on the Canadian Retailing Sector August 2014 E-commerce Growth Opportunities in a Changing Retail Environment The traditional retail model is changing at a rapid pace in Canada and as a consequence, retailers are facing numerous challenges such as: + Intensifying competition as an increasing number of international companies are entering the Canadian market, as well as the continued expansion of leading online retailers (such as Walmart and Amazon). + Consumers accessing vast sources of information rapidly due to the rising adoption of mobile technologies (in smartphones). In addition, these challenges are unfolding as consumer spending remains less robust than before the Great Recession of 2008-09, especially for some categories of discretionary items. The convergence of these challenges means that customers are savvier in identifying and leveraging many different sources of information and channels to optimize the different elements of their shopping needs (which range from saving time to value of dollar spent in terms of assortment, quality, convenience and service). The smartphone has become the new personalized shopping assistant and is having an increasingly significant influence on in-store shopping purchases. We believe that mobile commerce will be one of the major drivers reshaping the Canadian retail landscape by blurring the lines between virtual (online) and physical selling channels. AUTHOR Alda Pavao, CFA Portfolio Manager, Canadian Equities EDITED BY Benoît Durocher Executive Vice-President and Chief Economic Strategist Richard Beaulieu, CFA Vice-President and Senior Economist Insightful research: the key to our expertise
As part of our investment research, we have examined the implications of mobile e-commerce and the need to adapt to a multi-channel retail selling environment by Canadian retailers. This article will briefly review our findings and provide our view of the capital spending required, the challenges faced in building out an omni-channel retail strategy and the potential investment impact. The Rise of the Connected Retail Consumer Despite high levels of technology adoption and broadband access, e-commerce in Canada is underdeveloped relative to other developed markets. E-commerce currently accounts for less than 4% of all retail sales in Canada, compared to 8% in the United States, around 13% in the United Kingdom, and from 4% to 9% in countries of Continental Europe 1. In our view, there are two main reasons for Canada s lower e-commerce penetration rate: higher shipping costs due to vast geography and lower population density, and a less favourable sales tax structure. Canada taxes most e-commerce purchases whereas until recently, in the United States, e-commerce purchases were not taxed in individual states. Notwithstanding the current relatively low adoption rate, e-commerce and mobile retail sales in Canada are expected to see explosive growth, driven in part by a growing online population enjoying much easier access to data about products and pricing. As shown in Exhibit 1, the Boston Consulting Group suggests that online spending could account for 5% of total Canadian retail sales by 2016 2. The Forrester Research agency further predicts online retail spending in Canada will climb to almost $34 billion by 2018 (8% of overall retail sales) from a level of $20.6 billion in 2013, translating into an annual growth rate of 10.5% 3! Exhibit 1 Online Retail Sales Growth Projected for 2016 UK 23.0 Germany 11.7 Australia 8.9 Italy 8.0 US 7.1 Japan 6.8 France 6.7 G-20 6.0 Canada 5.3 Source: The Internet Economy in the G-20, The Boston Consulting Group, March 2012 To benefit from this explosive growth, retail companies in Canada need to transform their strategies from solely focusing on in-store merchandising and selling/marketing programs to omni-channel retail branding. 2 1 Forrester Research, July 2013 2 The Boston Consulting Group, March 2012 3 Financial Post, July 23, 2013
What is Omni-Channel Retailing? The way consumers buy goods is undergoing a significant change from a single selling channel via the store format, to a channel-agnostic, or omni-channel perspective. The move to a multichannel selling environment, whereby a customer can shop at a retailer through various channels, whether it be in a traditional brick and mortar store, through its website or via its app on a mobile device, presents a unique opportunity set for retailers but it also creates numerous challenges. Under a well executed omni-channel strategy, the processes, information systems and infrastructure (including store operations) of the retail operations must be managed in a truly integrated way (in spite of the separate and distinct selling channels) to offer the customer a consistently engaging, and seamless retail buying experience. For example, consider a customer who has placed an order through a retailer s website, and opts to pick up the purchase from a local store and then finds the goods have not arrived in the store and nobody at the store knows where to find the online order. In such a case, the physical reality has undermined the possibilities opened up by e-commerce and would perhaps result in a lost sale, a lower likelihood of repeat business and potentially reputational damage. Exhibit 2 The Omni-Channel Shopping Experience Tablet/Mobile Website Brick & Mortar Stores Catalogs Call Center Order from anywhere Flash Sales Fulfill from anywhere Retail DC(s) Kiosk ecommerce DC(s) OPEN Pop Up Stores Outlet Locations Brick & Mortar Stores Source: Forna 3
Retailers in Canada need to move towards reflecting the customer s buying perspective ( anywhere is now possible with a smartphone ) and must align their underlying technology and processes to offer a seamless experience or they risk losing sales and market share. Research from IDC Retail Insights has shown that the pay-off of success could be derived from higher sales, as omni-channel shoppers spend up to 3.5 times more than in-store shoppers 4. The good news we have found is that Canadian retail companies are now placing a top priority on investing in an e-commerce strategy. Many Canadian grocery, pharmacy and discretionary retail companies are investing in online informational capabilities, with most having enhanced mobile app features. Examples include electronically delivering weekly flyers customized for the user s preferred shopping location, and high-value and personalized weekly coupons available exclusively to the user s loyalty card imbedded in the mobile app. Significant Multi-Channel Investments Needed to Grow e-commerce Sales The not so good news is that Canadian retail companies appear to be only in the early innings of their omni-channel strategy roll-outs such that significant capital investments (in technology, logistics and human resources) will be required. We believe the following areas of retail infrastructure will require fundamental changes in the way they support retail operations: + Logistics/distribution networks + In store experience + Inventory management + Digital marketing with cross-channel promotional campaigns (and significant use of social media) + Loyalty programs interactivity with robust customer analytics We will elaborate on the first two areas cited above due to their significance to the consumer shopping experience. We expect that the omni-channel evolution will change the way in which retail logistics and physical distribution networks operate. As online retail growth accelerates in Canada, we believe that the drive to deliver orders to customers quicker with lower shipping costs will become an increasingly competitive advantage. This may require new types of logistics facilities such as mega fulfillment distribution centers (DCs), where the merchandise is stocked and individual items retrieved, parcel hubs that sort orders by cities and/or postal codes, and distribution centers which handle the delivery or pick-up by the customer. 4 4 IDC Retail Insights, Redefining the Shopper Experience with Omnichannel Retailing, July 2013
Exhibit 3 The Evolution of Retail Logistics* 1970s Direct store replenishment by suppliers or wholesalers Suppliers Shops 1980s CENTRALIZATION of deliveries through retailer distribution centers Mainly domestic suppliers Retail distribution centers Shops 1990s The rise of global sourcing Overseas supplier Domestic supplier Retail import center Retail distribution center Shops 2000s E-commerce model involving parcel network E-fulfillment center Parcel hub Sortation center Parcel delivery center Returns Customers home Collection point Local depot (urban logistics) Delivery point * Based on non-food distribution in developed markets Source: JLL Global e-commerce and retail logistics, November 2013 Dedicated fulfillment DCs combined with urban logistics could be an increasing competitive advantage for those retailers with numerous store locations that can either act as fulfillment centers and/or pick-up locations. We believe that many Canadian retailers can leverage their national store networks to fulfill online orders and assuage high shipping costs charged by their US domiciled competitors. As shown in some developed markets, such as the United Kingdom, the click and collect model is the fastest growing component of many retailers online sales, driven by consumer preferences for the convenience of collection over home delivery 5. We also consider the opportunity for Canadian retailers to re-define the in-store shopping experience to become a destination for consumers where they can do much more than simply browse and compare prices. We expect modest square footage growth (fewer new stores added to the network every year) but more capital allocated to in-store investments such as engaging/ interactive displays of unique products. 5 5 JLL, November 2013
Some Canadian retailers are already testing concepts and rolling out new store formats. One recent example is SportChek (owned by Canadian Tire) in the West Edmonton Mall which incorporates 470 screens, digital projectors and tablets. Interactive screens provide the customers and employees with the opportunity to source product information (including in-stock positions, sizes, and colours) and access to promotional vendor videos (see pictures in Exhibit 4). Exhibit 4 Interactive Displays located at SportChek in West Edmonton Mall Source: SportChek Feb.5 2014 press release In a more multi-channel world, the purpose of the Canadian retail store will change from solely driving sales of products in-store to being a brand and product showroom that drives revenues across all channels. We believe that this new focus on the in-store customer experience will further impact how retailers think about store formats, with potentially unique changes in the use of larger space, such as new interactive, informational displays and service offers such as cafés. Challenges Include Execution, Privacy and Security The transition to an omni-channel retail organization has major implications for capital investment, infrastructure and personnel, which will require significant senior management and board attention to drive and promote change throughout the organization. In our view, the biggest challenge facing retailers lies in the seamless implementation of new operating models in the most rapid and innovative manner to avoid being left behind or materially disrupt underlying business. 6
Security and privacy of personal information will also take on added importance as retailers embrace the omni-channel delivery model. An IBM study found that consumers are willing to share their personal information with retailers, particularly if they get good value in exchange 6. However, concerns over the sharing of personal data have risen considerably during the past few years as security breaches have been reported. We are hopeful that Canadian retailers will follow the lead of the Canadian banks that have evolved to successfully provide online banking services in a safe and secure manner. Investment Implications Notwithstanding expected growing pains in the evolution towards a multi-channel retail industry, innovation and successful execution will be the keys to long-term success for Canadian retail companies. We view the Consumer sector as an attractive investment opportunity, however, selectivity will be very important as winners will emerge from the transformation of the retail industry while other firms will be left behind. We have focused our equity research capabilities on understanding and assessing the companies relative abilities to adapt and thrive in a rapidly evolving omni-channel retail environment. We are encouraged to see Canadian companies like Canadian Tire, Loblaw Co. and Shoppers Drug Mart make omni-channel investments across all channels (in-store innovation, digital promotion, etc.) over the last few years and expect to see more in the years ahead. We strongly believe that Canadian retailers need to embrace a test and learn innovation process to continuously improve the customer experience as new technologies become available. Areas that will need to be watched and further analysed as this trend evolves include the ultimate impact on profitability and margins as well as implications for use and structure of real estate assets. Canadian retail companies also have some of the strongest loyalty programs in the world and we believe that the intrinsic value of such programs will show through in the effective utilization of customer data and their analytics, making it easier to target market consumers and influence sales. Conclusion The new omni-channel retail selling environment has and will continue to revolutionize the way retailers operate. Omni-channel retailing will allow companies to interact with their customers in almost real time, through a multitude of channels and platforms (e.g. social media). However, the speed at which Canadian retail companies invest in new technology and organizational processes will define their operational and financial success in the new digital retailing age. In our view, the winners in the domestic market will be the retail companies that evolve to continuously provide the highest level of convenience and service to their customers both in-store and online. We believe that this will prove to be a sustainable advantage over pure-play online, international and traditional brick and mortar retailers. 7 6 ABA Banking Journal, Omnichannel among retailers increases risk, January 22, 2014
Reference Materials L2 Intelligence Report, Omnichannel Retail Canada, March 2014. JLL, E-commerce Boom Triggers Transformation in Retail Logistics, November 2013. IDC Retail Insights, Redefining the Shopper Experience with Omnichannel Retailing, July 2013. http://www.newswire.ca/en/story/1300787/sport-chek-s-first-flagship-store-introduces-new-digitalera-in-experiential-retail-at-80-000-square-foot-location-in-west-edmonton-mall http://www.ababj.com/retail-banking/channels/item/4343-omnichannel-among-retailersincreases-risk/4343-omnichannel-among-retailers-increases-risk http://business.financialpost.com/2013/07/23/online-retail-sales-to-hit-40-billion-in-canadaby-2018/ http://www.theglobeandmail.com/report-on-business/what-keeps-online-retail-in-canada-fromclicking/article4178807/?page=all The Boston Consulting Group, The Internet Economy in the G-20, March 2012. Deloitte, The Changing Face of Retail: The Store of the Future, February 2012. 8 Addenda Capital Inc., 2014. All rights reserved. This document may not be reproduced without Addenda Capital s prior written consent.