Happy new year and welcome to all the new subscribers! MoneyLemma is kicking off the new year with e-commerce. What would our society look like if (or when) all retail shifts online?
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The US e-commerce penetration rate is about 14% right now. E-commerce penetration is just a disgusting way of saying the percentage of total retail sales that happen online. The business world loves using the word penetration. It’s weird. Most of the corporate lexicon is sexual in nature. A company gets seeded, makes a hard launch, rides, peaks, then eventually gets licked by a well-positioned peer. Gross nomenclature aside, e-commerce penetration was just 10% in 2019. Are we approaching a digital climax (whoops)? Or is this only the start? And why does it matter?
Consumers respond to price and convenience
To answer this, we first need to talk about consumer behavior. A good rule of thumb is that price and convenience explain a majority of customer choices. People want things cheap and easy. Big Macs are microwaved heart attacks made from cows so pumped with hormones they think Axe body spray smells good. They’re also cheap, fast, and the best-selling food in America. Remember when news broke that plastic six-pack rings were clogging landfills, strangling dolphins and assaulting the ozone? And the solution was to…yeah, there was no solution. What, are we going to carry beer cans in a bag and risk shaking them up? The laws of price and convenience don’t always hold, and don’t hold uniformly, but they can be used to broadly understand behavior of the consumer population. It’s human nature. If you think that sounds cynical, consider this: the very technological advancements widely celebrated for bringing about a new-age Utopia could very well be leading us on an inexorable march toward a dystopian hellscape where life consists of a dopamine IV drip, a feeding tube, and false memories implanted by a Facebook algorithm.
Cheaper and easier accelerate e-commerce penetration
Selling online is more profitable than selling offline. Imagine you want to open one of those stores that sell just olive oil. You have to find a lease, buy inventory, file permits with City Hall, and most importantly you have to hope that there are a few thousand people within driving distance that actually want to pay $45 for a bottle of olive oil. There never are and that’s why those places go out of business after six months. On the other hand, you could open your shop online. All you need to do is find a supplier and you could have your store live by the end of the day. You can sell to anyone in the country, have a lower upfront investment, have fewer employees, and pay less in rent. If selling is easier online, then why isn’t e-commerce penetration already 100%? Customers. That is to say, right now customers find online shopping cheaper and more convenience in 14% of cases. That will change. Here is a breakdown of e-commerce penetration by category:
In some categories, e-commerce is dominant. In other categories, e-commerce is barely existent. What should jump out about the lower-penetration categories is that they are tough to sell online. Dollar stores have done really well over the past decade because it’s hard for a website to ship helium balloons and single-use shampoos to individual households. Most car sales happen at dealerships because buying a “mint condition barely driven 2007 Camry” on eBay just screams scam. You might as well leave your card in the ATM machine. Computers, on the other hand, are easier to ship and sold by trusted online retailers. The products are homogeneous, the quality is generally reliable. Buying online is cheap and convenient, and therefore most sales happen online.
Those low-penetration categories aren’t immune from e-commerce forever. New technology, new investments, and new business models are constantly making online buying better. Carvana is guaranteeing vehicle sales so you don’t have to call your Attorney General after you find sawdust in the engine. Wayfair created an augmented reality app to test out your furniture before you buy it. More distribution centers mean faster delivery:
That pace of change isn’t slowing down, it’s accelerating. Better technology and online business models will continue to make online easier, and in doing so shift consumer behavior. Major grocers, for example, are spending billions right now on logistics and tech to make grocery shopping more convenient and cheaper.
The roadmap for the U.S. is clear
The shift to online will continue. In fact, we already know what the near future looks like:
What’s the endgame for e-commerce?
Book sales in the US can give us a clue. Before the internet, book sales were 100% offline. Today, the combination of Amazon and e-books have driven around 70% (and counting) of book sales online. What books are still sold offline? Well, there are a few large chains still standing like Barnes and Noble. They are either shifting online or are Bruce Willis in the Sixth Sense: it’s over and they just haven’t realized. Then there’s mega-retailers like Walmart or Costco that sell a lot of books, but overall books are a small part of what they offer. Customers still go to their stores because they sell everything, not books specifically. Lastly, there are pure brick-and-mortar bookstores that have invented new value propositions for consumers: lectures, personalized recommendations, community activities, etc. These booksellers have subverted the laws of price and convenience by offering products and services that can’t (yet) be digitized.
The broader trend is that, over the past two decades, countless people who swore they’d never buy books online have been wooed by cost savings, swindled by Kindles, and seduced by one day shipping. A fraction of physical booksellers have adapted to remain relevant, but they look vastly different from the 1990s when book sales were dominated by megastores like Borders.
The economy as a whole will follow this trend. Everyday buying online becomes more convenient and cheaper. Billions of dollars are available to any person or company who has a good idea for converting the next wave of offline buyers. The higher-penetrated categories in more digitally advanced countries are already north of 60%. 25 years ago the idea of 60% e-commerce penetration in any category, even something like electronics, would have seemed crazy. Best Buy, Circuit City, Radioshack - these stores owned electronics. Today, 60% actually feels low. Why is anybody buying a phone charger or a printer in a store? There’s no reason why this same dynamic won’t happen in every category of retail. It might take a few decades but ultimately e-commerce penetration will get north of 50% and 80% isn’t out of the question – again, from 14% today.
Why is e-commerce growth such a big deal?
The first 14% of retail sales shifting online has changed our culture, our physical landscape, and our infrastructure. Americans spend hundreds of millions of hours per year shopping, but those hours look completely different than a few decades ago. Department stores and malls are ghost towns. Retail stores that open today are billboards, literally:
“Our retail stores serve as valuable marketing vehicles for introducing new customers to our brand”
-Warby Parker SEC Filing
The way we work has changed. There’s 500,000 delivery truck drivers and over a million people working in distribution centers. Many of those jobs wouldn’t have existed 15 years ago.
More importantly, the second and third-order effects of e-commerce are almost impossible to overstate. Our cities and towns have changed. The types of buildings we construct, the zoning laws, where people choose to live, the way friends and family spend time, all of this has been affected by e-commerce. No one understood this dynamic better than Jane Jacobs, who wrote a hugely influential book on urban design called The Life and Death of American Cities (1961). She argued that thriving communities tend to have physical infrastructure that supports congregation, interaction, activity and diversity. Here’s an excerpt from a Fortune article she wrote:
“Where you find the liveliest downtown you will find one with the basic activities to support two shifts of foot traffic. By night it is just as busy as it is by day. New York’s Fifty-seventh Street is a good example: it works by night because of the apartments and residential hotels nearby; because of Carnegie Hall; because of the music, dance, and drama studios and special motion-picture theaters that have been generated by Carnegie Hall. It works by day because of small office buildings on the street and very large office buildings to the east and west.”
Take a walk down a city block or a town square and look at all the stores: convenience, clothing, sporting goods, sex toys, vintage chotsky boutiques. Think about why those things still exist. What do they offer that can’t be offered online? Will that still be the case in five, ten, or twenty years? Consider that every single one of those businesses is constantly under siege from new, digitally-enabled businesses desperate to poach their customers. It’s not just retail. Service businesses like gyms (Peloton), communities (social media), restaurants (delivery apps), workplaces (Zoom), and basically all commercial-use real estate is under pressure. What physical businesses are viable in a 60% e-commerce world? Does all commercial real estate get turned into condos and Warby Parkers?
In 1997 Jeff Bezos wrote to Amazon investors telling them the internet was in “day 1.” In his final shareholder letter earlier this year he reiterated “it’s still day 1.” Put another way, when 14% e-commerce penetration goes to 60% the way people interact and congregate - our culture - will transform far more than it already has. The e-commerce disruption hasn’t happened; it’s happening.