Insights: Temple & Webster and The Reality of eCommerce
The Lesson From Amazon Prime
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eCommerce is a competitive space, as online homeware and furniture retailer Temple & Webster's recent results have shown. But what is the long term lesson we should take away from the result?
“Insights” articles apply learnings from Venture Journeys to larger businesses. Learn about the capital intensity required to grow in eCommerce and the genesis of the Amazon Prime strategy.
For investors with only a few minutes to spare, here’s what you need to know about the capital intensity of building a competitive advantage in eCommerce*:
In their recent results, Temple & Webster’s reduction in active customers came as a surprise to investors, given how early they are in their growth journey.
There is a certain mystique surrounding technology businesses and their potential. But eCommerce businesses are simply the online version of the distributor business model. As the middlemen between suppliers and customers, their competitive advantage depends on how firmly they control access to these participants.
In the online space, Google and Facebook (Meta) control access to customers. As a result, eCommerce businesses face barriers to scale from price competition and rising customer acquisition costs.
This is why the most successful eCommerce businesses are marketplaces benefitting from network effects. Marketplace participants do the heavy lifting on customer acquisition and retention for these companies.
Building marketplaces requires upfront investment and time. As Amazon has shown, Temple & Webster needs to build the customer base and supply chain to attract large numbers of 3rd party merchants to their platform.
Scaling in eCommerce is not a capital-light endeavour. Investors need to consider this in their analysis and valuations.
* All opinions are personal. This is not investment advice.
The Reality of eCommerce
"Online homeware and furniture retailer Temple & Webster had $164 million slashed from its sharemarket capitalisation after it revealed the number of active customers using the site dropped by 11 per cent and group sales fell 7 per cent in the first five weeks of trading this year."
Simon Evans, Senior Reporter at The Australian Financial Review
Macroeconomic factors notwithstanding, Temple & Webster’s (TPW) loss of customers came as a surprise, given the early stage of their growth. As I outlined in my article on eCommerce last year, eCommerce companies are at the mercy of Google and Facebook.
There is a certain mystery about technology businesses. eCommerce can be a great customer experience. It should be a bigger part of the furniture and homeware industry, particularly in Australia, which lags behind the US and UK in online penetration. This is why results like this can be jarring to investors.
It’s best to keep things simple and think of eCommerce as the online version of the age-old distributor business model.
How Access Defines the Value of Distributors
Consumer markets broadly consist of 3 parts- Suppliers, Distributors and Consumers. eCommerce companies like TPW are distributors. They are the link between manufacturers and consumers. Their value and competitive advantage are based on access.
Take newspapers, the primary way news was distributed before the internet. The large fixed costs of the printing press and physical distribution made newspapers a virtual monopoly in a given city. A newspaper controlled consumers’ access to news, which gave it pricing power.
“When Charlie and I were young, the newspaper business was as easy a way to make huge returns as existed in America… No paper in a one-paper city, however bad the product or however inept the management, could avoid gushing profits… Typically, rates for both advertisers and readers would be raised annually – and the profits rolled in. ”
Warren Buffet, quoted from the Berkshire Hathaway 2006 Annual Letter
Distributors that don’t control access tend to be price takers, often reliant on macroeconomic or industry cycles. Commercial insurance brokers, which are distributors of commercial insurance policies between insurers and commercial businesses, are good examples.
“In accordance with market commentary of commercial lines premium rate reductions of up to 30%, premium income performance has been reflective of this environment with gross written premium on a same client / same policy basis reducing by 10.8% over the period… Accordingly, AUB anticipates its Adjusted NPAT to be in the range of $12.0 to $12.5m (down 17.8% to 14.4%..).”
Ausbrokers Market Update, January 2015
Most eCommerce companies are price takers because they don’t control access to the consumer. Google and Facebook do.
The Gatekeepers of the Internet and What It Takes to Succeed
The internet has changed the dynamics of competition for distributors in 2 major ways. First, it’s easier to set up an online store compared to a physical one. Second, and more importantly, it has created 2 global giants that firmly control access to customers online.
Google and Facebook dominate Search and Social respectively, the 2 largest sources of eCommerce traffic.
Google and Facebook (Meta) dominate Search and Social. Source: Statcounter and DataReportal
Google and Facebook extract an enormous amount of value through their auction-based pricing models. eCommerce companies are bidding against themselves.
https://twitter.com/jayvas/status/1296438514138177536
You can see this from the results of listed eCommerce companies shown in the chart below. Over the 4 years (FY18 - FY22), the revenue of these companies grew 32% per year while disclosed customer acquisition costs grew 44% per year.
Disclosed customer acquisition costs - TPW: Customer service, advertising and marketing KGN: Marketing, ABY: Marketing and Advertising, Wayfair: Customer Service and Advertising. Source: Company documents
So how can eCommerce companies succeed? It’s telling who the largest players globally are.
Global e-retailer market share 2021. Source: Statista
Leading players like Alibaba, Amazon and JD.com have marketplaces that benefit from network effects. The beauty of marketplaces is customers do much of the heavy lifting, which helps them scale sustainability. Unlike normal eCommerce businesses, scale works for them, not against.
While they are strong business models, they require capital to build.
Building Competitive Advantage
To have a competitive advantage online, companies need to provide customers with something Google and Facebook cannot. Amazon wrote the playbook here - build expensive offline supply chain infrastructure, and get someone else to help them pay for it. Free 2-day shipping was the genesis of the Amazon Prime program.
“I want to draw a moat around our best customers… I’m going to change the psychology of people not looking at the pennies differences between buying on Amazon versus buying somewhere else.”
Jeff Bezos on launching Amazon Prime 2-day shipping in 2004
Amazon started out as a pure e-commerce bookseller. But as we discussed, eCommerce is competitive. Jeff knew they couldn’t sustain their early advantage without some way to lock in their customers.
Prime locked in their best customers by charging them $79 upfront. In exchange, subscribers would get free 2-day shipping instead of the usual charge of $9.48 per order.
The genius behind Prime was it attracted new customers with its 2-day delivery and incentivised retention as subscribers would need multiple purchases to recoup their membership fee.
Amazon Prime exerts control over access to customers
Of course, building and maintaining the supply chain infrastructure for this service was expensive. So in 2006, Amazon launched Fulfillment by Amazon which allowed 3rd party merchants to use Amazon for storing and shipping their goods for a fee.
“That allowed merchants to qualify their goods for Prime two-day shipping and helped Amazon greatly expand the catalogue of goods available to Prime members. It was, and is, a huge competitive advantage.”
Julie Todaro, former Amazon Director of Finance
Amazon Prime exerts control over access to customers and suppliers
The issue with Amazon’s strategy was the upfront cost and time it took before they benefitted from the network effects of their marketplace. Building a competitive advantage and scaling in eCommerce is not a capital-light endeavour. Investors need to take this into account in their analysis.
Temple & Webster’s CEO, Mark Coulter, alluded to this when talking about Amazon’s success in an interview with the Australian Financial Review.
“In online, bigger is better… The bigger online retailers can keep investing.”
Mark Coulter, Temple & Webster CEO as quoted in the Australian Financial Review.
Venture Journeys articles are provided for informational purposes only and should not be construed as investment, business, legal or tax advice. Please do your own research or consult advisors on these areas.