E-Commerce Costs Rise Just as Commercial Real Estate Costs Fall
(Bloomberg) -- As Amazon remains seemingly unstoppable and the struggles of physical retailers like Toys "R" Us continue to make headlines, two trends in retail seem irrefutable: E-commerce will only get bigger, and physical retail needs to figure out how to reinvent itself. But some of the economic pressures facing both industries are changing the value equation. For the first time since the dawn of e-commerce, physical retail might find itself with some cost advantages over e-commerce firms — especially those not named Amazon.
The march of e-commerce has certainly looked inexorable. As a percentage of total retail sales, it matched its all-time high of 9.1 percent in the fourth quarter of 2017, and gained share on a year-over-year basis at its fastest rate ever. At current growth rates e-commerce will be 10 percent of retail sales in 2018, and 15 percent by the middle of next decade.
For consumers, ordering things online is often more convenient, faster and cheaper than buying in stores. But a look at trends in the costs involved in running a physical store versus an e-commerce site throws that "cheaper" part into question. The future of e-commerce might be "more convenient but more expensive," which is a different value proposition entirely.
The biggest shift going on between e-commerce and physical retail is how their "rents" are changing. Physical retail, you may have heard, is struggling, and in many locations vacancy rates are increasing and rents are falling. This is bad news if you own a strip mall but good news if you're a current or prospective physical retailer: If rents are falling, your costs are going down. It makes existing retailers more profitable and creates opportunities for new retailers.
An example of this, as the Wall Street Journal recently reported, is Bleecker Street in Manhattan. As retail vacancies have increased, property values have fallen, allowing opportunistic buyers the chance to come in at a cheaper price and offer cheaper rents.
Wait a minute, you might say, the beauty of e-commerce is that you don't need an expensive storefront in the West Village. You can run your website out of a warehouse in Cincinnati. That may be true, but you still need buyers, and for most e-tailers that means paying for advertising on Google or Facebook. Instead of acquiring your customers via a well-located retail property with high rents, you're buying them via online advertisers. It's essentially the same thing as paying for rent. In the first six months of 2017 alone, ad rates on Facebook are said to have more than doubled. A glance at Facebook's quarterly earnings shows that in North America, user growth has just about flatlined while revenue per user continues to surge, implying that the cost of reaching users is rising at a rapid rate.
The other challenge facing e-commerce firms, which is a broader challenge in the economy right now, is the rising cost of shipping. UPS is adjusting its business model, including raising rates, because shipping to home consumers isn't as efficient as shipping to businesses. Higher shipping costs are plaguing Amazon as well, which is one of the reasons it's raising pricing for Amazon Prime membership by 20 percent in May.
Given these trends, the future of the relative cost advantage between e-commerce and physical retail is looking less clear. For much of physical retail, there's the prospect of falling rents, making running a brick-and-mortar store more viable. For e-commerce, it's a surge in ad rates, or customer acquisition costs, plus shipping bottlenecks that will make "free shipping" more onerous to offer. And profit margins on an e-commerce sale were lower than the profit margin on an equivalent brick and mortar sale to begin with. All of this is happening when e-commerce is only around 10 percent of total retail sales. Presumably, these challenges will be even greater as that share grows.
It's possible e-commerce firms can innovate their way out of their situation. Maybe they find a way to acquire customers more cheaply or more efficiently, maybe by sidestepping Facebook and Google somehow. The shipping situation looks like a harder limit, but maybe someone can figure out a solution there as well (delivery to lockers like Amazon uses is one model for saving on delivery cost).
Regardless, the current trend seems unsustainable. Over the next few years as physical retail looks less daunting, and e-commerce more so, look for a renewed focus on brick and mortar.
©2018 Bloomberg L.P.