As Covid-19 broke out and US consumer businesses were forced to close their doors there was an obvious opportunity for online retail.  Demand has shifted to the online channel with the closure of brick and mortar driving accelerated online sales. Common sense, we know.

Perhaps there is a less obvious dynamic playing out within the retail channels, which is the change in the cost of customer or transaction acquisition.  One of the biggest challenges to profitability in online has been the high customer acquisition costs, but over the last week or so earnings reports have outlined the drop in advertising market costs which several digital retailers have cited (such as PTON, W and PRPL).  Yet at the same time online sellers have talked about cutting advertising given that demand is shifting online regardless of the degree of spend on customer acquisition.  The punchline is not only is the online channel seeing unprecedented demand, but it comes at unparalleled profit flow through for many.

On the flip side, we think the opposite is happening for brick and mortar retail, the cost of customer or transaction acquisition is climbing.  We have talked about how having a store in a market creates a de facto marketing outcome, in that being in the consumer’s community means the consumer is aware of the retailer and has bias towards shopping with it regardless of channel.  We see this in the results regarding how store openings in a market drive eCommerce shopping up within that market, and store closings result in eCommerce shopping declines.  The store acts as a marketing or customer acquisition vehicle.  However, now with Covid19 the return on that store "marketing spend" has drastically declined.  There is a lot less consumer traffic through brick and mortar shopping centers or stores, and consumers will be much more hesitant to make multiple shopping stops during a trip given each visited store is potentially another risk instance of virus exposure.  Then the consumer will also want to limit the amount of time spent within the store, meaning less browsing and less attachment buying.  Therefore not only is the B&M shopper pie smaller, but shopping visits will be less frequent, getting customers into your store as opposed to competitors will be harder/more costly, and those customers are likely to spend even less.  It will be harder than ever to win shoppers in B&M.

This means a new pressure on profits for an already poorly-positioned brick and mortar retail.  This could be a only 6-18 month phenomenon, meaning it starts to reverse perhaps as advertising market prices rise and when(if) consumers get more comfortable shopping in person again as government restrictions are removed. But at the same time there could be a lasting change on consumer shopping behavior which means reversion to the prior observed incremental profit levels never really happens (eCommerce settles at a more profitable level, B&M at less profitable level).

Those that can sell necessities via brick and mortar alongside other desired categories in a one stop shop should outperform from a traffic/sales perspective (WMT, COST, BJ, TGT, LOW, HD, TSCO, Dollar Stores) but probably still see some pressure on incremental margins.

Key Losers are brick and mortar retail with dilutive online economics and undifferentiated content, or potentially retailers with no online presence.  Also, brands with minimal direct online selling and over exposure to brick and mortar distribution: KSS, M, HBI, KTB, BBBY, GPS, FL, Off Price, Auto Parts, FIVE, OLLI

Key Winners are online retailers that own their customer, or brands with quality online distribution at very accretive margins: AMZN, CHWY, NKE, Adidas

Potential/Temporary Winners: W, PTON, CRI, SFIX