EQUITY RESEARCH | Apurgiul, s2t0 21,7 2017 The US retail sector is Matthew J. Fassler overstored and out of step in (212) 902-6740 an era of e-commerce. But [email protected] retail is not dead; it is Goldman Sachs & Co. LLC changing. How brick-and- mortar stores employ new Heath P. Terry, CFA technologies and new (212) 357-1849 models may determine how [email protected] they survive the relentless Goldman Sachs & Co. LLC shift online. In the latest report in our Profiles in Jesse Hulsing Innovation series, we look (415) 249-7464 at the enabling technologies [email protected] emerging to leverage the Goldman Sachs & Co. LLC benefits of a physical store, whether as logistics machines optimized for Lindsay Drucker Mann, CFA distribution or as (212) 357-4993 showrooms for the next [email protected] Goldman Sachs & Co. LLC generation of customer engagement. We draw on interviews with retailers, VCs Katie Price and entrepreneurs to map (917) 343-9516 the ecosystem of enablers [email protected] and challengers bringing the Goldman Sachs & Co. LLC Store of the Future to life, and to show the forces Rachel Binder super-charging data and (212) 902-0097 marketing to understand and [email protected] influence the shopping of Goldman Sachs & Co. LLC tomorrow. TPhReO SFItLoErS e IoN f ItNhNeO VFAuTtIuOrN e Reimagining Retail in the E-Commerce Era Goldman Sachs does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. For Reg AC certification and other important disclosures, see the Disclosure Appendix, or go to www.gs.com/research/hedge.html. 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August 2, 2017 Profiles in Innovation Contents Portfolio manager’s summary 3 How did we get here? 3 Toward a realistic transition 4 The retailer of the future 4 The store of the future 5 …for two kinds of markets 5 Advanced data analytics: The marriage of IOT and machine learning 6 Key tools 6 Story in Numbers 11 Why we are talking about the store of the future 12 The state of retail in six charts 14 How to respond to an existential threat? 15 Bridging the BI gap 17 Disruptive retailers are forcing the issue 19 What are the stakes? 19 Who else is talking about the store of the future? 21 The role of IOT 28 The evolution of beacons use cases 29 The role of computer vision 31 The role of RFID 32 Making sense of it all; AI drive processing power 36 Defining terms 37 BI-focused applications 40 Marketing-focused applications 45 Who is investing in the store of the future? 52 What could derail the store of the future? 58 Disclosure Appendix 62 Contributing authors: Matthew J. Fassler, Jesse Hulsing, Heath P. Terry, CFA, Lindsay Drucker Mann, CFA, Katie Price, Rachel Binder, Heather Bellini, CFA, Matthew Cabral, Natasha de la Grense, Richard Edwards, Hugo Scott-Gall, Toshiya Hari, Rob Joyce, Chandni Luthra, Piyush Mubayi, James Schneider, PhD, Stephen Tanal, CFA, Alexandra Walvis, CFA. This report continues our Profiles in Innovation series, which analyzes how emerging technologies are creating profit pools and disrupting old ones. Access the entire series below and visit our portal to see related resources. Virtual & Drones Factory of Blockchain Precision Advanced Artificial Space Augmented the Future Farming Materials Intelligence Reality Goldman Sachs Global Investment Research 2 August 2, 2017 Profiles in Innovation Portfolio manager’s summary The most dynamic story in retail today is the ongoing share shift to ecommerce. The biggest story in retail is the fate of the 85% of retail sales currently transacted in stores. Retail is not dead; it is changing. Despite the rapid and seemingly relentless rise of ecommerce, rolling forward its recent 15% growth rate on a progressively larger base still results in 70% of retail sales via the store in five years’ time. And the fate of those sales is, in part, up to the companies that still command that market share. Those that take their fate Watch a video into their own hands and play to the acknowledged strengths of the physical store by summary of this enhancing their stores should outperform those who choose to lean on legacy business report with author practices. Matt Fassler. Go> These successful retailers will make the difficult choice of optimizing either their logistics or showroom capabilities; they will lean on vendors to feed their content and fund their displays; they will deploy services tougher to mimic online; they will of course drive digital; and they will seek out, consume, and deploy data to run more intelligent businesses. Along this path, they will disrupt the store to enhance the store, rather than to replace it, adapting emerging technologies that bridge the information edge online retailers presently bring to the marketplace. They are merging IOT and machine learning to achieve new levels of business intelligence, beginning to use sensors to understand path to purchase, key customer triggers, and sensitivity to changes in pricing and display, and to use some of these same tools to engage in next generation customer engagement. An ecosystem of firms, some established, some brand new, is catalyzing and feeding this innovation, offering a much-needed boost to an increasingly besieged industry. We explore innovators such as RetailNext, which provides new depths of Business Intelligence to retailers; Farfetch, which is deploying emerging technology in service of an interactive in-store experience and next-gen customer engagement; Blue Yonder, a key provider of AI services to retailers loaded with data yet starved for insights; and Amazon Go, Amazon’s emerging effort to drive a frictionless brick & mortar shopping experience, which has shocked incumbents into considering more radical in-store innovation. And we hear from experts such as futurist Steve Brown; entrepreneur Healey Cypher; and, venture capitalist Steve Sarracino, all of whom explore opportunities for innovation in retail. How did we get here? Retailers built large chains with real estate funded by landlords through leasing and inventory funded by vendors through generous payables terms. These large chain retailers were able to turn to the capital markets to fund extensive real estate build-outs, leading to the development of lifestyle centers, outlet centers, and power centers without demolishing the traditional malls these formats cannibalized. They built out category-killer businesses serving increasingly limited markets. And for decades, this strategy worked, resulting in massive wealth creation. Even today, with all the growth and promise of ecommerce and the pessimism associated with brick & mortar, 131 of Forbes’ billionaires list, or 7%, have fortunes emanating from retail. Adding in fashion, consumer goods and real estate firms designated as “fashion and retail” by Forbes raises the number to 237, 15% of the total, and ranking second behind finance & investments. Goldman Sachs Global Investment Research 3 August 2, 2017 Profiles in Innovation Retailers worked to optimize their businesses, but in many instances they reached out through mass marketing and cut prices aggressively with the hope that they would capture share, settling for anonymous relationships with their customers. More recently, however, ecommerce has offered the extreme convenience of home delivery, at a diminishing cost, with an extreme assortment – the “endless aisle,” and, if not deep value from every retailer, price transparency that enables consumers to scrutinize price. In return, consumers by definition opt in to share their data with online retailers, with complete transparency to their behavior. In recent years, many retailers have filed for bankruptcy while others have been closing stores. The initial reaction of the rest of the “surviving” retailers has been to mimic the mechanics of ecommerce by offering consumers the ability to order online. In many instances, firms offer the additional option of in-store pickup as well as returns and live customer service (addressing product questions, break & fix). This effort is often dilutive, as the retailer is developing additional infrastructure to service the same customer and the same order. And even if these actions are necessary, they are not sufficient for retailers to thrive. Toward a realistic transition But there is still a long way to go between the current reality and a “Gattaca” of retail, an environment relieved of all of its inefficiencies (see the 1997 science fiction film), where groceries – the last bastion of brick & mortar – based on online’s modest share and Amazon’s planned purchase of Whole Foods – are beamed, seamlessly, to your home, unspoiled, unblemished, wholly organic and with no friction. We may be starting to order like the Jetsons – voicing our whims to Alexa, pressing a dash button on our fridge, or tapping out an order on our iPads – but most Americans still shop like the Flintstones, or at least like (and at the same store as) Lucille Ball. Amazon’s proposed acquisition of Whole Foods further confirms that the dominant US ecommerce retailer sees a future for the brick & mortar box. The retailer of the future The retailer of the future will likely be a retailer of the past – just the most efficient version therein. A sector with excess capacity is likely to slim down at the expense of suboptimal models and to the benefit of the best positioned firms, especially in the absence of venture capital funding traditional retail. From within the group of incumbents, the successful retailer of the future will need to operate either as an optimized logistics machine, an ultra-convenient shopping option, or an optimized showroom.