Corporate Research 27 November 2017
Contents
Retail apocalypse: The growth of e-commerce 1
Time is running out for retailers to go digital 2
Retail trade: A historical perspective 5
Interview: Investors have legitimate concerns 8
Online race will go on, retailers need to respond 12
Interview: Ready for any e-commerce scenario 25
Spotlight: Primark – refusing to go online 29
Interview: Convenience is key for online growth 32
Spotlight: Zalando – Euro no. 1 in online fashion 38
Interview: Retail is all about the experience 40
Retail property: Reinventing itself 46
Interview: Going for convenience and community 50
Disclaimer and legal disclosures
Nordea Markets and Nordea Corporate & Investment Banking Corporate Research 27 November 2017
Retail apocalypse: The growth of e-commerce
Online retail is taking off, shifting from price to convenience E-commerce has grown since its beginnings in the 1990s, with growth accelerating in the past few years, making online account for 10% of Nordic retail sales in 2016 – almost on par with the US. A competitive price was critical in the early years as a differentiator versus physical stores, but now convenience has taken over as the key driver for consumers to go online. Innovation and investments in technology and logistics are making click-based browsing, buying, paying and quick delivery easier and more accessible. We have yet to come across a retail industry participant who does not believe in strong continued growth in e-commerce.
Help, I run physical stores! What should I do? Many retail industry players believe omni-channel will be the successful future concept: following all the channels that customers go through. The customer can browse the market online, check or try products in physical stores or showrooms, then choose to buy from the shelf or take home delivery. We believe online, offline and omni concepts can all succeed, but it is high time for incumbent retailers to decide on a future model they believe is viable. As much as brick-and-mortar retailers may hesitate investing in digital platforms at the expense of today's more profitable offline business (still typically 95% of their business), they have to ensure that they remain relevant in a future likely to be much more biased towards consumption via mobile devices.
How to make sure shopping centres are not emptied in the digital age Retail property owners also need to consider how to prepare for digital disruption. Their job is to attract visitors to the centres where their retailer tenants have stores, which is tougher if customers are increasingly able to shop more easily with their phones. Shopping centres need to offer a richer experience than just shopping, with more entertainment and services and a strategic location to drive visitor traffic. We believe non-weather protected shopping centres reachable only by car and offering little other than shopping will be most at risk of being half-full.
Views from the experts: Interviews with retailers, shopping centre owners and Nordea analysts Mia Brunell Livfors, CEO of Axel Johnson Group, and Johan Ryding, CEO of Sportamore, share their views on how continued growth in e-commerce will affect retailers. Lars-Åke Tollemark, Managing Director Nordics at Unibail- Rodamco, and Citycon's CEO Marcel Kokkeel and CFO Eero Sihvonen describe their respective strategies for continuing to lure customers to their shopping centres as the e-commerce share of retail sales grows. Retail analysts Stefan Stjernholm and Stellan Hellström from Nordea Equity Research argue that equity investors have some legitimate concerns over the modest inroads into e-commerce that most Nordic incumbent retailers have made so far.
Nordea Markets and Nordea Corporate & Investment Banking 1 Corporate Research 27 November 2017
Time is running out for retailers to go digital
As an introduction to this month's Nordea On Your Mind, we ask Nordea's Global Co-Head of Corporate & Investment Banking Mathias Leijon about the meteoric rise of e-commerce, what it means for incumbent Nordic retailers, and how investors' view of the outlook may differ from that of the industry players.
JT: E-commerce has grown very fast since its inception some 20 years ago, and is capturing a growing share of retail sales. How do you expect the retail industry to change, and how do you think incumbent retailers with their roots in physical stores should respond?
ML: My 72-year-old father-in-law has started buying tyres and spare parts online, which has been quite an eye opener for me, highlighting how quickly things that were unthinkable five years ago have become the new normal. In the US, retailing accounts for one out of nine jobs, and the online sales trend has only just started. Some 8.5% of global retail spending is now online, and penetration will typically accelerate once it passes 10%. I think we are likely to see far more closures of retail stores in the US this year than we did at the low point of the global financial crisis in 2008.
Retail shops used to compete by offering a combination of selection, price, service and convenience. E-commerce's most obvious edge is in selection and convenience, essentially helping us save time – which is an increasingly scarce resource these days. On top of this, online retailers are able to collect ample data about our shopping behaviour, far in excess of what any shopping assistant in a store can muster. This data can potentially be used to make customised individual offers to consumers.
E-commerce share of total retail sales turnover in the US, Nordics and Europe, 2011-16 12%
10%
8%
6%
4%
2%
0% 2011 2012 2013 2014 2015 2016 US Nordics Europe
Source: Source: Eurostat, PostNord and US Census Bureau
I think it is only a matter of time until Competition from online retailers is typically oriented around logistics and all major cities in Europe have business processes, where we are seeing the fastest pace of innovation. I same-day delivery, and potentially think it is only a matter of time until all major cities in Europe have same- also return-on-demand, for goods day delivery, and potentially also return-on-demand, for goods purchased purchased online online. I guess it doesn't help that Amazon has conditioned consumers to think delivery should be free. Similar to how metadata aggregators like Booking.com and TripAdvisor have revolutionised the travel industry, I expect the retail industry to be transformed both by new, innovative e- tailers like Ocado, Asos, Amazon and Zalando, and by low-cost, offline retailers like Primark of the UK. The ones left in the middle will struggle, if not disappear.
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I think omni-channel retailers – those selling in all online and offline forums the customers go to – might potentially become the new norm. Recent evidence of this is Amazon's acquisition of Whole Foods in the US, but the jury is still out on this. Even though change is accelerating, many brick-and-mortar retailers have a great starting position and could still have an important role to play, but time is running out to adjust business models. In addition, an omni-channel strategy raises complexity in a very challenging transition period, which pressures retailers' returns and cash flow. The pure online players have adopted a strategy of growth ahead of returns, meaning the entire profit pool for the industry is pressured. Some equity analysts claim that a one percentage point increase in the online penetration of retail sales shaves 50 basis points off retailers' margins. How retailers communicate with their shareholders and what long-term support they can mobilise will be important.
JT: Is digital disruption of retailing mainly in the form of price pressure from increased transparency?
ML: I think the common perception that Amazon and Zalando compete on price is simply wrong. They reduce friction in shopping online with same- day delivery (requiring huge network investments), free shipping, financing, and goods "always" in store. Given that online shopping provides a superior customer experience at the same time as saving customers a lot of time, it is difficult not to expect that total current retail floor space will decline in the future. The three big listed US department store groups have seen severe declines in their market caps over the past two years, suggesting that investors expect returns to come under severe pressure. This will have consequences for their whole value chains, including real estate owners.
As seen in the graphs below online retailers are sacrificing short-term returns for future ones. Despite offline retailers still showing a high ROCE and margins, they will have to be courageous enough to do the same as online players: sacrifice short-term returns for more sustainable long-term ones.
ROCE of online retailers EBIT margins of online retailers 40% 10% 30% 5% 20% 0% 10% -5% 0% -10% -10% -15% -20% -20% -30% -25% -40% -30% -50% -35% -60% -40%
Source: FactSet Source: FactSet
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ROCE of offline retailers EBIT margins of offline retailers 35% 14% 30% 12% 25% 10%
20% 8% 15% 6% 10% 4%
5% 2% 0% 0%
Source: FactSet Source: FactSet
JT: Do you think the Nordic retail industry is prepared for the technological and consumer behaviour change that is happening? Do you see any differences between how retailers and investors view the industry's prospects today?
ML: The entire value chain needs to be assessed, since suppliers to brick- and-mortar retailers that need to reduce their footprint will also be exposed. Challenges include a long, gradual reduction of inventory in the entire value chain and greater price transparency. Strong brands will still have pricing power, while undifferentiated products face disruption both online and from offline discounters like Primark. So far, disruption has been more limited in the B2B segment than in B2C, at the consumer end of the market.
New retail business models need I think we will see radically changed business models with greater store greater store efficiency and shorter efficiencies and shorter lead times and product lifecycles in response to lead times and product cycles quicker shifts in customer demand. Return dynamics will also change, with lower margins in general having to be compensated for by both greater asset turnover and greater sales volumes in order to maintain or increase returns. To achieve this at the same time will be challenging, and my guess is that returns will come down in the transition period.
Investors have for quite some time already been punishing retailers that may be reasonably profitable today but that are considered slow to respond to change. This actually offers a great opportunity for the bold retailers daring to make large(r) investments to speed up the transformation, since the stock market does not at this stage believe the existing return/margin levels are sustainable. Stated differently, they have already been punished from a market cap perspective.
The Nordic retail industry is in I would argue that the Nordic retail industry is well-prepared in general, general well-prepared, but the but there is a disconnect between how the industry and how investors view industry and investors seem to have its prospects. I think some investor humility is appropriate, as Nordic different views on its prospects retailers have a strong track record of adjusting to new trends. The biggest challenge is probably each retailer's ability to respond to rising complexity while remaining agile; hence being able to withstand a transition period with lower margins amplified by higher investment levels. This is not entirely unlike on our home turf – the banking industry.
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Retail trade: A historical perspective
Trade was not a significant part of regular citizens' lives as recently as 200 years ago, when rural populations were self-sustaining at the community level for most ordinary goods. But trade has since shifted from dedicated marketplaces, to become a retail industry from which most of us get the majority of the goods we use in our lives. Formats have evolved from service-counter stores, through self-service stores, shopping centres, mail order and convenience stores, to e-commerce – selling goods over the internet, directly to own customers or through third-party platforms. The outcome of the digital disruption of retailing should matter to society: As an example, the (broader) retail industry is 20% of Sweden's GDP.
As recently as 200 years ago, rural We need to go back no further than 200 years or so in history, to find an households were quite self- era when trade typically played a minor role in the lives of most citizens. sustaining, with trade confined to Marketplaces in or near some cities enjoyed privileges to conduct trade, marketplaces in or near cities and certain cities had privileges to engage in foreign trade. But for the population in the rural areas (the clear majority in the 19th century), going to a market to buy or sell goods was not a common occurrence, but something typically done on special occasions, to obtain rare goods or to sell high-value goods, such as livestock. Rural households were largely self-sustaining, producing most of what they needed for their own consumption.
Industrialisation and lower transport The 18th and 19th centuries brought industrialisation, which in turn drove costs made manufactured goods urbanisation. Mechanisation of agriculture drove migration from the outcompete cottage industries provinces into the cities, where populations grew. Technological innovations, such as railroads and steamships, reduced previously high transportation costs, which increased the geographical reach of the goods markets. Goods manufacturing on an industrial scale proved to be far more competitive than the dispersed cottage industries of the past. Consumers were able to buy goods manufactured cheaply and efficiently far away, instead of making inferior equivalents on their own at home. This set the scene for what was to become the modern retail trade.
Medieval marketplace in Novgorod, Russia Store in Detroit, USA, 1922
Source: 'Novgorod Torg", painting by Appolinary Vasnetsov (1856-1933)
Source: Scan of original photo by Bill Whittaker, Wikimedia
The late 1800s saw the emergence of The late 19th century saw innovations such as market halls for sale of food stores in cities, later with street in the major cities and mail order, where customers placed orders from a windows, electric lighting and catalogue and took delivery via mail. Food retailing was further stimulated heating by the introduction of preservation technologies like canned food and refrigeration. Stores started to emerge in the cities, with windows and entrances facing the street, and made more welcoming to customers after the introduction of electric lighting and central heating.
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In the early 1900s came the first The early 20th century saw the emergence of the first store chains, multiple store chains, exploiting scale stores under the same name or brand, operated by the same owner. They advantages first appeared in the US, and were able to exploit scale advantages to offer lower prices than independent, individual stores. In the following decades, better infrastructure and even lower transportation costs (not least owing to the widespread introduction of motor vehicles) spurred further centralisation, the pursuit of scale benefits and specialisation in retail trade, to the advantage of bigger players.
Self-service stores came in 1930s, Self-service stores, where shoppers pick the goods they want to buy, and followed by shopping centres outside pay at a checkout, were first introduced in the 1930s. A few decades later, the cities, with lower land costs when it became common for households in developed countries to own a car, stores started to get clustered together in shopping centres (shopping mall in the US, retail park in the UK) outside city centres. A key driver was the lower land costs (and hence rents), allowing bigger stores with greater inventory and convenient parking. Lower staffing and service levels than traditional department stores in the cities also made it possible for shopping centre stores to offer lower prices.
Retailers use own brand goods and The balance of power between suppliers and retailers has been in constant suppliers use their brands to change since the emergence of the retailing industry, with retailers using strengthen their relative positions own brand (private label) goods to strengthen their position vis-á-vis against each other suppliers, and suppliers investing significantly in their own brands, to strengthen their position vis-á-vis consumers who then show greater demand for their goods. Suppliers have also made efforts to sell directly to end customers instead of via retailers, through own sales channels, and – more recently – through e-commerce, including third-party platforms.
The internet has made e-commerce The widespread availability of the internet from the mid-1990s has had possible since the mid-1990s, and major implications for the retail industry. The internet has become a the coming years will see new common platform for reducing information asymmetry (when buyers and players with digital platforms fight it sellers of a good or service have different levels of insight into its quality out with brick-and-mortar and characteristics, like in the market for used cars). It has increased price incumbents transparency (and hence price competition), offering opportunities for easier, more convenient customer experiences, such as making purchases of goods online, and getting speedy home delivery. New players, starting from zero and building an online-based business model, have entered the retail industry. Amazon in the US is a striking example, currently alone accounting for nearly 40% of the market cap of the entire stock exchange- listed US retail sector. Other examples include Alibaba in China and Zalando in Europe. In the coming years, they will compete with incumbent retailers coming from a history of operating physical stores, and looking for optimal ways of trying to take advantage of their legacies, while meeting the new challengers in the digital arena.
The outcome of the digital disruption The outcome of this competitive showdown should be of interest, as in retail should matter to society: retailing has grown to be an important sector in the economy in developed The retail industry account for 20% markets. Taking Sweden as an example in the Nordics, a broadly defined of GDP and employment in Sweden, retail sector, including some relevant transport and logistics, and related and 10% in the US business services used by retailers, such as cleaning, security, IT, design and property management, has grown to represent roughly 20% of GDP and employment.
In the US, we believe the traditional retail industry accounts for roughly 10% of employment, or some 16.5 million jobs. The ones most at risk from e-commerce competition are arguably those in the GAFO (General, Apparel, Furniture and Other) categories, which account for 6.2 million jobs. To put this into perspective, we have seen estimates that there have been about 2 million total US manufacturing jobs lost to competition from China in the past five years. Perhaps the employment threat from the digital disruption in the US retail industry has – so far – been less of a political hot potato than Rust Belt industrial jobs because fewer of them
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are full time, unionised and held by white males? From a purely macroeconomic point of view, a loss of roughly 12% of US retail jobs to e- commerce competition (or perhaps also from structural overcapacity of retail floor space), would be an issue of similar magnitude to lost competitiveness to China in the manufacturing industry.
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Interview: Investors have legitimate concerns
We interview Nordea Equity Research retail analysts Stefan Stjernholm and Stellan Hellström on how the growth in e-commerce could disrupt the retail industry, how equity investors currently see risks and opportunities related to this, and what strategic options incumbent and online retailers have for ensuring their businesses stay viable.
EB: During the past ten years there has been a sharp increase in the e- commerce share of total sales in the retail industry. Is this the beginning of the end for brick-and-mortar retailers?
SH: First and foremost the e-commerce trend involves a huge change for brick-and-mortar retailers. It includes completely new channels to meet the customers, new ways to communicate, and new ways to build trust and loyalty. But there are also big opportunities if they succeed in adapting to Stefan Stjernholm and Stellan Hellström this new playing field: it doesn’t necessarily need to be the end for them.
EB: What are the reactions in the industry so far? What strategies do brick-and-mortar retailers have to address the e-commerce trend? Do they feel threatened? Are they prepared enough?
Brick-and-mortar retailers have SH: Of course they feel threatened when e-commerce keeps taking a been reluctant to pursue less bigger share of total sales in the industry. Given what the industry looks profitable online growth at the like today, there is some resistance to going online. Sales in brick-and- expense of profitable offline business mortar stores are still much more profitable than their online business. Many companies avoid going online up until the point at which it becomes necessary in order to survive. We have also seen many retailers that have gone online but have been so unsuccessful that they have felt forced to withdraw. After a while most of them try again in another way, and succeed. It is apparently not easy for retailers to find the right mix between the online channel and the physical stores – many are still struggling with this.
SS: When the e-commerce trend really took off, some three to five years ago, the development went much faster than I believe anyone could have imagined. Many brick-and-mortar retailers have realised that they really need to be a part of this, and cater for their customers’ new online needs; otherwise they risk losing those customers.
Competition from e-commerce is Time will tell if the brick-and-mortar stores are sufficiently prepared, but starting to matter much more, now given the fast development I suspect many retailers are not. We are also that extraordinary growth in retail coming from a period where especially the fashion industry has sales is stagnating experienced extraordinary growth, and hence it has not mattered greatly that e-commerce has taken a growing share of the market. With growth currently stagnating, competition with “e-tailers” becomes much more relevant.
EB: What do you think the retail industry will look like in 5-10 years? Who will be the winners and losers? Will physical stores fill a different purpose in the future, or will they barely exist at all?
Omni-channel – a combined online SS: “Omni-channel” is a real buzzword in the industry – the combination and physical store concept – is likely of online and physical store. I think the winners will be the retailers that to outperform in the future are able to combine the physical store with online platforms in an efficient way. So apart from pure online players, I also think the combination – 'omni' – concept will perform well over time.
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SH: The number of physical stores will most likely be lower than it is today. I also think that stores will be smaller, and typically have more of a showroom focus. The customer will be able to see and feel the items in the store, and then order them online.
SS: The consumer behaviour is changing significantly. Today, many customers prepare their shopping online before visiting the physical store, also deciding online what to buy and from whom. They then go to a specific store and buy it. Many people talk about the declining numbers of customers in stores, but the conversion rate – how many store visitors actually buy something – is increasing, offsetting some of the negative impact from declining customer traffic. This boost is coming from online pre-sale preparation.
Surprisingly, we hear from some retailers that some 50% of items ordered online are actually picked up in stores. Pre-ordering items to the physical store can also be a way for customers to make sure that the actual item found online will be available when they arrive. I think this is a sign that there is still a need for the physical store. In the future, there may be different solutions for this. We have for example heard plans for apartment buildings to have goods receptions or storage rooms dedicated to items ordered online. Today it can still be a bit of a hassle to collect ordered goods at your local post office or delivery centre.
EB: Are there any Nordic "pure offline” major retailers?
Retailers with pure low-cost focus SH: Yes – for example Rusta and Ö&B in Sweden. Jula was strictly offline are those most likely to stay offline for a very long time, but after several unsuccessful attempts has now actually gone online. Generally, one could say for the Nordics that retailers with a pure low-price focus are most unlikely to go online. The reason for this is that delivery is still relatively expensive. Many retailers may also have online stores set up just in order to say that they offer it to their customers, while in reality sales are minimal in the online channel.
EB: Among retail categories, fashion is one of the most popular categories for e-commerce in the Nordic countries. We have started to see major fashion store closures in the US in 2017. Could Nordic fashion retailers face similar pressures?
We have already started to see SS: To some extent we can see that this has already happened in the fashion retail store closures in the Nordics, and it will most likely continue. It is most apparent among more Nordics, particularly for mature mature concepts, but not – at least yet – of the same magnitude as in the concepts US. Many of the bigger store chains have expansion areas in which they are still managing to grow. KappAhl, for example, has its 'KappAhl newbie' brand, which is seeing growth in a niche market. But looking at KappAhl Group, we can see that the number of stores has declined.
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Looking at H&M, there is a similar trend, with most growth in the stores in developed markets coming from 'young' labels such as "&other stories', 'Cos', etc. Compared to the Nordics, I also think the US has built up overcapacity in retail floor space per capita.
EB: In the US, there have been shopping malls closing, citing a lack of customers because of e-commerce. Do you think we will see the same development in the Nordic countries and in Europe?
We could see shopping centre SH: Yes, it is likely that especially smaller shopping malls will have to closures in the Nordics, especially close down. It will also become more important to offer not only the smaller malls without entertainment physical stores, but entertainment, good restaurants, etc, in order to keep visitors coming. It is rather evident that the large shopping malls in Sweden today focus very much on the whole shopping experience, and not just on providing store space.
EB: Are traditional brick-and-mortar retailers, in your opinion, being “too punished” by the equity market in terms of valuation multiples and earnings estimates versus e-commerce retailers?
SS: This varies greatly between companies. Zalando, for example, has completely different valuation multiples than many brick-and-mortar retailers, explained by the expected high growth. It is certainly not the case that all brick-and-mortar retailers have worse multiples compared to e-tailers; some of them actually trade at higher valuations. Brick-and- mortar retailers are also typically rather cautious with regard to financial disclosure for the e-commerce part of their business. This contributes to uncertainty among investors, who want to see more e-commerce business data. This more secretive policy is probably due to the structure of the current business. Given that retailers still have a huge share of sales in physical stores, they don’t want to show how small their online business is in comparison. They prefer to defend their offline business, and want to highlight the fact that 'omni-channel' is the future of retail.
Investors are often nervous about As an investor, one could get anxious about the structure of the typical incumbent retailers being stuck in brick-and-mortar retail business. The fact that many of these retailers have old structures, and not being 90-95% of sales in the traditional physical stores, and that sales per responsive enough to e-commerce square metre are declining is worrisome. Investors are often sceptical about incumbent retailers being able to 'take their share' online. Investors fear that brick-and-mortar retailers may be stuck in old structures compared to a newly started e-tailer, which has created and tailor-made its business for e-commerce, and that they may not be agile and competitive enough.
SH: E-commerce also brings more competition to the industry. For an old company there is not much to win from this development. You can of course go “all in” on the online market, but the consequence would almost certainly be cannibalisation on sales in your own physical stores. If you are a market leader, you're bound to be a relative loser in this case.
EB: What do you see as the biggest challenges for pure online retailers going forward?
The biggest challenge for pure SS: There are high expectations on continuous growth. I would say that the online retailers will be living up to biggest challenge is to keep up with these expectations going forward. The high growth expectations traditional retailers are still tough contestants, since they are established and have the 'omni-potential' with their network of physical stores. We are also seeing tougher competition between e-tailers when more and more players entering the market, players which are facing the challenge of retaining loyal customers and preserving healthy profitability.
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EB: Today customers can shop online from all over the world. In the end, most customers may purchase from the store that can offer the best price. How do you think this could affect Nordic retailers?
Nordic retailers have already seen SS: We have already seen that Nordic retailers have been affected by this margin pressure from international competition through some margin pressure. But it is also worth mentioning e-commerce competition that it is not as easy as it may sound to shop from anywhere in the world. Customers shopping from abroad are often faced with trade barriers and costly shipping and returns. I think these structures have to change quite a lot before global competition will be a substantial threat to Nordic retailers. There is also the security aspect – many consumers feel more confident sharing their credit card or other payment information with a local company.
You can also turn this around and look on the bright side of this matter, and conclude that the Nordic retailers also potentially have an enormous market! We have a lot of strong brands here in the Nordics.
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Online race will go on, retailers need to respond
The online share of retail sales has reached 10% in the Nordics over the past 20 years, ahead of Europe and now almost matching the US. There are strong technological drivers for continued growth in online penetration, and we believe all retailers need to prepare for this. We see room for both digital and physical stores in the future, but retail players need to differentiate to be viable in the future playing field. Greater price transparency online is a competitive challenge, but a more critical one is innovation in software and logistics to make online shopping more convenient than visiting physical stores.
E-commerce – digitalisation of the retail industry Better software and logistics, greater We ask the reader's forgiveness for the dramatic title of this report, and we connectivity, have driven strong want to make clear that we are not predicting the demise of the retail growth in e-commerce industry, in the Nordic region or elsewhere. The retail industry is, like many other industries today, facing major disruption from technological innovation. It has been possible to sell goods on the internet for more than 20 years, but platforms have improved greatly since the early days, as has internet – and more recently, smartphone – penetration among the global population. More new and incumbent retail players are active online. And the infrastructure for storing and delivering goods has improved, and continues to improve.
We would highlight four specific strong drivers for growth in e-commerce:
1. Fast technological change in areas such as software, mobile communications, artificial intelligence and logistics automation 2. Reduced barriers to entry through lower information (processing capacity, data storage) and transaction (execution of a trade – to buy a good) costs 3. Reduced economies of scale making it easier for successful new business models to achieve global breakthrough 4. Competitive race for first-mover advantage to achieve network effects – winner takes it all for those who first become the household name in a niche. This means greater access than before to venture capital for startups who grow so fast that they remain loss-making.
Online shopping experiences can In short: Most consumers today have easy access to the internet through today rival, or even beat, physical computers and mobile devices, and the shopping experience they are stores offered online has evolved, in many cases to the extent that it can rival or even beat that of a physical store. It has become easier to compare prices, find product reviews, get good product descriptions, select goods for purchase and choose payment options, and arrange convenient delivery with possibility of hassle-free returns.
E-commerce has become big business. Exactly how big is a matter of definition, and e-commerce is still immature in terms of available public data, which is quite difficult to come by. Categorisation of online consumption and sales volumes is not standardised, and data is not generally available from national statistics agencies. As we are focusing on the retail industry in this report, we have opted to look for e-commerce data excluding travel and accommodation, which are two of its clearly biggest constituent industries, which have gone almost totally digital.
We use e-commerce data from the Census Bureau in the US, statistics agency Eurostat for Europe, and the Danish-Swedish postal service and logistics operator PostNord for Sweden, Denmark, Finland and Norway in the Nordic region.
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Total e-commerce turnover in Europe, the US and the Nordic region for 2013-16 500 450 438 400 382 378 351 350 300 EURbn 250 189 200 170 180 181 150 100
22 50 9 16 17 0 2013 2014 2015 2016
Europe US Nordics
Source: Eurostat, PostNord and US Census Bureau
The US e-commerce market last year reached turnover of EUR 438bn, which is more than twice that of the EU. The Nordic e-commerce market is comparatively small at EUR 22bn, but not in relation to the size of the Nordic economies, or total Nordic retail sales turnover.
E-commerce share of total retail sales turnover in the US, Nordics and Europe, 2011-16 12%
10%
8% US 6% The online share of retail sales in the Nordics Nordics has grown faster since 2013, Europe reaching 10% in 2016 4%
2%
0% 2011 2012 2013 2014 2015 2016
Source: Eurostat, PostNord and US Census Bureau The Nordic online share of retail Looking at the share of total retail sales represented by e-commerce, we sales has historically lagged the US, note with interest that it is growing rapidly. The US has seen quite steady but has now almost caught up growth in the past five years, while the Nordic region has lagged the US, but in the past few years it has actually accelerated and almost caught up with the US e-commerce penetration of the retail trade.
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E-commerce share of total retail sales turnover by country for 2011-16 14.0%
12.0%
10.0% Denmark 8.0% Norway Sweden 6.0% US 4.0% Finland
2.0%
0.0% 2011 2012 2013 2014 2015 2016
Source: Eurostat, PostNord and US Census Bureau
Similar e-commerce growth trends in When we split the data by Nordic country, we see a similar pattern for all Denmark, Norway and Sweden the Nordic countries. E-commerce penetration of retail sales has increased quite steadily, year by year since 2011. In the Nordic countries, e- commerce seems to have grown more or less in line with overall retail sales in 2011-13, taking off and strongly outgrowing total retail sales since 2014.
E-commerce share of total retail sales turnover by country in 2016
14.0%
12.0%
10.0% Denmark Norway 8.0% Sweden 6.0% US Finland 4.0% Europe 2.0%
0.0% 2016
Source: Eurostat, Postnord and US Census Bureau
Looking at the e-commerce penetration of retail sales in 2016, we see some differences between the Nordic countries, with Sweden at the top and Finland at the bottom. Sweden is even slightly ahead of the US. Both the Nordics and the US are ahead of Europe, which was at just over 7%.
E-commerce sales by category, E-commerce sales by category, Europe in E-commerce sales by category, the US in Scandinavia in 2016 2016 2016
Toys, hobby Fashion Fashion and DIY 20% Toys, hobby Toys, hobby 19% Fashion 17% and DIY and DIY 30% Furniture and 22% 23% appliances 12% Furniture Electronics and Furniture and Electronics and media appliances appliances and media 31% 14% Electronics 19% 28% and media 25% Food and Food and personal personal care Food and care 20% personal care 9% 11% Source: DIBS Source: Eshopworld Source: US Census Bureau
Nordea Markets and Nordea Corporate & Investment Banking 14 Corporate Research 27 November 2017
To allow comparisons between the US, Europe and the Nordics and see which product categories are big in e-commerce (popular to buy online), we have had to carefully examine and categorise our data. The result is shown in the pie charts above. We would highlight the following observations:
Fashion is the big e-commerce Fashion is a much bigger e-commerce category in Europe, than in both category in Europe, well ahead of the US and the Nordics the US and the Nordics Furniture and appliances is a much bigger category in the US than elsewhere Food and personal care is much bigger in the Nordics than elsewhere Toys, hobby and DIY is smaller in the Nordics than elsewhere.
Highlight: Swedish e-commerce study by HUI As a sample of current retail industry thinking on how digitalisation may transform the industry, we include a highlight of the study Det stora detaljhandelsskiftet ("The Great Transformation of The Retail Industry") commissioned by Swedish retail industry body HUI. The study was completed in December 2016, and offers five key predictions for the future:
1. Swedish e-commerce should grow from SEK 50bn in 2015 to SEK 192-287bn in 2025, leading the online share of retail turnover to grow from 10% to 20-30%. 2. Swedish retailers will face increasing international competition; in 2025, imports via e-commerce should reach SEK 48-96bn, representing 5-10% of Swedish retail turnover and 25-33% of online retail turnover. 3. The 46,800 stores and 177,800 staff in non-food retail in Sweden should decline 12-24% by 2025. 4. Swedish retail industry prices and margins should fall as digitalisation allows the introduction of new business models. 5. Swedish retail trade should consolidate into fewer but bigger players.
Future retailing: Virtual, physical, or both? Now that we have established that online retailing has grown rapidly and shows few signs of slowing down, what will this mean for the retail industry going forward?
Physical stores offer immediate Let us start by considering the value proposition of a typical traditional availability of goods and pre-sale (bricks and mortar) retailer. The physical shop offers access to goods at a service competitive price and location. The core of the offering is to hold inventory, available to pick up on site. But shops also offer varying degrees of pre-sale service, showing an appealing selection of products with good price and quality in an attractive setting, and offering opportunities for customers to get advice on the products from knowledgeable staff. Shops generally charge for convenience, with more expensive goods at shops in central locations (in cities and communication hubs) offering longer opening hours.
Information asymmetry in retail Historically, as trade evolved from local cottage industries to widespread trade has been addressed by distribution of industrially manufactured goods, markets grew big and consumer and product regulation developed a need for mechanisms to preserve trust and to cope with rising and through brands information asymmetry (consumers more distant from the produced goods would know less about their quality and functionality than goods produced at home or locally). Regulatory tools addressing this issue include consumer protection legislation and regulated product standards. Institutional solutions that have emerged include warranties and – most importantly – brands.
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In online retailing, information Digitalisation of retail trade and the emergence of e-commerce have asymmetry can be addressed through brought new tools for managing information asymmetry – notably digital digital marketplaces, where buyers marketplaces. There are active marketplaces such as Amazon, which offer and sellers rate each other both own and third-party goods, and neutral marketplaces like eBay, which only connect buyers with sellers. Both types vouch for the credibility of sellers and a minimum quality of products, and are able to guarantee payment and delivery to both buyer and seller.
Digital marketplaces reduce the need for sellers to build own brands to offset information asymmetry, instead relying on digitised trust, through systems where buyers and sellers rate each other. Digitalisation allows convenient, anonymous and easily scalable scoring, with an accumulated strong rating filling a similar function to that of a brand.
E-commerce increases price E-commerce gives greater power to consumers through increased choice transparency for consumers (theoretically, access to virtually any online store worldwide that delivers to that customer's home) and greater transparency. The latter means more price competition.
Online sales give retailers more At the same time, e-commerce offers new opportunities for retailers. customer intelligence, with the Online shopping leaves more and better footprints, potentially letting opportunity to make tailored offers retailers use historical browsing and purchase information to tailor the most tempting new, individual offers for consumers to drive additional sales. There could also be opportunities to make offers with differentiated pricing, based on estimates of an individual customer's preferences and willingness to pay.
Physical retailers risk both being Incumbent, physical retailers are facing dual challenges from goods bypassed by suppliers getting own producers, who are, through digitalisation, able to more easily and digital channels and by free riding effectively establish own sales channels to end customers, and from new on pre-sales service by pure online pure online retailers free riding on their physical stores and the competitors experiences they offer. Consumers can browse the internet for the goods they are interested in, seeking the best desired specs and prices, go to a physical store to evaluate them, and maybe even get in-store advice. Their minds then made up, consumers can go back to the internet and buy what they have chosen at the lowest available price.
Physical stores could cater to 'the Physical stores could certainly still have a major role to play though, and experience economy', offering may have an advantage in the form of the experience economy. Changing shopping as entertainment rather consumer behaviour has a bias towards experiences over ownership, with than just picking up goods a growing propensity to pay for having a time-limited enjoyable experience, instead of investing greatly to own capacity for repeated experiences – such as with a leisure boat, summer house or sports car. In this respect, shopping is becoming an enjoyable experience in its own right for many, irrespective of what goods are actually purchased. It represents a social activity, with physical stores offering trials, evaluations, physical look-and-feel and testing of products, which cannot quite be matched online. And goods are available for spontaneous purchase, literally picked from the shelves. The experience can also go beyond individual stores, with shopping centres offering an attractive selection of restaurants, cafés, cinemas, go-kart tracks, bowling halls and other forms of entertainment.
Nordea Markets and Nordea Corporate & Investment Banking 16 Corporate Research 27 November 2017
Michael Porter's generic strategies applied to retailing and e-commerce Wide focus
Tradi onal market leader, omni‐channel Pure e‐trade
Cost leadership Differen a on leadership
Superstores
Low cost Differen a on and quality
Exclusive trade Cost focus
Differen a on focus
Hard discount
Service stores
Tight focus
Source: Company data and Nordea Markets Further growth in online sales could We do not believe that digital disruption will ultimately leave room for still leave room for physical stores, only one successful retailing business model in the future. Harvard but will increasingly require retailers Business School professor Michael Porter's concept of generic corporate to differentiate strategies can serve as an illustration of how today's retailers may need to choose their own differentiated approach to be competitive. Those "stuck in the middle" will certainly struggle, but the rest could find different recipes for success, opting for an online or offline cost-driven approach, or going for quality or premium differentiation, possibly using both online and offline channels.
Many retailers expect an omni- That last option reflects a belief expressed by many retailers today that channel approach to be successful: their future lies in an omni-channel approach. The idea is that the retailer follow customers and have a "follows" its customers wherever they go and establishes a presence in presence in all forums they choose to every channel its customers like to use. We believe this idea has merit, use since it is based on responding to demand for both goods and services, and for how they are to be offered, sold and delivered. Interestingly, the omni- channel approach can mean both incumbent physical store retailers setting up digital channels and new pure online retailer challengers building or acquiring their way into physical stores (such as Amazon's acquisition of Whole Foods in the US).
We believe an omni-channel We would also argue that the omni-channel idea, and of following the approach makes sense customer and looking at their behaviour and preferences, gives a good indication of what digital disruption for retailers is really about. It is still a fairly common view that the big threat comes from increased competition Online eventually beating physical in the traditional sense, that online retailing puts pressure on prices and stores in convenience is a greater profitability. The increased transparency is certainly a threat, but in our threat than price transparency, in view a more disruptive – and perhaps even greater – threat comes from our view digital retail challengers changing the game by lowering thresholds to buying online, by introducing technology that makes the online shopping experience easier, more convenient, more efficient, less time-consuming and ultimately (possibly) more enjoyable.
Nordea Markets and Nordea Corporate & Investment Banking 17 Corporate Research 27 November 2017
It will require major investments by It will require major investments in software, data processing, distribution, retailers to achieve one click buying logistics, payment processing – all the infrastructure needed – for with same-day delivery, easy consumers eventually to just check on a whim, click, choose same-day payment and hassle-free returns delivery, and immediately return anything they don't like or which does not fit. Such investments could require scale and the retailer being of sufficient size to generate the cash flows to invest in an IT and logistics Physical retailers could benefit from platform and marketing. This is where incumbent retailers could have an funding such investments from a still advantage, as they could milk still profitable and cash-generative physical profitable legacy business stores to fund the establishment and growth of a viable online footprint.
When comparing bricks and mortar retailers with pure online retailer challengers, this is worth keeping in mind when thinking about who may still be standing a few years from now. As an illustration, our equity analyst Stefan Stjernholm estimates that ~15% of H&M's revenues are derived online, and we note that its online revenues almost match those of Europe's leading pure online fashion retailer Zalando.
Zalando and (our estimates for) H&M's online revenues, EURbn
4.00
3.50
3.00
2.50
2.00 EURbn 1.50
1.00
0.50
0.00 Zalando H&M online
Source: Thomson Reuters and Nordea Markets Physical stores could evolve into If viable, it would mean the physical store loses most of its advantages. It showrooms would then need to be abandoned, or given a different function or purpose. We would not rule out many physical stores possibly evolving into showrooms, for consumers to see, try and seek advice about goods they are interested in, as part of a shopping experience they find social and enjoyable, rather than a chore.
No one knows what to expect in ten No one knows what the retail landscape will look like ten or 20 years from years, but all retailers need to now. The one thing we can be certain of is that it will be quite different prepare for what may come from today. We see a need for all retailers to review their current business models and evaluate if they will remain viable in a future with different consumer behaviour.
Amazon in Sweden? Amazon's recent purchases of One factor that could potentially affect e-commerce penetration of Nordic Swedish property and domain name retail significantly would be if global e-commerce giant Amazon of the US amazon.se are seen by some as entered the market. Some industry participants see this as a distinct strong signs it will enter the Swedish possibility, pointing to Amazon's cloud provider AWS (Amazon Web market Services) opening a Stockholm office and buying the domain name "amazon.se" this year, in addition to acquiring property in Eskilstuna, Västerås and Katrineholm, all within 100 km of Stockholm in Central Sweden. This could be related to cloud services, data centres, or a build-up of logistical capabilities ahead of a full-scale launch of its online retail offering in Sweden.
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IKEA's CEO aims to boost the Moreover, Jesper Brodin, CEO of global furniture giant IKEA with company's 5% online share of the revenue of USD 40bn, said to Bloomberg in October that the company total and could consider online aims to expand its e-commerce business, which today accounts for only distribution by third parties 5% of sales. E-commerce will be introduced in all of IKEA's 29 markets worldwide in the coming 12 months, supported by investing in urban warehouses for faster delivery of goods ordered online, offering assembly services through recently acquired TaskRabbit, and the introduction of its new AR shopping app "Ikea Place", letting customers view simulated IKEA furniture placed in their own home.
IKEA's new AR shopping app "IKEA Place"
Source: IKEA Swedish tech site Breakit reports that Also, Swedish tech site Breakit reported in late October that according to IKEA will let Amazon Marketplace industry sources, IKEA has entered into an agreement with Amazon to sell sell its furniture in Sweden its furniture through Amazon Marketplace in Sweden. This ties in with IKEA CEO Brodin having told Bloomberg that the company would consider online distribution partnerships with third parties. While Amazon entering the Swedish market could pose a major competitive threat, other local e-commerce industry representatives point to the UK, Germany and Japan. In these markets, Amazon has risen to account for a similar 40% or so of the e-commerce market that it commands in its US home market, but without killing off major local players.
Verdict from the capital markets: Online matters... a lot! What we believe and what incumbent and challenger retailers believe is one thing, but how does this compare with what equity and credit investors believe about how digital disruption will affect the retail industry?
Investors expect listed retailers to It is evident from our interview in this report with Nordea Equity Research have a strategy for being viable in a retail analysts Stefan Stjernholm and Stellan Hellström that equity more online-heavy future investors see the growth in e-commerce as a very significant phenomenon and a clear challenge for incumbent bricks and mortar retailers. Investors expect retailers to have a strategy for being relevant in the online channel, to have faith in the potential to exploit growth there, but perhaps more importantly, to give assurance and visibility that the retailer will not be marginalised in a likely different retailing landscape in the future.
Nordic listed retailers typically have Listed physical retailers in the Nordics have so far been reluctant about low transparency into their online providing much financial transparency into their online businesses. activities and tend to hesitate about Typically it still accounts for a small share of the total, is loss-making or investing in unprofitable online at possibly profitable, but much less so than the physical store business. The the expense of profitable offline incumbent retailers have a natural and understandable reluctance to push business their online businesses too much, as investment in them will be at the expense of investments in the clearly more profitable legacy business.
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Why plough new, good money into a unit that is bleeding cash? For new, pure online players, this is not an issue. They have only their online retail business, and of course want to grow it as much as they can in pursuit of future profitability.
Investors can choose to ignore and not invest in small cap retail companies, whether they be incumbent retailers with less convincing online ambitions, or new online players with business models investors do not fully believe in. But investors need to take an active view on large cap retailers, as owning them or not means a bet relative to the index the investors are benchmarked against. Here, it is very difficult to say with any certainty how investor views on the online efforts of physical retailers affect valuations, as we do not have much data on which to base any analysis of the value of the online part of their business. But we can make some observations from valuations and share price performances of pure online retailers.
Market cap of US S&P 500 retail sector and Amazon, USDbn, 2012-present 1,400
1,200
1,000
800 Amazon 37% USDbn 600 of sector 400 Amazon 20% 200 of sector
0 2012 2013 2014 2015 2016
S&P 500 retail index Amazon
Source: Thomson Reuters and Nordea Markets Amazon has grown to represent 37% Looking first at the US, the graph above shows us that Amazon – the of total US retail sector market cap, dominant online retail player in the industry – has seen its market cap from 20% in 2012 grow twice as fast as the US retail sector in the past five years. In 2012, its market cap already represented 20% of the whole US listed retail sector's market cap. Today, Amazon's share of the sector's total market cap has nearly doubled to 37%. One company, and arguably the global pioneer for online retailing, represents almost 40% of the public equity value of its entire industry! As online sales are still "only" ~10% of total retail sales in the US, Amazon of course represents a much smaller share of industry sales than of the industry equity value. Mathematically, this only adds up if Amazon's growth remains superior, giving it a bigger future revenue base relative to its industry, or if it achieves much higher future returns.
Nordea Markets and Nordea Corporate & Investment Banking 20 Corporate Research 27 November 2017
Selected US store closures needed to re-achieve 2006 sales per square foot
Source: Green Street Advisors and The Wall Street Journal
Some US retailers would need to While Amazon has been the shining market cap star in the US retail sector, close 30-40% of their stores to bring there are relative winners and losers among the offline retailers, too. The their sales per square foot of floor worst hit players are the traditional department store operators, struggling space back up to 2006 levels with decreased store traffic from both online and shopping centre competition. The graph above gives an idea of the magnitude of the decline in customer visits to stores, showing how many (and how large a share of total existing stores) would need to be closed today for the current retail sales volume to reach the same level per square foot of shop floor space as in 2006. We see that big players such as J.C. Penney and Sears would need to close 30-40% of their existing stores.
OMX Nasdaq Nordic retail and OMXN40 general equity indices with 2011 = 100 225 OMXN40 200
175
150 Nordic retail index 125
100
75 2011 2012 2013 2014 2015 2016
Source: Thomson Reuters and Nordea Markets In the past two years, Nordic For the Nordic region, we have plotted the OMXN40 general blue chip retailers have underperformed the equity index and the OMX Nasdaq Nordic retail index since 2011, indexed stock market by 30%, in a favourable to 2011 = 100. Historically, the correlation between the two has been macro environment almost absolute: the retail sector has moved with the overall equity market. But two years ago this correlation was broken, the retail sector losing ~15% of its value compared with the market gaining ~15%. This is a 30% performance gap between the retail sector and the market in a two-year period, and in a period with a generally strong macroeconomic environment, supportive for retailers. We find it hard to come to any other conclusion than equity investors seeing challenges and uncertainties for retailers, including from digital disruption.
Nordea Markets and Nordea Corporate & Investment Banking 21 Corporate Research 27 November 2017
Selected Nordic retail stock performances, indexed to 2014 = 100 350
300
250 Sportamore 200 Verkkokauppa OMXN40 150 IC Group H&M 100 Stockmann
50
0 2014 2015 2016 2017
Source: Thomson Reuters and Nordea Markets Some pure online retailers have To delve deeper, we have looked at individual share price performances sharply outperformed incumbents for selected Nordic retailers since 2014. Some differences in performance are truly striking. Pure online players such as Sportamore and Verkkokauppa.com are up 200-300%, while blue chip incumbent players such as H&M and Stockmann have lost 30-50% of market cap. Again, the magnitude of the performance differences suggests equity investors do see a massive potential growth opportunity online, which it might cost dearly for a retailer not to be fully part of.
Retailer S&P credit rating quality sliding A growing list of US retailer So much for the equity investors' view, but can we learn anything from bankruptcies since 2016 how the credit markets view retailers? The question feels relevant, not least since US private equity-owned toy retailer giant Toys 'R' Us filed for bankruptcy this September. The list of US retailer bankruptcies is growing, with more well-known names going bust in 2017 including BCBG Max Azria, RadioShack, Payless ShoeSource, Rue21, Gymboree, True Religion and Vitamin World. And this comes on top of several bankruptcies in 2016, including Sports Authority and American Apparel.
We have examined the S&P credit rating migration among US and Source: Toys 'R' Us European retail companies in 2012-17, using data sourced from Thomson Reuters and consisting of a sample of almost 1,500 US retail companies and close to 3,500 European retailers with 2016 revenues above USD 50m. It includes both private and public companies. Of these 5,000 companies, 74 had an S&P rating in October 2017: 60 in the US and 14 in Europe. Of the 60 US rated retailers, two received their first rating in 2017. The rating migration of the remaining 58 rating companies is illustrated in the graphs below.
Nordea Markets and Nordea Corporate & Investment Banking 22 Corporate Research 27 November 2017
US retailers by S&P rating category, 2012 vs 2017 US retailer S&P rating changes, 2012 vs 2017 12 25 23
10 20 18 17 8 15 6 2012 2017 4 10
2 5 0 ‐ ‐ ‐ ‐ − C B A D B A B+ CC A+ BB AA BB ‐ AA BB+ CCC BBB AA+ AAA 0 BBB CCC+ CCC BBB+ Downgrade Equal Upgrade Source: Thomson Reuters Source: Thomson Reuters
While there have actually been more rating upgrades than downgrades in this five-year period, there has clearly been trouble brewing among the lower-quality rated retailers. There have been many downgrades from "B" to "CCC+", which fits with the picture of the numerous bankruptcies, even if most of those have been by unrated retailers. The most recent high- profile default, Toys 'R' Us, had a "B" rating in 2012, but was downgraded to "B-" in 2013, and kept that rating until it defaulted in September 2017.
US retailers by S&P rating category, 2012-17 No. of US retailer rating upgrades and downgrades, 2013-17
14 13 2017 38% 50% 10% 2% 12 2016 39% 54% 7% 10 10 10 9 AAA:BBB‐ 2015 38% 56% 7% 8 7 BB+:B‐ Downgrade 2014 37% 60% 3% CCC+:C 6 55Upgrade 4 D 4 2013 37% 57% 6% 3 3 2 2012 36% 62% 2% 0 0% 20% 40% 60% 80% 100% 2013 2014 2015 2016 2017
Source: Thomson Reuters Source: Thomson Reuters
The share of High Yield rated ('CCC Most upgrades were in 2013-15, early in the period, and most of the +' or lower) US retailers has grown downgrades were made in the most recent two years. Breaking down the to 12%, from 2% in 2012 retailers into four different rating categories, we see that the share of companies in the strongest category (Investment Grade, or "BBB-" and higher) has been quite stable during the period, while the High Yield category ("CCC+" and below) has soared, rising from 2% to 12% of the total.
In Europe, only 14 of the 3,500 companies in our sample had an S&P rating as of October 2017, and three of the 14 received their first rating this year. The following chart describes how the ratings for these 11 companies have developed since 2012, or later if they got their rating after 2012.
Nordea Markets and Nordea Corporate & Investment Banking 23 Corporate Research 27 November 2017
European retailers by S&P rating category, 2012 vs 2017 European retailer S&P rating changes, 2012 vs 2017 3 9 8 8 7
2 6 5 2012 4 2017 3 1 2 2 1 1 0 0 Downgrade Equal Upgrade ‐ ‐ ‐ ‐ C B A D B A B+ CC A+ BB AA BB AA BB+ CCC BBB AA+ AAA ‐ BBB − CCC CCC+ BBB+ Source: Thomson Reuters Source: Thomson Reuters
Of these 11 companies, one has been downgraded and two have been upgraded, and the rest have maintained their rating during the period. Over the five-year period, the share of highest-rated (Investment Grade) companies has declined, from 75% to 46%, explained by there only being eight rated European retailers in 2012 and by every additional retailers who have received an S&P rating since then getting a rating of "BB+" or lower.
European retailers by S&P rating category, 2012-17 No. of European retailer rating upgrades & downgrades, 2013-17 3 2017 46% 54%
2016 55% 45% 2 2 2015 50% 50% AAA:BBB‐ Downgrade
2014 50% 50% BB+:B‐ 11 Upgrade 1 2013 60% 40%
2012 75% 25% 0 0% 20% 40% 60% 80% 100% 2013 2014 2015 2016 2017
Source: Company data and Nordea Markets Source: Company data and Nordea Markets
To sum up, growth in e-commerce has accelerated in the past few years, driven partly by technological innovation leading to better online shopping solutions and experiences, and by the growth in connectivity and smartphone use. The online penetration of retail sales has grown sharply but according to most observers is far from mature yet, at least for most goods categories.
Equity markets seem to expect and price in strong continued growth in e- commerce, particularly for well-entrenched players such as Amazon. Bleaker prospects are accordingly priced in for retailers with business models and capacity least matching current consumer preferences and demand, such as US department store chains. Corporate bond markets are starting to price in greater business challenges for retailers, although not nearly as much in Europe as in the US.
Brick-and-mortar retailers need to We argue it would be imprudent to assume anything other than online decide how to try and stay viable in retail sales continuing to claim a gradually bigger share of total retail sales a likely more online-heavy retail in the coming years. While many pure online retailers are seeking a future presence with physical stores, brick-and-mortar retailers are those who most urgently need to decide on a strategy for being relevant in a more online-heavy retail future, which we believe is lying ahead of us.
Nordea Markets and Nordea Corporate & Investment Banking 24 Corporate Research 27 November 2017
Interview: Ready for any e-commerce scenario
We interview Mia Brunell Livfors, CEO of Swedish private retail and service group Axel Johnson with businesses generating SEK 72bn in sales, on potential disruption from growth in e-commerce, how the group adopts digital platforms in its businesses, and how groceries could potentially be made a profitable online retail category. Axel Johnson's holdings include department store chain Åhléns, ~50% of listed food retailer Axfood and 25% of listed IT products and services reseller Dustin.
JT: E-commerce has seen strong growth in the past decade and today accounts for 10% of total retail sales in the Nordics. Do you think that it will continue to grow, and if so, how big a share could it ultimately represent?
MBL: We are seeing one retail category after another taking off and really going online. In our analysis, we see a pattern that growth is initially almost linear until it reaches an inflection point, and then it starts to grow exponentially. This point is often reached when e-commerce represents 10-15% of total sales in the category. We first saw this happen for books, music and movies, a while later for shoes and apparel, and now most recently for beauty products. The famous Ernest Hemingway quote "gradually and then suddenly" is actually also a very good description of the development in e-commerce. Industry body Svensk Handel is projecting that by 2025 e-commerce will be 20-30% of total Swedish retail sales. It could be more, it could be less. We are trying to be prepared for any scenario.
JT: What do you see as the main drivers for growth in e-commerce?
MBL: We believe the main drivers are: Price Choice/availability Convenience
On the internet, there is almost total price and quality transparency, and the marketplace is global. A small e-tailer can market its goods on Amazon Marketplace and compete on the same terms as everyone else. This implies downward pressure on prices. For durable goods, especially for those that have migrated online, there is even price deflation. Also, as a consumer today, you are just one click away from accessing millions of goods.
Offering customer-friendly delivery Consumers seek convenience; not having to think about opening hours or options will be crucial for e- how to get to the physical location of the store. They want to be able to commerce growth going forward make purchases whenever it suits them. In Sweden, we are not very good at this yet, but we are getting there. I think this will be a crucial factor for e-commerce going into the future: to be able to offer deliveries in a customer-friendly way.
Nordea Markets and Nordea Corporate & Investment Banking 25 Corporate Research 27 November 2017
JT: What is your view of physical retail in the future? Will it stay the same? More focused on the experience rather than the products themselves? Differentiate towards budget or luxury products? Showrooms? Omni-channel?
Physical stores will vary in size and MBL: We are convinced that the physical and digital channels complement shape, depending on segment, brand each other, and hence we believe in the omni-channel concept. We think and country of operation physical retail will look different depending on segment, brand and country of operation. What we can already see and what should become even more pronounced going forward is that the physical store will have a different profile and size depending on its location. There will be everything from large flagship stores, where services are also offered, such as our Kicks stores in both Gothenburg and Malmö, to small pop-up stores with selective offerings in locations with constant flows of people, like metro hubs. Overall, we think the physical store will be smaller. However, stores will probably play a more important role when home deliveries become even more common.
A key factor is delivery for “the last Within the retail industry, there is a lot of talk about “the last mile”, which mile”, from the store to the is the last part of the delivery chain to the customer's front door. Instead of customer's doorstep shipping the goods from large storage facilities outside cities, retailers could, for example, use bike messengers for delivery within half an hour of purchase in the store to the customer. The Axel Johnson group is currently looking into how to manage the “last mile” delivery in the most efficient way.
JT: If you are a retailer with a lot of stores, is it possible to compete with e-commerce businesses with inherently lower costs?
MBL: The evolution of physical retailing is at a very critical stage right now. The physical store will still be important in the future, but the economics of its business model no longer add up. In Sweden, there is a pipeline of 1.4 million m2 of new retail floor space to be added in the coming years. Industry body Svensk Handel's forecast of a 20-30% online share of total retail sales in 2025 thus implies that physical store sales per m2 will fall by 15-23% in the next eight years.
Sweden has, from an international In addition, Sweden has comparatively high rental levels of 10-15% of perspective, high rental levels for total sales for retail properties, versus an international average of ~6%. retail properties Landlords seem to believe that it will be possible to charge even higher rents going forward. This is not in line with the outlook we see for physical retail. Rental levels need to drop, otherwise we will have another driver for even fewer physical stores in our cities.
Nordea Markets and Nordea Corporate & Investment Banking 26 Corporate Research 27 November 2017
JT: Food retailing has not yet experienced any boom in e-commerce. What could change this? Will grocery shopping online be profitable? And if so, how?
Today's in-store grocery picking for MBL: At the moment, it is growing steadily. We are still in the “gradual home delivery is ultimately too phase”, and it is hard to project what the growth curve will look like in the expensive, and will be replaced by near future. Yes, profitability is a challenge today, for all players in the (highly volume-dependent) 'dark market. At the moment, there are still many companies that pick groceries stores' in-store and then deliver them to the customers. In the long term, this is too expensive. Instead, you need to invest in “dark stores”, storage for e- commerce, which are, however, highly dependent on volumes. At Axel Johnson, we focus a lot on how to win market shares, test different concepts, and reach more target groups.
JT: Who are the main winners and losers from growth in e-commerce now and in the future?
MBL: Within retail in Sweden, we can already see that the survival of the fittest process has started. Many retailers with physical stores in categories where more than 20% of total sales are now online are struggling. It is evident that there will be losers from this development, but there will be also be winners.
JT: What is your view of how Axel Johnson is positioned within e- commerce today? What are your new business opportunities? Challenges?
Kicks has installed mobile checkouts, MBL: We believe our position is strong. There are many reasons for this. eliminating queues in physical stores To start with, we have a long-term focus. That doesn't mean that we are slow; we feel impatient every day. But we also have a lot of patience. We are able to make tough investment decisions, which we know are not profitable today but will be profitable in the long term. We have a strong financial base to stand on, which gives us good opportunities to develop. To meet our customers' needs, and to be able to stay strong in the increasingly tough competitive environment, we have around 200 ongoing digital projects within the group. All of our companies are shifting towards digital solutions. One example is Kicks, our cosmetics chain, which has good growth in its online business. It has now installed mobile checkouts in its stores, so customers no longer have to queue to make purchases. Kicks is among the pioneers in Europe with this solution.
In food retail, we are testing which Since we don't know what the future will bring, we are testing a lot of concepts work best, including different alternatives. Within our convenience shopping segment, both acquired online players mat.se and Willys and Hemköp – our food retailers – have introduced e-commerce. Middagsfrid We have also acquired the pure online food retailers mat.se and Middagsfrid. We are continuously evaluating which of these concepts work best, and in what way.
Last but not least, we are letting the group evolve by acquiring both small and large companies. Since 2015, we have bought 25% of Dustin, a listed e-tailer within electronics and services focused mainly on B2B solutions with a turnover of SEK 8bn. We are also investing in startups through our vehicle D-Ax, and now have ownership in six different ventures.
Nordea Markets and Nordea Corporate & Investment Banking 27 Corporate Research 27 November 2017
JT: What do you think Axel Johnson will look like in ten years? Regarding your 10/50 vision – that 50% of your business will be new activities in ten years – what could the new half of your business be in 2027?
It is important for us to align with MBL: Instead of me just guessing where we might end up, we let our our customers’ needs, to be able to customers decide. It is important to remember that ten years ago, the first change rapidly and set up new iPhone was launched, and since then our lives have changed dramatically. business models We are now seeing new technologies like artificial intelligence, virtual reality and Blockchain starting to break through. It is important for us to align with our customers' needs, to be able to change rapidly and set up new business models. I am convinced that in the future, digital solutions will be even more in focus for our businesses.
Nordea Markets and Nordea Corporate & Investment Banking 28 Corporate Research 27 November 2017
Spotlight: Primark – refusing to go online
Primark, often described as the jewel in the crown of listed UK food and retail group Associated British Foods, is a discount fashion retailer which has seen a remarkable expansion in the past 10 years. It has almost doubled its number of stores, increased its market presence from three to 11 countries, and has almost quadrupled its revenues. And this has all happened despite Primark – unlike most peers – not selling online, arguing its so far highly successful business model is not suited for e-commerce.
Physical stores only, crammed with cheap garments Primark is a discount retail chain offering fast-fashion apparel and accessories, including cosmetics, at very low prices. It opened its first Headquarter Dublin, Republic of Ireland Founded 1969 store under the name Penneys in Dublin in 1969, and is today a wholly Founder Arthur Ryan Parent Company Associated British Foods plc owned subsidiary of the GBP ~26bn market cap UK-listed food and retail Markets Austria, Belgium, France, Germany, group Associated British Foods. Primark accounted for 44% of revenues Ireland, Italy, Neterlands, Portugal, Spain, UK, US and 62% of operating profit at ABF in 2016. CEO Paul Marchant Revenue GBP 5.9bn (2016) # of stores 315 (2016) Primark’s strategy is to offer fast fashion at a bargain. In its stores, you can # of employees 68,000 (2016) easily find a T-shirt for GBP 1, or a pair of skinny jeans for GBP 7. The Source: Primark low prices and plentiful choice in well-stocked physical stores attract a price-conscious, often younger, clientele who are susceptible to impulse buying and typically leave the stores with more garments than they originally intended. Prices are low enough to encourage buying more than one of the same garment, to use when the first is worn out, or to buy for use over just one season. Being a discount retailer, Primark has also benefited from a more polarised retail industry since the global financial crisis, with many consumers (also from the middle class) opting for greater value and looking to trade down.
By being lean, and by opting for a minimal marketing spend (Primark relies heavily on word-of-mouth), the retailer can keep low costs and hence prices, despite often buying from the same suppliers as many other fashion retailers. The brand and store concept are now well known, particularly in the UK and Ireland, an illustration being the opening of a store on London's most famous shopping venue, Oxford Street, in 2007, which saw thousands of shoppers lining up, even leading to some injuries as the crowd entered the store.
A growth saga – sustainable offline? In the past 10 years, Primark has Primark has grown organically, with 17 average annual net new store reported a revenue CAGR of 16%, openings in the past 10 years, and through acquisitions (which include corresponding to nearly GBP 6bn Woolworth, C&A and Littlewoods), together driving a 10-year revenue CAGR of 16%. It has been the fastest growing fashion retailer in the UK during this period. 55% of its stores are in the UK, with the remainder spread out over 10 other countries, including the US since 2015. Primark has 40 stores in Spain (same as in its Irish home market), which is Inditex's home market, but only 11 stores in Germany, which is H&M’s biggest market.
Nordea Markets and Nordea Corporate & Investment Banking 29 Corporate Research 27 November 2017
Primark's number of stores, 2007-16 Primark's number of employees, thousands, 2007-216 350 80 315 68 61 293 300 60 54 278 48 257 43 250 242 40 36 32 223 28 26 204 23 200 191 181 20 170
150 0
Source: Company data Source: Company data
Primark has a website, and is active on social media, but unlike most major fashion retailers, it does not sell online. According to Primark's parent company ABF, Primark's business model is not really compatible with e-commerce. The ultra-low prices aim to stimulate impulse shopping, customers spontaneously grabbing more garments and accessories in-store. Customer behaviour would be different, perhaps less frenzied, which is likely to decline when purchases are made online. Also, Primark's approach is maximum stimulation to purchase in-store, encouraging Source: Primark customers to return garments which do not fit. Stores are usually so crowded that it is hard to find an available changing room. If customers cannot resist the great deals on offer in the store, they can buy the garments and try them on at home, and they are encouraged to come back to the store for any returns. This drives a high volume of returns, which can be good from the point of view that customers are lured back to the stores, being tempted to buy more cheap garments when there. But it would mean high shipping and logistics costs for online sales channels.
Primark's revenues and adjusted operating profit margin, 2007-16 7 16%
13.4% 11.6% 6 12.6% 14% 12.0% 5.9 12% 5 10.2% 10.2% 5.3 5.0 10% 4 4.3 8% 3.5 GBPbn 3 3.0 6% 2.7 2 2.6 1.9 4% 1.6 1 2% 0 0% 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Revenue Adjusted operating profit margin
Source: Company data
Despite its stellar offline record, It is hard to argue against a business model that has Primark's record of Primark may need to ensure that it growth and profitability. That said, there are analysts and other observers does not miss out on the trend of its noting the seemingly unstoppable growth of e-commerce who are vocal in core (young) clientele going online their argument that Primark should consider developing an online sales channel to ensure that it does not lose out from further customer migration to online shopping. This might be particularly important for Primark, owing to its core customer base being youths in their 20s – an internet- savvy generation very much driving the migration to e-commerce.
Nordea Markets and Nordea Corporate & Investment Banking 30 Corporate Research 27 November 2017
There are some potential indications that Primark's business model is starting to lose momentum. For the first time in 16 years, same-store sales growth turned negative in 2016, and in the past three years the operating margin has fallen from 13.4% to 11.6%. This could be partly explained by a shift away from disposable fashion related to sustainability issues like environmental impact and labour conditions among garment suppliers. The question is: if Primark's business model needs an overview, should it still completely exclude online sales in the future?
Nordea Markets and Nordea Corporate & Investment Banking 31 Corporate Research 27 November 2017
Interview: Convenience is key for online growth
We interview Johan Ryding, CEO of listed Swedish online sporting goods and fashion e-tailer Sportamore, on its prospects and key drivers for growth in e-commerce, and what will be critical factors for competing successfully with other e-tailers as well as physical retailers.
JT: E-commerce has grown substantially during the past few years and now represents ~10% of Nordic retail sales. What do you expect going forward? How much growth potential is there? And what are the key drivers for consumers to buy more online?
JR: I think there have been several key drivers to date and they have changed over time. If we ask our customers today why they choose to make a purchase online, most of them say that it is a matter of convenience. This has become the strongest driver today.
In the early days of e-commerce, price was the main driver. It was often much cheaper to buy a specific good online than in a physical store. Many consumers at the time were reluctant to go online, as they where afraid to submit their credit card details. There was also uncertainty as to whether the goods would be delivered or not, as well as the actual time of delivery.
E-commerce growth has also been very much about competition and supply. I like to use the analogy of how the evolution of a butcher shop as an example of how retail has developed over the last decades. Share price performance since IPO May 2015 Historically, in a typical town there was one butcher. The supply of meat 180 was limited, without much choice available, but the service level was very 160
140 high. This evolved into the local grocery store. It won most of the old 120 butcher shop's customers, because it could offer better prices and a better 100
80 selection of meat, although its service level was a bit lower. Next came 60 large supermarkets, with even greater supply and choice, and even lower 40 prices, but as a consequence also an even lower level of service. After that 20 0 we had mail order, and more recently e-commerce, moving the store even 2015 2016 2017 further away from the customer, offering an even better supply at an even Source: Thomson Reuters lower price, and at an even lower level of service.
At this point we are starting to reach pure competition, meaning that the price is as low as it will ever get and supply is [effectively] unlimited. The one factor that we still can control is the service level. As online players, to differentiate ourselves we can provide outstanding service. Let's say you buy meat online today – it can be in your fridge the same afternoon when you get back from work. And ultimately, now, today, we want to be close to our customers again, just like the butcher shop once was, so we are taking the service level one step further.
Convenience is now a more The early drivers of e-commerce growth matter less today. The critical important e-commerce growth driver driver today is convenience. Hence, for Sportamore to offer the right than price products at the right price is now considered simple hygiene factors. We focus a lot on providing outstanding customer service and helping our customers save time. I think that we have today reached a point when it is often actually easier to shop online than in a physical store.
When customers choose which e-tailer to shop from, they now typically make their decision solely based on convenience, service and price. As a customer online, you are just one click away from another e-tailer, so if their offering is better you will simply chose them. Another reason to go online and do your shopping is of course the vast supply of vendors – it is outstanding compared with what your local shopping centre can offer.
Nordea Markets and Nordea Corporate & Investment Banking 32 Corporate Research 27 November 2017
JT: Have e-tailers been able to shift focus more towards convenience because technological innovation makes it possible to deliver, or is it because online retail has matured?
JR: I would say that these two factors are very interlinked. Platforms for e- Smartphones have revolutionised e- commerce have improved dramatically, especially after the introduction of commerce – over 70% of traffic to smartphones. When we started our business in May 2010, there wasn’t Sportamore's website is through much talk about smartphones. Back then you could access the internet mobile devices with your phone, but that was pretty much it. We barely knew that smartphones existed. Today 70-75% of the traffic to our website is via these devices. This is a good example of a technical development that lowers barriers and increases simplicity. Before smartphones, you had to wait to make the purchase until you got home and could access your computer. Today you can do it instantly, once you feel the need for something.
There is a clear trend towards an increasing use of mobile devices among all online customers.
New payment solutions are also a part of the favourable technological development. You are just one click away from a purchase, and you no longer need complicated security solutions to identify yourself online.
JT: With an online store you have the ability to reach customers from all over the world. Are you planning on expanding outside of the Nordic countries? Are there logistical constraints to how far or fast you could expand?
JR: When we started in 2010, we had the ambition that we should always Sportamore offered free next-day offer free next-day delivery and free returns. That was rather unique back delivery when it started up in 2010 then. What we encountered, however, was that the delivery company could only offer a solution that would take 3-4 days, otherwise it would be very expensive. Next-day delivery didn't exist at all. This has changed a lot.
Seven years ago, free delivery was considered an extra service to our customers which differentiated our business. Today free delivery is expected, no one will shop from you if you don't offer free deliveries. Customer expectations increase all the time, which is especially evident in the parameters which are connected to flexibility, such as:
Customer expectations keep rising, Free delivery expected delivery time is falling one Free returns day per year to one to three days at Purchase on approval present Price guarantee
In 2010, the average customer expectation for delivery time was 6-7 working days, in 2015 it was 3-5 days and now in the most recent study it has come down to 1-3 days. This implies expected delivery time is falling by 24 hours each year.
Five years ago, we expected the next In response to rising customer expectations, we have decided to keep our move for our main distribution hub main distribution hub in the Stockholm big city area. When we moved it would be to mainland Europe last time, five years ago, we thought that when we would relocate the next time, we might head for mainland Europe. We would still be close to our main market - we could reach the Nordics within 24 hours and we could probably lower our labour cost significantly. We expected it would also be good from a strategic point of view, for any future expansion to continental Europe.
Nordea Markets and Nordea Corporate & Investment Banking 33 Corporate Research 27 November 2017
We decided to keep our hub in But when we were about to make the actual decision a couple of years Sweden, to be able to offer next-day ago, the rapid development in expected delivery time convinced us that we delivery to customers going forward can’t move our logistics capability out of our main market. We must stay close to the Stockholm area to be able to meet our customers' service expectations. In one or two years, customers will probably expect goods delivery within 24 hours, and then we simply cannot be based somewhere else. The need to be close to the market is increasing, and this turns things around for many e-commerce companies. Suddenly, it is important to be a large player on the local market in order to be able to provide the service that consumers expect at the right price.
Amazon was able to offer next-day One thing that I like to use as an example of this, is Amazon's competitive delivery in the US with limited advantage over other e-tailers when US consumers started to expect next- marginal cost – competitors had to day delivery. For Amazon, which has many local distribution centres, the use expensive air freight extra cost for next day delivery was rather low. However for many other e- tailers who had only one or two distribution hubs in the US, the cost was substantial, since they were forced to use air freight in order to stay competitive.
Sportamore prioritises growing big We use the same reasoning today when we develop our business. This has in the Nordics, with logistic also impacted our view on competition, it is no longer possible to conquer capability for high service level, the Swedish market by sending packages from, say, Germany with four versus international expansion days standard delivery. For us it is more important to grow big in the Nordics, than to be present on many different markets, which was our previous long term strategy.
Local logistics hub is needed to offer To successfully expand outside of the Nordics, we believe that we need to competitive delivery times be able to provide the same service level as we have here. We cannot just open up websites in new geographies, we need to be close to the market. It requires many more investments today than some years ago. Your choice of logistical approach will also depend on who you are. We are primarily a retailer with third-party brands. If you make your own, unique product, you might be able to offer it worldwide, and with less than fully competitive delivery times.
JT: How do you see goods deliveries from online stores in five years? Faster? Cheaper? Simpler returns processes? Who will build the infrastructure – forwarders or retailers themselves?
The biggest e-tailers will likely build JR: I think it will be very much up to who you are as a retailer, what your delivery infrastructure themselves, strengths are, and will also depend on the size of your business. E- but could also handle logistics for commerce grows in importance for everyone within retail. Even if you are others not a pure online player, customers expect you to be present in the online market. I think we will see many different solutions. If you are big enough, you will probably develop the infrastructure yourself.
Nordea Markets and Nordea Corporate & Investment Banking 34 Corporate Research 27 November 2017
For smaller companies the option instead of building their own warehouses or committing to long-term leases, is to hire a third party contractor to handle their fulfilment. This is more expensive, but also gives more flexibility. On the other hand, if you are Zalando or Amazon, for example, you can also potentially capitalise on the logistical capability you have built, and offer to handle logistics for others. A large part of these online businesses is actually pure logistics.
JT: We have noticed that omni-channel is a real buzzword in the industry and something many retailers believe will be "the future of retail." What is your take on that? Are you planning on adding any physical stores in the future?
Sportamore wants presence in JR: We think that it is of course good to meet the customers in many physical channels, but not different forums and channels. To do it in the physical world is as necessarily stores important as doing it online. However, it doesn't necessarily involve opening traditional brick-and-mortar stores.
At Sportamore we want to be present in a "sports ecosystem", meaning being a part of all the things you do that involves physical exercise. It can be anything from inspirational sports magazines to classes, events and competitions. Our key challenge is to find a natural presence in these environments. In this context, we think there are good opportunities for us to be "physical" as well. We work a lot through collaborations to make this happen. As an example we are the title sponsor for the Swedish Tjejmilen running race for women. For us this means being present on the day of the event, but also before and after. For Tjejmilen we built a website for managing the registration process for the race. On this site we could also offer contestants training schemes and inspiration before the race, as well as show our products. Finding a way to connect with the contestants after the race is also important.
Another example of a collaboration in a physical channel is that we run the online shop for the Swedish gym chain SATS. We always look for opportunities to be more present in the "real world". Taking the gym as an example, if you have a spinning class scheduled at 5 PM and you realise you forgot your socks, we could make sure that there are new socks waiting for you at the gym when you arrive. Or suppose that we together with a sports brand launched a new collection of clothes, and we could make sure that the spinning instructor wears it, and that you are offered [the opportunity] to buy it afterwards. We think that those kinds of smart and convenient things are the future ways for us to be present in the physical world.
Sportamore's Swedish online storefront Online store of Swedish gym chain SATS, operated by Sportamore
Source: Sportamore
Source: SATS
Nordea Markets and Nordea Corporate & Investment Banking 35 Corporate Research 27 November 2017
There is value in physically In the future, I think the distinction between what is physical retail and displaying your products, but does it what is online retail will be even more blurred. I think there will always be have to be in an owned store? a benefit from displaying your products physically where there are a lot of people. But why would that mean that you as a retailer need to own the floor space? It may be more profitable to lease the space for a shorter period of time, or there might even be someone else displaying your products. When we make the purchase, I think we would rather use mobile devices than an old fashioned cash register at a checkout counter. We already have the infrastructure needed for a purchase in our phones.
After a physical store purchase, When the purchase is made, it is up to the customer to decide how they customers should get to choose a want the product. Should it be delivered to you home, to your car, or do delivery option you want to carry it with you in a bag – or should it be gift wrapped and sent as a gift to your grandmother? Depending on what solution you choose, it may be different companies executing your order. Even if you do shop in the physical world, to carry the item home from the store might not be the optimal solution.
I believe this is a development that physical retailers will have to drive. When sales per square metre decline, they will have to cut back on floor space and they will have to carry less inventory. Hence, I think they will have to incorporate more digital solutions and faster distribution of their items to maintain their output. They have to shift approach from "the item is available in another store, we can reserve it for you", to "the item is available in another store, it will be at your door when you get home."
JT: What do you see as your main competitive advantages a pure online player, compared with brick-and-mortar retailers?
JR: The structure of our business is very different. We are present in a channel that based on current trends will within five years be 2-3 times the size it is today. Online sports apparel sales will on conservative estimates grow by around 150% over this time. For us, it means that if we just keep our market share, we will be 2-3 times as big in the near future. And, of course, we want to beat the market.
If you are able to keep your share of the market in the physical world, I think you will, if you are lucky, on the same time horizon be around 90% of what you are today. Hence it think it is urgent for brick-and-mortars to change. But if you have 95% of total sales in physical stores it is not that easy. You have to shift the focus to your online channel, and that will most likely harm sales in your physical stores.
Sporting goods retailers face Looking at the physical world of sporting goods, we also have a trend with competition from both e-commerce discounters taking market shares. Hence, for an average sports retailer, you and discounters are threatened from two directions. If you are a sports retailer in a small town in Sweden and an XXL store opens close by, it is an immediate threat to your existence. You will then not have the resources to address competition from e-commerce as well.
JT: Do you think you have any disadvantages compared to incumbent retailers with physical stores?
Everybody knew what Blockbuster JR: They often have a solid turnover and a well-known brand. As a new was and no one had heard of Netflix, player, we don't have this. However, I believe that this will not be enough, but you see what happened! if you cannot solve the underlying problem. Everybody knew what Blockbuster was and no one had heard of Netflix some years ago, but you see what happened!
Nordea Markets and Nordea Corporate & Investment Banking 36 Corporate Research 27 November 2017
JT: What do you think will happen with physical stores? More or less of them? Same function as today, or more as showrooms? Is there Nordic overcapacity in shopping floor space?
JR: I think that total retail floorspace must decline. Looking at the Brick-and-mortar retailers need to structure of the traditional retail industry, I think they are facing huge shed floorspace overcapacity as soon change. I believe there is an overcapacity in terms of retail floor space, and as possible that this will become much more evident going forward. I think the big challenge for brick-and-mortars is to get rid of this overcapacity as soon as possible.
Not many retailers show positive like-for-like growth today. In a positive scenario for the coming five years, brick-and-mortars could potentially keep their absolute sales volume, but the more likely scenario is that their market share will decrease. Ten years ago in the retail industry, we could see profit margins of 8-10%. Today you have 3-4% if you are very good, with many retailers being closer to zero margins. This implies there may not be sufficient money to invest in the change that I think is needed.
JT: What is the biggest risk for you going forward and what could really turn things around?
The biggest risk is when you stop JR: I think that the biggest risk is when you stop adapting to change and adapting to change stop developing your business. To be honest, back in 2010 I didn't realise how crucial smartphones would be to our business. I'm certain this was not the last thing I will need to figure out in digital development. You have to keep this in mind and be open to changes that lie ahead in order to stay relevant. Change within digital channels happen extremely fast.
Nordea Markets and Nordea Corporate & Investment Banking 37 Corporate Research 27 November 2017
Spotlight: Zalando – Euro no. 1 in online fashion
Only nine years after its creation in Germany, Zalando has become Europe's leading fashion e-tailer. It offers some 200,000 articles from own and external brands in 15 European countries, has seen a sales CAGR of over 50% in the past six years, and targets continued 20-25% annual top-line growth. Zalando is deliberately IT-heavy, employs 1,600 engineers, runs its logistics operations in-house, and even offers both fulfilment and marketing solutions to third parties.
Berlin-based Zalando was founded in 2008 by start-up studio Rocket Internet as a German online shoe shop, inspired by US online retailer Zappos. It has since broadened to include fashion and sportswear, and now offers some 200,000 articles from more than 1,500 brands. Zalando has
Headquarter Berlin, Germany also evolved from an online fashion store into a digital platform, emulating Founded 2008 particularly Chinese e-commerce companies by in effect becoming a Founders David Schneider and Robert digital shopping mall. Gentz Markets Germany, Austria, Switzerland, France, Zalando's offering includes women's, men's and children's fashion apparel, Belgium, the Netherlands, Italy, Spain, Poland, Sweden, accessories and shoes, ranging from globally renowned brands to local and Denmark, Finland, Norway in-house private labels. The Zalando website is accessible via and the United Kingdom smartphones, tablets and desktop computers, and is nationally customised CEO Robert Gentz for each of the 15 European countries in which Zalando does business. Revenue EUR 3,693m (2016) # of employees 13,218 (2016) Zalando offers customers free returns within 100 days of purchase, which Source: Zalando is unusually long for a fashion retailer.
The corporate strategy is based on The corporate strategy is based on three pillars: fashion, technology and three pillars: fashion, technology operations, which are considered essential for future growth and success. and operations Regarding fashion, the company has a clear value proposition not only for retail customers but also for fashion brands. Zalando provides a sales channel for brand owners, with support from targeted advertising and more accurate sales forecasts, and is a prominent European technology partner for supporting fashion brands transitioning into the digital era.
Zalando's revenue and adjusted operating profit margin, 2011-16 4.0 10.0% 5.9% 3.5 3.6% 3.6 5.0% 3.0 -1.3% 3.0 0.0% 2.5
2.0 2.2 -5.0%
EURbn 1.5 1.8 -10.0% 1.0 1.2 -15.7% -15.0% 0.5 0.5 0.0 -20.0% 2011 2012 2013 2014 2015 2016
Revenue Adjusted operating profit margin
Source: Company data Revenue CAGR of 52% for the past With a revenue CAGR of over 50% in the past five years, Zalando turned five years profitable in its seventh year of operations. The company is continuously exploring additional synergies between operational and technological processes, in order to meet its target of 20-25% annual top-line growth.
Nordea Markets and Nordea Corporate & Investment Banking 38 Corporate Research 27 November 2017
Zalando's share price performance since the 2014 IPO 50 45 40 35 30 25 EUR 20 15 10 5 0 2014-10 2015-10 2016-10 2017-10
Source: Zalando Source: Thomson Reuters
Zalando was listed on the Frankfurt Stock Exchange in 2014, and its share price has surged nearly 200% since the IPO. Its market cap is EUR ~10bn.
Number of employees in thousands, 2013-16 Number of website visits in millions, 2013-16
14 2,500 12.0 12 1,992 10.0 2,000 10 1,656 7.6 1,500 1,364 8 6.9 1,217
6 1,000 4 500 2
0 0 2013 2014 2015 2016 2013 2014 2015 2016
Source: Company data Source: Company data Zalando's business model is heavily Technological solutions drive all workflows at Zalando, all the way from focused on IT, and it employs more purchasing to order delivery. IT forms the backbone of the company, and than 1,600 engineers in seven tech Zalando now employs more than 1,600 engineers across seven tech hubs hubs in Europe in Europe.
Although it is an online player, Zalando operates three physical stores in Germany. These are a part of its off-price business, where it sells the previous season's collections at discounted prices. Since 2010 Zalando also has its own brands, "Z-labels", aimed to fill identified gaps in the collections from its suppliers.
In addition to its three main business areas (Online store, Off-price and Z- labels), Zalando also operates in three rather new fields: Zalon, Zalando Fulfilment Solutions and Zalando Media Solutions. Zalon is an initiative to connect freelance fashion designers and stylists with Zalando's suppliers, including brand owners. Using this service, apparel makers can consult and get inspiration from a selected stylist. Through the fulfilment solutions business, Zalando makes its own logistic capabilities available to external parties, and with Zalando Partner Solutions, it offers customised Source: Zalando marketing solutions for brand partners.
Nordea Markets and Nordea Corporate & Investment Banking 39 Corporate Research 27 November 2017
Interview: Retail is all about the experience
We interview Lars-Åke Tollemark, Managing Director Nordics of French-listed commercial property group Unibail-Rodamco that specialises in shopping centres, about competition from e-commerce and how it could affect retail property owners. In the Nordic region, Unibail-Rodamco owns flagship shopping malls such as Mall of Scandinavia, Täby Centrum and Nacka Forum outside Stockholm, Fisketorvet outside Copenhagen, and Jumbo outside Helsinki.
JT: E-commerce has grown from zero in the early 1990s to represent some 10% of Nordic retail sales last year. What do you think the retail industry will look like in 5-10 years? How could this affect Unibail- Rodamco's business?
LT: Data on e-commerce can vary a bit by source. We have, for instance, looked at reports from the Swedish retail industry body HUI, which currently put Swedish e-commerce penetration of total retail sales at 7%, plus another 1 pp in sales from foreign e-commerce players. In its report "Det stora detaljhandelsskiftet" ("The Great Transformation of the Retail Industry") HUI shows two scenarios for 2025: Swedish e-commerce penetration reaching 20% and 30%, respectively. Both are big numbers.
What do we think? For starters, the shift towards e-commerce has taken longer than we had expected. This has now started to change, with big retail players focusing much more on e-commerce, and I believe this will drive change more quickly going forward. It is also important to break it Big retailers have become more down by sector. Not all retailers will go online. Even if e-commerce takes active within e-commerce, which 30% of the market, offline will remain a huge market in which there will should drive further penetration be relative winners and losers. And there is also the omni-channel concept, going forward which we think will grow in importance, supporting physical stores.
From my own background in fashion retailing, I think the physical store concept needs to evolve. The typical store has looked essentially the same for the past 30 years, and is basically 0% digitalised. In the future, consumers will have totally different expectations for their shopping experience in a store, and it will not be enough to just have some iPads in it. A whole new level of digital integration will be required.
E-tailers will also need physical We believe the pure online retail players will need to have some physical stores – Nespresso is a good example interaction with the customers, too. But they will of course have a much more targeted and strategic expansion, compared to traditional retailers. Our strategy is hence to operate the relevant shopping centre, where you as a retailer want to, even have to, be. Nespresso is a good example of an e- tailer with physical presence. It has one of the best products for pure online business and still keeps opening a lot of new physical stores. Why? Because it needs to physically meet the customer, strengthen its brand and establish a relationship. I think we will see more physically present e- tailers in the future, but this will not compensate for the number of stores that brick-and-mortar retailers will probably have to close.
Shopping centres have to offer some If we look from our perspective as property owners, the trend is to offer products and experiences that cannot more products which are impossible to buy online. As an example, you be bought online can't buy a caffé latte online and have it instantly delivered to your home fresh and hot. Hence, the number of restaurants and cafés in shopping centres is increasing. Other critical factors for shopping centres include easy access to public transportation and proximity to office buildings and residential areas in order to get a constant flow of customers throughout the day. At our flagship Mall of Scandinavia in Stockholm, the gym opens at 06.30, and the last movie in the cinema ends at 01.30, which gives us a steady flow of customers at all hours.
Nordea Markets and Nordea Corporate & Investment Banking 40 Corporate Research 27 November 2017
JT: Who do you think will be the winners and who will be the losers in this great transformation?
LT: We expect three different types of commerce going into the future. There will be convenience proximity shopping centres, located close to transportation hubs and which mainly focus on convenience shopping such as pharmacies and groceries. There will also be the larger shopping centres, which is our business area, and the third category is e-commerce.
Shopping centres that are not easily accessible without a car will probably have a tough time going forward. There is an expression from the US: "Cars invented external shopping centres, and smartphones will kill them." The emergence of e-commerce has made the whole world our marketplace, which is putting pressure on small, independent, local retailers. We can certainly see that the number of store closures has increased in recent years, but these closures are mainly in small town areas. This does not necessarily mean that large shopping centres will have to close down as well. I doubt that any major shopping centre has so far E-commerce and shopping malls are been forced to close entirely due to e-commerce. In Sweden, shopping gaining market share at the expense centres and e-commerce are still both growing their shares of total retail of smaller retailers outside major sales, while retailers outside the major cities are seeing their share shrink. cities And regarding shopping in the cities, I like to sometimes provoke a bit, asking whether shoppers necessarily expect to do their shopping in the city centre? Isn't it better and more convenient to shop close to where you live?
JT: 44% of projects in your development pipeline are brownfield retail. Is this typically related to increasing capacity in existing premises, or modifying them for a changing mix of tenants with different future needs?
Brownfield development is about LT: We always look at how we can improve our existing shopping centres better use of land, and improving the where we already have all the infrastructure in place. A typical case for mix of experiences available in Unibail-Rodamco is our Täby Centum shopping centre outside Stockholm, shopping centres which is located in one of Europe's wealthiest catchment areas with a 99% penetration rate. We expanded the centre to 80,000 square metres on land previously used for a parking lot, and instead built an underground car park. By making these improvements, we went from 10 million to 12.5 million visitors per year.
In brownfield projects we work a lot with sourcing and with local authorities. We have also started to develop multi-use centres, eg properties with offices, retail space and apartments, where we can have a bigger stake than just the shopping centre. Within the shopping centres it is important to find the right balance between stores and entertainment. Today we actually compete with the service industry as well. We want you to choose to go to Mall of Scandinavia to play adventure mini-golf, instead of going to the Swedish ski area Sälen for skiing, yoga and other activities.
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Täby Centrum, Stockholm Mall of Scandinavia, Stockholm
JT: In the past few years a growing number of US shopping centres have had to close down. Do you see a risk of the same happening in Europe and the Nordics? Do you see overcapacity in existing or planned retail floor space?
Movie theatres are not extinct – they LT: I like to use the cinema industry as an example of how this could play have evolved to offer a richer out. The cinema has been declared dead as a concept several times: when experience, and it will be the same television came, when the VHS player was introduced, when DVD players for shopping centres became available, and most recently when Netflix and other on-demand media streaming services became widely available. And yet, cinemas are doing better than ever. Even though the same film is accessible at home, people go to the cinema to watch them. The main reason for this is that cinema operators have constantly improved the product, through the quality of the seats and premises, surround sound, 3D, food, snacks and beverages, etc. Watching a film has become a richer experience. This is exactly what we are doing with our shopping centres as well. We don't believe people will just stay at home and order stuff online, even if e- commerce takes 20-30% of total retail sales. They will to some extent, but we think they will also want to engage in shopping as a social experience. The big question is what kind of experience are they then looking for?
The US has far more shopping centre In the US, there is roughly 1,600 square metres of shopping centre GLA floor space per capita in Europe, (Gross Lettable Area) per 1,000 habitants. The corresponding number for and a different mix, with less Sweden is 460, and for continental Europe 251. This is a huge difference, entertainment and that's only for shopping centres. Other retail stores are not included. The other big difference versus the US is how the typical shopping centre is structured. In the US, it is basically built around one or a few large retailers, such as JC Penney, Sears and Macy's, which have around 50% of the floor space. There are a limited number of convenience stores, and not much entertainment. In contrast, in Europe virtually all shopping centres are anchored with convenience stores and more entertainment.
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GLA sqm per 1,000 inhabitants in the United States and Continental Europe
Source: Unibail-Rodamco
There is still growth in the retail I think virtually all forecasts show that there is still growth within retail. industry – the question is who will Looking at Sweden, for example, the Greater Stockholm area is growing gain and who will lose share rapidly, and we actually don't have enough retail floor space to meet the growing customer base. According to HUI you could open one Mall of Scandinavia each year just to meet the population growth. While encouraging, this does not mean it would make sense to open just any shopping centre.
Outdoor retail parks are more Looking at the actual statistics from HUI, there are some 40,000 shopping vulnerable than shopping centres centres in the US, and we have seen around 20 net closures over the past due to competition from e-commerce seven years. It is not an alarming number, I would say, but this doesn't necessarily mean there will not be pressure in the future. I am curious to see what will happen to outdoor retail parks. Will people still go there in the future? As it is today, they have limited access to public transportation and compete mainly on prices. I believe this is an area which is potentially very vulnerable to competition from e-commerce.
JT: Unibail-Rodamco – a key to success is to differentiate the shopping centres and create a “multisensory shopping experience”. Could you elaborate on what this means in practice and how you differentiate your shopping centres from the competition?
Unibail-Rodamco's malls offer a LT: Multisensory for us represents the quality of what we do. Our offering premium environment, convenience caters to the mass market, but is of very high quality, with a top level near and top locations – at a necessary "the bridge-point to luxury." What we deliver are shiny floors and super- cost which pays off clean facilities. The toilet facilities in our malls are probably nicer than the ones you have at home. And in Täby Centrum, for instance, we have received a prize from the municipality for the most beautiful parking garage.
Wayfinding is another important aspect of quality. It starts on the website or in the app when you look at how to get to the mall, and where you should park if for instance you want to be close to the cinema. We also have a feature in our app which is called "find my car," that gives you the geo-position of your car. When you enter the mall we have fragrance in the entrances. It is clean, it is clear, it is entertaining, and there are good offers.
All of our major events are free and for everyone. We had the drawing of opposing teams for the European championship of football, we had the launch of the latest Samsung Galaxy smartphone, and we hosted the premiere of the Star Wars movie "The Force Awakens" one day before the rest of the world. We strive to be multisensory and inclusive. It is important that it doesn't get too exclusive.
We also work a lot with "the customer journey." It should feel like you are walking in different environments within the shopping mall. In Mall of Scandinavia for example, we have a curved layout to achieve this
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sensation. We also change the floor, the furniture and the colours within the mall and cluster the boutiques by type. There is quality WiFi and charging ports for smartphones and for electric cars. These kinds of services are expensive but should be fast and free, you cannot cut any corners here.
We look at the national sales index in order to see how we are performing compared to the overall retail market. We want to continuously deliver better numbers than the index. We also have a targeted tenant rotation rate of 10% annually. This means that for example in Mall of Scandinavia we should deliver 22 new concepts each year. We track all our tenants with regards to sales, and map them on their occupancy cost ratio. The retailers that are in the bottom of this list will eventually need to be replaced. Looking at our numbers, we can clearly see that tenant rotation improves sales. Hence, it is crucial for us to relentlessly try to identify new up-and- coming retailers, and to help develop new concepts for existing ones.
We have also had many new market entrants in our shopping centres: we had the first Apple store in the Nordics in Täby Centrum, the first Hollister store, the first Rituals, and also the first Tesla showroom in continental Europe. The consumer of today doesn't want to see the same retailers all the time in shopping centres, and we have to adapt to that.
JT: Mall of Scandinavia in Stockholm is a recent big project, having opened in late 2015. Has it performed as you expected? Has it brought lessons or experiences for upcoming projects?
LT: I believe Mall of Scandinavia is the most successful opening of a shopping centre in Europe, and I believe it is because of the content within the centre. The mall and its surroundings are now actually sometimes referred to as "the second downtown" of Stockholm. Interestingly, fashion sales, which have been declining for several years, are actually seeing growth in Mall of Scandinavia. From this we can conclude that fashion is still possible to sell well in malls - it all comes down to what retail mix you can offer.
JT: How agile are you to changes within the stores? Is it possible for a retailer to implement specific tailor-made technologies locally? Can you adapt if physical stores become showrooms or delivery centres?
Unibail-Rodamco is often ahead of LT: We are actually often ahead of our retailer tenants in this area. Usually its tenants in developing and the large retailers have huge resources to spend on this, while the smaller digitalising store concepts, actually ones have less; and there we are able to help. We work a lot with this all contributing to driving change the time in order to stay relevant and at the forefront. We constantly need to challenge our retailers on how they present themselves. I have personally signed off on all 224 shop fronts in Mall of Scandinavia. In our contracts we control the appearance of the first 2.5 meters in each store, which is critical for the overall look-and-feel of the shopping centre.
We are also active in developing different concepts. One example from Mall of Scandinavia is the O'Leary's sports bar, where together with them we have successfully created two different parts of the restaurant: one family friendly area, and one dedicated to sports fans.
A recent initiative from us has been to integrate e-sports into our shopping centres. We have had a collaboration with Niantic, which owns Pokémon, which has been a huge success. I believe we will work even more with these kinds of collaborations in the future. I also think it will be a big thing for retailers to shift focus from designer collaborations to YouTubers, e- gaming, etc, where you can find new correlations and synergies.
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JT: What, in your opinion, is the biggest risk factor for your business going forward?
Business risks include any potential LT: Since we are present in Europe, I would say that potential security security incidents incidents are a risk we have to live with. We know from experience that such incidents can put temporary dents in visitor traffic. When it comes to other risks, we are vigilant and try to evaluate them, and we are not afraid Competition from e-commerce is met to take tough decisions and sell off property if we deem it necessary. Our with investments and mix renewal strategy is to be as ready as possible when e-commerce hits traditional retail sales for real. The "e-commerce risk" has been mitigated through a lot of investments, and by focusing more on large shopping centres. When we eventually experience a downturn in the economy, we want to have the malls that customers will still visit even if they have a lower consumption capacity.
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Retail property: Reinventing itself
Digital disruption risks for retailers mean shopping centre owners need to watch out, too. The perceived US retail apocalypse is a scary example of what may lie ahead, but is not only being driven by e-commerce gaining business from physical stores. US retailers with flawed concepts (department stores) or high leverage are closing stores, but few entire shopping centres have closed. US overcapacity in retail floor space is not mirrored in Europe, although there are some risks of local excess capacity being added in the Nordics. Shopping centres offering more than just shopping should stay most viable going forward.
Digital disruption also for retailers' landlords Retailers being exposed to digital We have now taken a good look at what the growth in e-commerce could disruption from e-commerce growth mean for retailers, and how brick-and-mortar players may need to means shopping centre owners being articulate a view on how to stay viable and relevant when consumers buy exposed as well more goods online in the future. But what about their landlords? Retailers typically do not own their shops, and the property owners who do are arguably every bit as exposed to what happens to their tenants as the retailer tenants themselves. If there were to be no need for those physical stores in the future, could the premises be used for something else? Let us take a look at what digitalisation of the retail industry could mean for commercial property groups specialising in owning and running shopping centres.
The shopping centre owner rents out retail floor space to tenants who pay a rent for the privilege of operating a store in the premises. Rental contracts typically have a fixed rent, although a limited share of contracts can be turnover-based, ie the retailer pays a fixed rent plus a share of revenue generated by the store. The landlord (shopping centre owner) is committed to providing core infrastructure and services, such as parking, toilets, information, maps, communications like WiFi, advertising for the shopping centre, security, etc.
Shopping centres need to attract Landlords make money from rental income, and thrive when retailers are visitors, retailer tenants need to queuing to lease store space in their particular shopping centres. For the convert visiting into shopping shopping centre owners, luring consumers to visit the shopping centres is crucial. They need to show visitor traffic. Then it is up to the retailers renting floor space to convert the visiting into shopping and spending. If the shopping centre cannot attract visitors, retailers have no wish to be there, as there are no potential customers to lure into their stores.
When consumers buy more online, So what happens when consumers start buying more goods online? They shops may not be enough to lure visit physical stores less frequently. This means lower physical store sales them to visit shopping centres for retailers, and less visitor traffic for shopping centres – a vicious circle.
The US example – not a template for Europe E-commerce growth, store closures A lot of media attention has been given to the perceived "retail and retail bankruptcies have led to a apocalypse" in the US, with major store closure initiatives particularly perceived 'retail apocalypse' in the among department store chains, high-profile retail bankruptcies such as US private equity-owned Toys 'R' Us in September 2017, and the continued stellar growth of online retail pioneer Amazon, which alone accounts for ~40% of total online retail sales in the US.
Pressure is not only from e- One could be forgiven for claiming to see death looming for the US retail commerce, but also from a faltering industry with this kind of backdrop. But the reality is not quite as department store retail concept and straightforward. There is no doubt that the US retail industry is seeing overcapacity in US retail floor space significant competitive pressure from growth in e-commerce, which continues to capture a rising share of total retail sales. But the retail industry's woes are not exclusively explained by digitalisation. The decline is also driven by the department store channel's structural decline – it has
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for many years seen a strongly decreasing ability to attract consumers, and is not the concept today's shoppers are looking for. Another crucial factor is the extent to which the US is "over-served" by shopping centre retail floor space.
Retail floor space, square metres per 1,000 inhabitants, in selected countries 2500
2000
1500
1000
500
0
Source: Statista
Development in the US, 2010-16 The graph above is an illustration of the extent to which the US population Closed malls 20 Total number of malls 40500 is potentially over-served by shopping centres. Measured by square meters Source: HUI of retail floor space per 1,000 inhabitants, the US has almost 5x the retail floor space capacity per capita of Sweden, 11x that of Germany, nearly 17x that of Russia, over 50x that of China, and almost 400x that of India. These are big numbers: The US is by a wide margin in a league of its own regarding shopping capacity available for its consumers.
There are factors explaining why the US is so heavily penetrated within retail, including:
There are structural reasons why the GDP and household income per capita is high US is more retail-heavy, but with There is a shopping and consumption culture and tradition 5-10x more floor space per capita There are many very professional and successful retailers than Europe, and 50x more than The US tax system has created incentives for local authorities to China, there is a capacity challenge encourage the establishment of retailers – they generate local property and sales tax revenues Consumer goods prices are comparatively low in the US, as there is no national sales tax, or VAT, which boosts retail sales
These factors should continue to support retail sales in the US, but the combination of e-commerce continuing to capture a greater share, and the sheer magnitude of how much more retail floor space is servicing US consumers compared with other countries (many of which also have high household wealth), in our view suggests structural pressure on the US retail industry going forward. And this means corresponding pressure on shopping centre operators – the owners of retail property.
Few entire shopping centres have To put things into perspective, only 20 US shopping centres have closed closed in the US, but retail chains down in the past seven years, out of a total of some 40,500. But it is not with obsolete concepts or excessive common for an entire shopping centre to be discarded. The real story is leverage are closing stores told by retailers underperforming or defaulting (such as the Toys 'R' Us bankruptcy), and by the net of store openings and store closures. And we are seeing, and will probably continue to see, major waves of store closures from retailers whose concept does not strike a chord with today's consumers, such as Sears (including Kmart), Macy's and J.C. Penney. Add to this retailers who may have a viable concept, but are excessively
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leveraged and may find it difficult to keep servicing their debt in a market where lenders are increasingly reluctant to extend credit (or at least to extend cheap credit) to a sector perceived to be in trouble.
Nordic retail property: Potential overcapacity in some places While in the Nordics there is nowhere near a similar structural retail floor space overcapacity challenge that we can see in the US, there are some capacity risks.
With ultra-low interest rates, yield- In today's ultra-low interest rate environment, investors are hungry for hungry investors can be tempted by yield, which "safe" assets such as government bonds do not offer. It can be shopping centres offering 4-7% a very tempting proposition to consider acquiring retail property which could yield perhaps 4-7%, looking perhaps less at a thorough analysis of the prospects for Nordic private consumption and retail sales, and more at the relative consideration: if I do not invest in bonds or in (more volatile) equities, what do I invest in to find a yield which gives me a chance to achieve my performance target? Perhaps in one of those nice new shopping centres?
Long lead times for construction And this can become problematic. Lead times are long in property projects means a risk of too much development, with many years between applying for land development new retail capacity when the market permits, to a new shopping centre standing ready to receive its first slows down customers. If new ones open when private consumption slows down, the market can become over-saturated, with old and new shopping centres in the same catchment area standing half-filled with customers.
Annual retail floor space additions, Sweden, square metres 350000
300000
250000
200000
150000
100000
50000
0 2013 2014 2015 2016 2017* Average yearly planned 2017-2025
Source: HUI
Sweden: Eight more peak years of The graph above illustrates the capacity outlook in Sweden, with planned retail capacity additions in current retail property expansion in the next eight years at an annual average of pipeline – biggest overcapacity risks just above the recent peak in 2015. So there is a lot more retail floor space outside big cities on the way to be added in the market. This is a potential challenge, but it will also matter greatly what type of capacity will be added, and where. The major cities are growing, and can arguably absorb quite a bit of new capacity. Rural areas could suffer badly from major capacity additions, if they are already in structural decline.
Most obvious retail overcapacity risk Judging from our interviews with Unibail-Rodamco and Citycon, the retail in Finland, no new capacity on the floor space capacity outlook is manageable in Sweden (at least in the way in Norway major cities), good in Norway (where for the time being there is a moratorium on new shopping centres), but threatening in Finland, which is seeing major capacity expansion in a still weak consumer environment.
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Also summing up the impressions from our interviews, the healthiest prospects should be seen for shopping centres which:
Best prospects for up-to-date urban Are located at strategic hubs in super-urban areas which are integrated prime spot shopping centres with with public transport to allow great visitor flows not dependent on cars entertainment and services or traffic Have an appealing mix of up-to-date retailers, entertainment and services, and offer a rich experience beyond just buying goods Are fresh, clean and modern
And the most challenging outlook should be faced by shopping centres which:
Biggest challenge for non-urban Are located in secondary or tertiary location, with less compelling centres reachable only by car and catchment areas offering little more than shopping Are reachable only by car Are not weather-protected, ie outdoor retail parks Offer only shopping, little or no entertainment or services Are located next to a new centre being built, facing cannibalisation
The big, professional and well-resourced players in retail property have spotted e-commerce growth trends and formed a view of what is coming. Their exact responses and strategies vary, but all address the same structural challenges. Time will tell what works best. But for those shopping centre owners for whom retail is not a core competence or business, who happen to run one or several "me, too" centres, it is high time to seriously consider how and from where they could remain able to attract visitors, in case the e-commerce share of retail sales grows to 20%, 30% or 50%.
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Interview: Going for convenience and community
We interview Marcel Kokkeel, CEO, and Eero Sihvonen, CFO, of listed Finnish shopping centre- specialised property group Citycon, about the role of and success factors for tomorrow's shopping centres in an environment where consumers have shifted a greater share of their wallets to online purchases.
EB: Growth in e-commerce has accelerated in the past few years, pushing it to a 10% share of total Nordic retail sales in 2016. What are the key drivers for e-commerce growth, and how far do you think it could go?
MK: Nobody knows how big online sales will ultimately get, but I see an evolving consensus in the markets that it is not simply about online versus physical retail, but rather about what customers want to buy. Customers don't spend a lot of energy pondering if they should buy through an online or an offline channel – they simply want to buy a specific good. Sometimes they go online and sometimes they buy it in a store. I think the Marcel Kokkeel and Eero Sihvonen future of retail is all about multi-channel. I could argue that we are already there. If you don't go multi-channel, you will have a hard time. To only stick with your online platform as an e-tailer is not good enough, and will not be good enough in the future.
Earlier this year Amazon bought Whole Foods. Why did it do that? I see three reasons:
1. Amazon wanted to provide its customers with an even better service, E-commerce will continue to capture which is only possible to do in-store. a greater share of retail sales, but e- 2. The company cannot create the same excitement in an online store, and tailers are increasingly also looking credibly call it an experience. for physical channels 3. It wanted to add another layer in their distribution system, where the physical store is needed as a distribution hub.
So now Amazon is in a new world, our world! But I think that the combination is the future. The new world, e-commerce, will not survive without the old world.
Walmart's online growth is 60% annually. Where will it end up? I will not hazard a guess on a specific number. But I am certain that for the fashion category, the share of online sales will be much higher than for groceries and services.
ES: There are actually many online operators opening brick and mortar stores. In the US, more than 50% of the pure online brands open physical stores, highlighting Marcel's point that it is all about the combination.
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EB: What will growing e-commerce mean for brick-and-mortar retailers? What should they do in response? Have you seen their behaviour or strategies change in the past five years?
ES: In shopping centres, we need to add another layer of service, entertainment or convenience to the customers – there needs to be more than just retail. It can be cafés and restaurants, it can be municipal services, or it can be healthcare. There are many potential routes to attracting consumers, beyond the actual shopping.
MK: Public transport is another trend. We think shopping centres will weather the digital storm for several reasons. One is that when public transport is integrated into the shopping centre, it brings lots of people to your centre on a daily basis, who have easy access to everything on offer there. Our shopping centres in Kista and Liljeholmen in Stockholm, Sweden, are right on top of metro lines, as is our new project Globen Shopping at the Ericsson Globe arena.
Shopping centres need to offer more And we indeed need to offer more than shopping in our centres. We have than retail – Citycon aims for for example added digital libraries, in which you can meet friends, study, convenience and community, adding or listen to presentations. It is a kind of new, modern forum for socialising digital libraries and healthcare and studying. In the past few years we have also added many health care providers providers as tenants. They are a different type of tenant from a fashion retailer like H&M or Cubus, but their expertise and often strong, stable customer relationships add value to the shopping centre. Our best example of this is Iso Omena in Espoo, a Helsinki sub-region in Finland. This is our largest shopping centre, in which we have 6,000 square metres (out of a GLA of 101,000) for what we call "public service space", which includes a digital library and healthcare providers. These tenants alone attract 1.5 million people to Iso Omena, out of an expected 14.5 million annual visitors after the stabilisation of the shopping centre’s expansion.
Shopping centres will not disappear, but they have to change. For us at Citycon, it is all about convenience and community. Maybe we will have even less retail and more services going into the future.
EB: From your point of view, is there a difference in profitability between retail and the community-oriented tenants?
Healthcare and digital libraries MK: Community-oriented tenants are, of course, typically not the highest complement retail tenants, making rent payers, but they bring a lot of visitors to our centres and normally they use of non-prime space, driving have a very solid and stable cash flow, boosting the credit profile of the visitor traffic and remaining very shopping centre. I like to compare it to a bond investment. stable
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ES: These tenants do not typically need the best locations in a shopping centre and they could be located eg on the third floor of a shopping centre, which might otherwise be difficult to lease for high-street retailers. In Kista, for example, we had a few retail stores which all had an in-store connection to the second floor above. Traffic to the second floor was not good enough, so the costs for the retailers became too high. We re- negotiated, took back the second floor space from the retailers, and converted it to a digital library. The library pays the same rent as the retailers did, but generates much more visitor traffic. We sustained cash flow and the shopping centre changed its mix towards less retail.
EB: Have you seen any major changes in consumer patterns at your shopping centres in recent years? Number of visitors? What hours? Customer demographics? Sales volumes?
Shopping centre visitors today look MK: I think today's customers tend to be more focused on self for more entertainment and are more entertainment and we have responded with a big increase in the number of focused shoppers, having done their cafés and restaurants in our shopping centres. We constantly need to homework online in advance improve the atmosphere in the shopping centre, to encourage visitors to shop and entertain themselves. And entertainment does not have to be a spectacular Jurassic Park, or the biggest aquarium with sharks – it can also be a nice cup of coffee.
ES: The customers that we see today are more informed. Everybody has a smartphone and a smaller volume of people can generate more sales, because when they visit they are more dedicated – they have already done their research at home. If you go to a shopping centre today, you are generally more focused, not just browsing at random.
EB: How do you see e-commerce affecting the business model for shopping centres? Different for city versus suburban, or for big versus small centres? Shopper "experiences" versus low prices?
MK: We think that for shopping centres the battle is not about size, but about positioning. You can still have nice smaller shopping centres that service customers on a local basis – community and commerce. However, at Citycon we have set a minimum size of around 15,000 square metres, having decided what we want to be. The rest we have already sold, or they will be sold in the coming years. With the size that we have, we say less is more, so fewer shopping centres but higher quality. Although the smaller centres can still be profitable, we have taken another strategic approach.
Citycon's asset selection is driven by We don't believe in shopping centres that are only reachable by car. We super-urban and public transport think they will be the relative losers in the future. We believe that "urban" is a megatrend. If we were to choose between urban and suburban, we would chose urban, and if we were to choose between cars and public transport, we would chose public transport. Hence, the drivers for our asset selection are super-urban and proximity to public transport.
ES: We like to have centres that are dominant in their catchment area, like Kista, and like we think Globen will be. Such shopping centres have a natural protection against new competitors.
MK: Kista is a good example of the pros for being in a super-urban environment. In 2015, Unbail-Rodamco's Mall of Scandinavia opened only 10 kilometres away. If that would happen in a non-urban environment, you would have a very hard time. What we see is that Kista changed and will continue to change, and hence survive in a completely different setup from Mall of Scandinavia, as a local daily convenience shopping centre. And it is possible for the two to live and prosper next to each other.
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EB: Are there differences in what tenants are mainly looking for in your shopping centres today versus five years ago? Rent levels? Location? Functionality and logistics support in the premises? Image and appearance?
MK: Yes, we have a different tenant mix today, with more tenants focused on sports and entertainment. Five years ago there were virtually no gyms in our centres, while today every centre has at least one. As we mentioned earlier, the number of cafés and restaurants has also increased. In our largest centres we have approximately 25% of food and beverage tenants. Tenant mix has changed: Less retail, Five years ago it was clearly lower. In Asia, you see 30-40% of shopping more sports and entertainment centre tenants in sports and entertainment.
The restaurants need to be of good quality, McDonald's is usually not good enough. Today, our customers want to go wining and dining in a "fast- fashioned way". The restaurant culture has changed. We less often make reservations, instead going there spontaneously to order one course, and leave after 40 minutes as a happy customer, without paying a lot.
EB: Your malls are located in urban areas and you have many supermarkets among your tenants. In your annual report, you state that your centres are "grocery anchored". Is that anchor critical? Could it be less solid, if online food sales were to take off in the future, from current low levels?
Online penetration of grocery sales MK: We strongly believe that people want to taste, feel and pick fresh food should be much lower than for other themselves. Fresh food is a megatrend. We think that food online will retail categories, like fashion grow, but not by the same magnitude as the non-food segment. I think that it could end up somewhere between 3-5% of total sales. Hence, groceries will continue to bring customers to shopping centres, also because people love to be in control of the necessities.
ES: The logistical aspect is also a real challenge for online groceries. Most likely it will be better to pre-order the groceries and then pick them up in-store. Sweden, Finland and Norway are countries where distances are often great and many people live far away from major distribution hubs, hence there are serious challenges for online groceries, as they mainly consist of perishables.
EB: Do you see a need to refurbish your properties to meet new customer needs? Appearance or mix of tenant types between shops, restaurants and entertainment? Logistics? New technology in stores?
Shopping centres will continue to MK: Yes, we spend a lot of money on refurbishing and that will continue. need investment, as well as a retail But it is more than only investing money. In today's environment, it is hard and customer preference-sensitive to survive if you neglect the customer's way of thinking. It needs to be in mindset your veins if you work in this business. At Citycon, most of our people come from retail, so that is an expertise that we have.
At the same time, we are not experts in letting out office space, hence the offices we acquire are most of the times converted into health care. The Globen centre that we recently bought into, by the Ericsson Globe arena, is a great example of a centre in a superb catchment area, connected to public transport, that has lacked a retail- and customer-centric way of thinking. Its potential is there to be exploited. It will be a "hybrid centre", which means convenience shopping, also connected to certain events in the adjoining arena. We will also add public services.
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EB: The US is often highlighted as an example of excess shopping floor space in relation to demand. Do you think there is any such issue in the Nordic region, today or for planned floor space in the coming years?
Pressure on US shopping malls is not ES: There is a similar issue, but not at all of the same magnitude as in the only from growth in e-commerce, but US. A majority of US malls are anchored by one or more department also from flawed shopping centre stores like Sears or J.C. Penney, which are 'average quality'. The concepts department store retail concept has struggled for a long time, even before e-commerce surged. Also, most US shopping malls are only reachable by car. Basically everything in that business model is wrong.
The US economy is built on consumerism. What we see now is that people behave in a different way, they don't just want to gather stuff to consume. When you add all this up, these weak concept malls get in serious trouble. There are of course some similar examples of this in our part of the world, but they are rarer.
Shopping centre overcapacity is MK: In Helsinki, too many shopping centres have entered the market and much less of an issue in the Nordics, continue to enter the market. That is a fact. In Sweden, I think we have a but still a risk, as evident in much more moderate development. Excess shopping centre capacity will secondary cities today bring only losers – investors as well as consumers. We risk ending up with half-empty shopping centres, and no one wants to visit a half-empty shopping centre. This is certainly something that we see today in the Nordics, especially in secondary cities.
You have to build in response to demand. But the real estate industry does not always work like that. There is often a lot of pressure from politicians, landowners, construction companies, but also from retailers who wants to expand.
ES: This is also a consequence of the ultra-low interest rate environment that we find ourselves in today. Since returns are so low for most asset classes, the prospect of getting a 4-7% yield from investing in a shopping centre is tempting for many investors.
EB: What would be the greatest risk for you as a real estate company going into the future?
The key business risk is any collapse MK: I would say consumer confidence is number one. We live by the in consumer confidence, which willingness and the ability of consumers to spend money. If they fear that would hurt retail spending their income will be less in the future, they will start to cut back on their spending and we will have a hard time. This happened in Finland for several years. Was Finland that bad? Not at all. If you looked at household debt, it was lower than for Sweden. So why didn't they spend? Apparently there was something in their perception of what lay ahead that held them back. For Finland I think it was a combination of the collapse in trade with Russia and the demise of prior mobile phone champion Nokia. Both happened simultaneously and all of a sudden people didn't spend anymore. In our industry that is one of the biggest risks.
Nordea Markets and Nordea Corporate & Investment Banking 54 Corporate Research 27 November 2017
ES: Excess capacity in shopping centres is also a major risk. Not so much here in Sweden, but certainly in Finland and Estonia, where we also operate. In the end, it all comes down to who has the best location and the best concept, but in the meantime it will impact the margins and the profitability of the whole industry. For the time being, that is a bigger threat than online retail growing its share of the total.
The countries where we operate in are very different in this aspect. In Norway, it is practically impossible to build new shopping centres. This is not something that will last forever, but for the time being they have this ban. You can expand, but you cannot build totally new centres, which limits the overcapacity risk in Norway. It is also low in Stockholm, because here we know with great certainty what is going to be built and where. Generally, the further away you move from the main cities, the higher the capacity risk. In Finland, this risk is big even in Helsinki, as retail floor space is already expected to grow by 30% in the coming years.
Funding cost and availability risks Of course there are other risks as well. There is always the risk that are significant, but currently financing will be less available and that the cost of debt will be higher, but manageable we are well-equipped to handle those risks. Our balance sheet is in good shape, we have investment grade ratings, we have access to bond financing and our debt portfolio is 95% fixed so we are not among the first companies to suffer when interest rates start to rise. That is the reason why we are not mentioning this as our number one risk.
MK: Everything goes in cycles, economies as well as trends. But what we do know for certain is that tonight we are going to have dinner again, we need to eat, we go to the hairdresser, we need new clothes – so retail will always be there. Especially within the service industry. Whatever the economy will look like, you need to be served, and I think that is the defensive part of our strategy choice. Together with our necessity-driven, super-urban and public transport philosophy, I think we have a quite conservative business model.
EB: If we assume that there will be some new entrants in the market that will not perform well, would you consider acquiring assets and redeveloping them, or would you rather stay as you are?
Citycon has a clear strategy it will MK: First of all, money is for us a not an unlimited resource, so we are maintain, rather than looking for very much aware that we need to recycle capital for the plans that we have, distressed assets to buy to further urbanise our shopping centres and make them even better. We opportunistically can't just buy whatever we want to buy. I also think we need to be disciplined. If we sell some of our properties that we have deemed too small or non-urban, we are not going to buy new ones just because you can buy them at a 7-8% yield. We have our strategy and we want to stick with that.
ES: We remember the previous local banking crisis of the early 1990s. What is different now is that of course we don't have a crisis, but interest rates are very low. During that banking crisis they were very high. This is the reason why very few properties are likely to be taken over by banks, or default. Interest rates are so low that even if you have a sizeable vacancy, your property can service the loan and make interest payments. And banks are especially reluctant to take over. This means that it would take a rather extreme situation for such a shopping centre or property to even become available.
Nordea Markets and Nordea Corporate & Investment Banking 55
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