘experiences’ and the ‘Amazon effect’.

Unlocking experiences

Much has been written about the shift in consumer spending, from goods to services. While this is certainly true, it is not a particularly new development, as shown in the following chart. Historically, this shift has been driven by spending on essential services such as healthcare (and healthcare costs continue to increase). However, what’s interesting is that post-crisis, the shift has been driven more by discretionary spending on services such as food, travel and leisure.


Given it started in 2010, well before the lower energy costs dividend, our view is that the shift in consumer spending is more of a structural change in spending habits, enabled by digital adoption. In the digital world, it is easier to find the services and experiences you want and, once found, the digital world delivers them to you more cheaply than was previously possible. Indeed, in some cases there is almost no delivery cost – think Airbnb for accommodation for example.

It is no surprise to us that the start of this trend occurred around the time that smartphone penetration in the US began to accelerate (75% of people in the US own smartphones today compared to 20% at the beginning of 2010) giving us confidence that this trend towards experiences will continue.

The Amazon effect

As we can see from the data, it’s not that consumers aren’t buying things, but an increasing share of their spend is moving online. As the following table shows, around US$12 billion of the US$30 billion growth in retail sales in Q1 2016, is estimated to have come from ecommerce, but in our view, the majority of the retailers have not adjusted their business models to the new reality fast enough.


However, one company that was born online and has thrived ever since is Amazon, which saw a US$7.4bn year-on-year increase in the Gross Merchandise Value (GMV) running through its online market place last quarter. This accounted for 25% of the US$29.5bn overall growth in retail sales (ex autos, gas) and 62% of the growth in e-commerce sales. E-commerce continued to grow robustly, with its share of retail sales increasing to around 11% in Q1 from around 10% a year ago and it can be argued that Amazon has driven the e-commerce evolution in the US.

In many ways, Amazon has accelerated consumers’ transition to online purchasing with initiatives such as Amazon Prime, which has made online purchases virtually frictionless. Even companies that have tried to adjust their business models to the new reality have been caught out by the speed of this transition.

Amazon Prime membership is estimated to have grown at a 50% CAGR (compound annual growth rate) since October 2012 and now stands at 64 million users or around 50% of total US households. There are also secondary effects to this trend; for example, online purchasing means fewer trips to the mall.

The digital world is one of transparency and business models predicated on information asymmetry are in trouble. There is increasing pricing pressure on retailers, as customers enter their stores knowing exactly what they want to purchase and how much it costs. Understanding the customer’s needs and having the speed and flexibility to accommodate these needs is becoming vital to retailers’ existence.

Jeff Bezos, CEO of Amazon put it best when explaining Amazon’s success: “We’ve had three big ideas at Amazon that we’ve stuck with for 18 years, and they’re the reason we’re successful: Put the customer first. Invent. And be patient.”

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.