a16z Podcast - a16z Podcast: Ecommerce and the Holiday Shopping Collision

Episode Date: November 21, 2014

How can ecommerce companies deal with the conflicting expectations of consumers and logistics realities of an on-demand economy? How can they compete with ecommerce giant Amazon, which just gets bigger every year? And given all this, how is physical retail faring? The views expressed here are those of the individual AH Capital Management, L.L.C. (“a16z”) personnel quoted and are not the views of a16z or its affiliates. Certain information contained in here has been obtained from third-party sources, including from portfolio companies of funds managed by a16z. While taken from sources believed to be reliable, a16z has not independently verified such information and makes no representations about the enduring accuracy of the information or its appropriateness for a given situation. This content is provided for informational purposes only, and should not be relied upon as legal, business, investment, or tax advice. You should consult your own advisers as to those matters. References to any securities or digital assets are for illustrative purposes only, and do not constitute an investment recommendation or offer to provide investment advisory services. Furthermore, this content is not directed at nor intended for use by any investors or prospective investors, and may not under any circumstances be relied upon when making a decision to invest in any fund managed by a16z. (An offering to invest in an a16z fund will be made only by the private placement memorandum, subscription agreement, and other relevant documentation of any such fund and should be read in their entirety.) Any investments or portfolio companies mentioned, referred to, or described are not representative of all investments in vehicles managed by a16z, and there can be no assurance that the investments will be profitable or that other investments made in the future will have similar characteristics or results. A list of investments made by funds managed by Andreessen Horowitz (excluding investments and certain publicly traded cryptocurrencies/ digital assets for which the issuer has not provided permission for a16z to disclose publicly) is available at https://a16z.com/investments/. Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Past performance is not indicative of future results. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others. Please see https://a16z.com/disclosures for additional important information.

The content here is for informational purposes only, should not be taken as legal business tax or investment advice or be used to evaluate any investment or security and is not directed at any investors or potential investors in any A16Z fund. For more details, please see A16Z.com slash disclosures. Welcome to the A16Z podcast. I'm Michael Copeland, and this is the e-commerce edition. I know everyone has shopping on their minds. And no better person to talk about this than Jeff Jordan, general partner here at in Dresen Horwitz. Jeff, welcome. Thanks very much, Michael. So I want to dig into this, and you raised this really interesting point, and this observation,

it's been coming for a couple of years now, but especially last holiday shopping season, that, you know, there's the sort of expectations of all of us out there, and then there's the realities, you know, in the logistics kind of sense of meeting those expectations. So describe for us a little bit what you mean, and you describe it. as a collision between expectation and reality. So describe that for us. So it's a high quality problem for e-commerce companies to have. But, you know, first, e-commerce continues to grow and gain share.

So there's more volume being done. At the same time, the Amazonization of e-commerce has increased consumer expectations on, if I order it today, it's here tomorrow. And the real collision came last year on right before Christmas because everyone said, okay, on December 23rd, I can place order and get them on the 24th, and I'm a hero on Christmas. And everyone placed those orders, and it just flat out overwhelmed the carriers. UPS, UPS, they just couldn't handle the flow.

And they, in many cases, you know, failed to get the package there. And, you know, the day after Christmas stories are, you know, failure UPS, failure, e-commerce, failure, or everything. And it was a high, it was a problem that is erupted out of a high, quality issue, which is the share gain. The share tsunami is getting so big that it overwhelmed the infrastructure. Right. So from Hero to Goat, unfortunately, I guess. So how did we get there? I mean, you mentioned Amazon. Is it Amazon's kind of, you know, raising the bar for everyone? Or is there something else in combination with that? Yeah, I mean, I think Amazon is raising the bar for everyone. Yeah, they keep improving the service that they, that is just a core expectation, you know,

free delivery, same-day delivery, free returns, you know, they just keep making their customer support better, and they have to scale to be able to invest behind great customer support. So if you're an e-commerce company, and, you know, it's better service, fast shipping, is getting to be table stakes for more concepts. It was funny, Zooli, which is a flash sales business, does not do immediate shipping. They take like 10 days. And, you know, a number of Wall Street analysts said, that can't work because, you know, the consumer expects it.

In Zooli's case, they're offering such a great value and, you know, and such a great merchandise selection that mom is willing to wait. And if she needs it tomorrow, she knows she shouldn't buy it on Zulili. But it's funny. Everyone else is in the free return, next day shipping and all that. So, I mean, the Zulili example makes me think that as long as you are clear about, you know, setting expectations on your side. And delivering a value prop.

If you're competing directly with Amazon, you know, selling the same goods, but we shipped them a week later and it's not going to work. You need the differentiated value proposition. So, yeah, I want to get into how to compete with Amazon a little bit. But let's remind everyone, for starters, both on the online side, but also in physical retail, the holiday shopping season accounts for what in sort of ballpark terms? You know, for physical retailers, it's close to all their profits. I mean, it's called Black Friday because it's when they,

the retailer went from being in the red to being in the black, you know, turning a profit. So, you know, when I was at the Disney store, I think it was over 40% of sales happened in the fourth quarter. But, you know, but then, you know, given all the fixed costs in retail, you know, that over-delivery of sales just gushes into profit. So it really is where most retailers, particularly anyone who's business improves through gifting, makes all their money. Right. So let's go back to this sort of collision idea. What are both shippers and companies sort of, what are you observing them doing to forestall

kind of those tragedies again this year? I mean, they're trying to get out in front of it. And so there's a story in the newspaper a couple weeks ago about UPS and USPS, proactively going to the companies and saying, how much last day shipping do you want to basically reserve. And by the way, that's all you're going to get. So you have to, and then they're trying to optimize their system to be able to scale and deliver that, which means massive hiring of seasonal workers and things along those lines. But they're trying to, you know, get in front of it such that, you know, that the expectation, you know, if Christmas overall is up 12% online or something like that, that last day could be up 25% or 50% because of the combination of share shift and expectation shift.

And so they're trying to get out in front of it and work with their e-commerce companies to say, don't do it. I mean, when I was at eBay, we were ecstatic if people would order for Christmas by December 10th. Right. Because in our community,

we'd kind of say, okay, we should stop promoting the fact that you can do Christmas gifts two weeks out. And now it's, you know, the companies on the 23rd were saying, we can get it to you. We can get it to you.

It's just a different world. And it's interesting that, you know, in some situations you can, certainly, and everybody and their mother is doing the same thing. If everyone does all their shopping on one day, you'd build your entire supply chain for that massive peak,

and that's just not sustainable. So that gets to a question of forecasting. And do you think, you know, e-commerce companies and physical retailers and sort of the combination that you have enough visibility to really make those calls when UPS comes knocking and says, look, this is all you get?

And USPS, the same thing. Is it that fine-tuned yet? or is there something more information that we could use? You know, there are unknowns. In a couple unknowns is this is going to be a good holiday season or not. The calendar changes. I used to be CFO of the Disney store. And we would have a daily forecast for the holiday.

We also had a pool going who was going to be closest down to every day based on how many days between Thanksgiving and Christmas. You know, prior year weather patterns, you're trying to normalize for blizzards and things like that. So, I mean, there's an enormous amount of effort that goes into it that said that then there's unknowns, like, you know, how many consumers will wait to the last minute this year because they've been conditioned that they can. Right. Do you, I mean, I don't want to put you on the spot, but I will put you on the spot. I mean, given that sort of long experience that you have, do you have any sort of spitey sense for how this shopping season might go? The only spiky sense is the macro spitey sense is that the e-commerce guys are going to have a, you know, a joyous, you know, Christmas with lots, you know, confusing.

continued share gains and continued growth and the mall-based retailers are going to have another tough holiday season. I mean, you look at the macros in physical retail and they're just dismal and gloomy. Yeah, we were talking a little bit about mall-based retailers. I mean, what, you know, what are we actually starting to see when you walk into a mall that are, you know, manifestations of that macro problem? First is vacancies. I mean, you know, there's something like a quarter of malls have over 30 percent of their storefronts vacant. When you, walk into a mall like that, you feel like you've walked into a ghost town. I mean, it's just, they're just dying a slow death. I tweeted, I blogged on this a while back, but my favorite

quote from one of the REITs, the real estate trusts that does retail space was, we're not overbuilt, we're under demolished. And frankly, those 25% of malls just need to go away, and they will go away soon. You know, some are being repurposed into other, other, you know, areas and things like that. I've seen some photo series where this guy goes into basically vacant malls and they're like ghost towns and he takes all these. Deadmoles.com. I think it's a URL. It's eerie

and yet just fascinating. I mean the whole subculture. I mean, they call the storefront that used to have the store sign but now the sign's been taken down because it's out of business. They call it label scars. Oh, God. That sounds like more of a Halloween story. So when you look at

online versus physical, what are some trends that you're seeing, you know, through the, through the entire year, is physical retail responding in some ways that makes sense? Is there a hybrid model that seems to be working for anyone? You know, the buzzword right now is Omni Channel. You know, we have stores and website, and we can, we have advantages in having both of those because you can order online, return to the store, or can order online, pick up in the store is the saying goes. Most, I think most, of that is hyperbole. I think most of the retailers are keeping their store base open, incurring the additional costs of having an online store and they're still not online presence and they're

still not growing. So Omnichannel there means, okay, I'm going to take my cost uncompetitive physical business and layer in additional cost over it and not change, end up with more costs in the same amount of sales. And that just doesn't end well. So you're seeing trends some retailers are embracing reality. I think Staples is right now up to something like 40% online and they're starting to close stores pretty furiously. Because they understand that if you have your store cost base and your online cost base, you're less competitive than a pure play office supply store. So as they're successfully hollowing out the sales in their store through online purchases, they're closing stores. And that is a rational behavior.

very few retailers are doing it at any kind of scale, the scale that they need to do it, to truly kind of leverage their physical presence into a really strong and profitable online presence. And online the trends are, I mean, when you step back and actually look at the overall revenue figures, online is still a relatively small, you know, percentage of overall sales,

and yet it's growing like math. Yeah, it's growing really strongly. And I mean, I think the overall average is something like 8 or 9% of retail in the U.S. now happens online, but a layer below that, things get really interesting. Because that, you know, grocery and personal care, the two largest categories are included in that. And they're largely not online very much, although with Instacart, we hope one of them goes online very quickly. But then you get into what I call the specialty retail categories,

apparel, home, media. They are growing and are sizable. So, you know, some of those categories are already 20, 25%. All of them are in the teens. And so, you know, the size of the total market in most of those categories isn't growing that strongly because the U.S. economy isn't growing that strongly. It's about the same now as it was before the 2008-2009 financial statement. But this portion of the pie that's taken by online has exploded, which means the remaining pie available to the rest of retailers is shrinking. And so you're seeing that to take kids apparel. They're called the 3A's, Abercrombie, American Eagle, and I forget my third A. they're just getting crushed because, you know, teenagers are ordering online maniacally.

And, you know, the amount left for them in malls is just shriveling up. So is the holiday season, even though it accounts for sort of the majority of profits? Is it an anomaly in terms of, like, us rushing out and walking the streets and going to stores? Or does that not even happen as much as we think it does? I mean, it's happening less, you know, less and less, you know, more and more people are shopping online for the holidays. And you're just seeing, you're seeing tangible manifestations. They're talking about traffic declines. Where it really came home to me last Christmas was a Starbucks in their fourth quarter earnings call came in light on the revenue line.

And they blame the fact that their stores in malls experience declining year over year foot traffic. Your people are in the stores. They're just shopping online. Right. So fewer people pounding the pavement for last minute gifts or whatever and guzzling whatever, venti lattes. Yeah. I mean, it's fascinating. you know, you're getting second, third order effects.

Who would have thought, you know, Starbucks is vulnerable to the surge in e-commerce? Let's get to the biggest player in the e-commerce for moment Amazon. You have written and talked in a lot about how to compete with Amazon. Amazon always seems to sort of do something every year to, like, distance itself even further. I don't know if we have seen what that is this holiday season yet, but why is Amazon so good at? And then how do you advise, you know, some of your companies and just retailers in general on how to compete with Amazon? I mean, Amazon is at a scale that it's kind of hard to fathom relative to the rest of the e-commerce world.

I mean, I've done some back-of-the-o envelope calculations that Amazon, if you take their first-party business and their third-party business and normalize it for consumer sales, they represent about $1.5 spent on the Internet. Interestingly, eBay also represents about $1.5 spent on the Internet. They're sellers in aggregate. That means the entire rest of every other e-commerce company and physical company is fighting for that 60%. Amazon's bigger than the next 15 players or some number like that. I put in a blog a little while ago. So they have such scale, and they're just ruthless at leveraging that scale into lower

and lower costs that they translate into better and better customer experience in terms of lower costs as well as, you know, higher quality service, you know, free shipping, overnight shipping, that, you know, they're just brutal to compete with. So, I mean, in that sense, we talked about this collision, is Amazon immune to that at some level, just because their own infrastructure is so resilient and massive for that moment? I think they would like to make themselves more immune to it. I've got a thesis that they will soon be, I think they are already entering the shipping

market, cherry picking, the best. The lowest cost shipments, they are trying to do themselves increasingly and just leave UPS with the higher cost shipments, which is a very rational thing to do. There's cherry pick off. But there are Amazon trucks running around. Amazon fresh now is, you know, those trucks are constantly in the city. I don't think it's a far reach to expect to see, you know, non-grocery goods starting to run around on the Amazon trucks. So you talk about this is interesting. You talk about high-cost sort of shipping addresses versus lower cost, and Amazon is keeping

the lower cost or easier ones for itself. What's the difference? I thought an address was an address. You know, it's all, it's a density play. So if, you know, when you're in a city, a truck can go and within, you know, X blocks, it can, you know, deliver and it's incredible, you know, they're just, you know, the delivery guy is literally walking from door to door to door. You know, you see him in our office complex. He's got, he's got the rolling cart with the pile of boxes, half which are Amazon boxes. Now, you go out into the suburbs or up in the hills or, you know, take it to farming farmlands to get, you know, to deliver, you know, the dairy farmers in Wisconsin, you know, rural Wisconsin's package. You're not going to be anywhere near as efficient.

And what's happening in the overall mix at UPS is it's because of the growth in e-commerce, it's going more and more, it's being skewed more and more towards those more expensive residential deliveries relative to business deliveries. Right. And, you know, They've got concerted efforts to reduce their costs materially in order to maintain their competitiveness in costs as well as their profit margins. And so in this trend toward, you know, same day, same hour delivery, that's just going to get harder and harder to do. Yeah. You know, and their scale advantages to that, too. I mean, I blog UPS is, USPS has, you know, been having, you know, been running a massive loss for many, many, many years.

I mean, for me, the best outcome is either one of two people buys it and basically privatizes it, UPS or Amazon. And so it's, you know, because I think Amazon, you know, if you're one in five retail dollar already and you're gaining share, you know, you can efficiently start thinking about shipping options. Right. And you also will need to help at some moment. Yeah. At some point, you overwhelm everyone else. Yeah. And if you have the ability to do it, you're going to differentiate yourself and they have the scale to have the ability. Wait, but I thought all of this was going to happen by drones. Yeah, it would say, yeah, no, don't get me there. All right, well, so we're not going to see drones delivering holiday gifts. Not this year.

I mean, it's actually, it's a serious effort. And, you know, there were companies well before Amazon's announcement on 60 minutes, you know, running around with the business plan raising money for that very use case. Right. I mean, it's an intriguing use case in the right things. So, I mean, for me, it's not absurd at all. Okay. So let's get back to competing with Amazon. You know, Amazon's got all this scale. We know what they sort of are up against and the advantages they have. Given that, what do you tell companies or, and when you think about it, what are ways to go after them? You just have to, you want to avoid doing what, selling the same merchandise that they sell in some form. So there are a lot of strategies to be able to do that. You know, Zulili and Fab aggregated a long tail of designers who lack national distribution.

Most of the goods they sell are not on Amazon, and if they are on Amazon, they're typically more impulse purchases. They're not the kind of things you search for. For me, Amazon's a search engine. You can build your own product. We have a couple investments, Julep and Walker and Coe, in beauty and personal care for people of color, respectively, where they're building products that they elect not to sell through Amazon because they can control the distribution of their own product.

That avoids head-to-head price comparison. You can go in categories where Amazon isn't particularly strong. In spite of a lot of efforts, they're really strong in hard goods and mass marketed UPC code type things. They're not that good in soft goods. And that's a whole big slice of retail. And then you can do alternative distribution methods, you know, monthly subscriptions, boxes, you know, personalized offerings to people, you know, like Stitch Fix or Trunk Club do. Right, so you get a monthly or weekly or whatever selection of curated things. Yeah, so you're playing convenience, you're playing curation, you know, there's a number

of ways you're doing. But again, you're desperately avoiding, you know, the huge elephant feat that come down if you sell what Amazon sells. Let's shift gears a little bit to payment. We're all waiting to see how now with the iPhone 6 out there, how Apple Pay plays out. first, who does that help from your perspective and how much of a change is it going to be in the retail landscape? I mean, the person it helps is, I mean, it helps a lot of people. It helps Apple, clearly. Apple doesn't do anything that doesn't help Apple. Yeah, they're good for that. It helps

the credit card industry. I mean, basically, for me, this whole innovation is just another form factor for credit cards at this point. You know, at one point, the credit card companies were trying to get you to do these little teeny credit cards that you put on your key chain. And then, they're all different form factors, but this is still a overlay leveraging the entire credit card transactional, you know, the rails they're called. As a result, essentially, it's a small tax on top of what's already a huge tax on payment. So a credit card payment, you know, runs something like two and a half to three percent of, the cost of credit cards, run to two and a half, three percent of sales for different merchants. This will just raise that number because

Apple's now going to take a big on top of what the credit cards already. take. And a lot of people think the merchants pay that. I believe the consumer pays that, just because the merchants pass on those costs for their profit margins. So I think it helps them. But I don't see it as a huge payment innovation. It's a new form factor on top of credit cards. But given Apple scale, are we apt to see actually people using it? Yeah, and that's the interesting thing. It's probably not a huge technology innovation. It's a pretty good exhibit of their business power and the power of their network where banks look at this and goes we we you know apple's doing it it could explode we need to support it so they lined up to support it really quick plus it

reinforces and supports their credit card business so at this point it's not a threat at all and then you know a lot of retailers looked at it and go oh my god if there are all these iPhones and we don't accept it we might lose share so the the respect and almost fear of apple led everyone to say we can't ignore it. We have to support it unless they are working to support a competing standard. Yeah, you know, in my mind, it seems to me one of those things that's for physical retail, right? Like you whip out your phone and then like pay with it. So it may help physical retail is more than online, but it doesn't sound to me like you think it's a big game changer. I mean, it could work. All it's going to do is, you know, continue the move towards

electronic payments, both credit and debit gaining share is a percent of total payments. And I agree with that statement. I think it's much more of a physical retail innovation than an online innovation. That said, I will tell you, I think the credit card is a pretty good customer experience. You know, at physical retail, you take it out of your wallet, you swipe it and you sign something. And you get credit, you get points, you get, you know, all these other things. Taking your phone out, needing to, you know, do your security thing, you know, just, it's not that much better of an experience from my perspective. But, you know, that's, so we'll, but the, the, the, the ultimate test is with the consumer.

Well, Jeff, I want to thank you so much. You know, it sounds like we shouldn't wait till the 23rd to do our shopping, and UPS would be happy. At the 22nd. Do the 22nd. Shop early this year. Shop on the 22nd, yeah.

Well, you heard it then, and that's a wrap for us. Thanks, Jeff. Thanks, Michael. Much appreciate it.