Why The ‘Amazon Effect’ Matters For Small Caps

Why The ‘Amazon Effect’ Matters For Small Caps
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Portfolio Manager Steven McBoyle discusses the significance of the ‘Amazon Effect’ and its effects on e-commerce and small-cap retailers.

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Can you define the Amazon effect?

The term "Amazon Effect" is a broadly used term to describe really, the significant share shifts that we've seen within the retail landscape, so think of apparel, department stores, brick and mortars, but really the Amazon Effect is a subset of a much larger phenomenon, that being e-commerce.

E-commerce is really introducing to the economy in many market places, price transparency and algorithmic-based pricing strategies that in effect are shrinking, if not completely eliminating profit pools amongst complete economic value chains.

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I go as far as to say that e-commerce is perhaps one of the greatest deflationary forces that we witness today and it goes well beyond retail. You can consider industrial distribution where it is having a powerful effect. You can think about how companies buy and sell media today, how aftermarket auto parts are provided to consumers today.

So just recently a premium, high-quality North American furniture manufacturer just partnered with Amazon. You can find a little blue box that holds jewelry items being sold on a third-party website today. You and I can actually go into your local auto repair garage shop and have them install tires that you, the consumer, have purchased on a third-party website.

Again, from a consumer perspective, this is altering the way a lot of transactional activity takes place in, again, a broad set of market verticals.

Have these e-commerce business models benefited from low interest rates?

Unquestionably, financing is a large portion of how these models have been able to expand into market place in an economic fashion that would not be allowed, if you will, from a traditional business model perspective because, in effect, they have completely different set of rule books, in terms of what the capital markets expects from them.

And so, this is a fascinating question because where you see this issue most acutely at play is really seeing, amongst retailers, having to address this omnichannel method of selling. And this is where managements are having to make rather significant and challenging decisions in terms of buy versus build, in terms of addressing what the consumers' requiring of them today.

Do you think this is a lasting phenomenon?

E-commerce is a permanent, structural change. And I think the mind share, certainly from a consumer perspective, will only get larger over time. Not for the obvious reasons of it being generational, but I think just the value proposition provided to the consumer is just too great.

Again, I've never known a consumer that doesn't like lower prices and so to the extent that there's a mechanism that introduces price transparency and drives down price, consumers are not only going to ask for it, they're going to demand it. And that is the pull element of this dynamic. To the extent of lasting certainly the other issue we're having to come to grips with is a lot of these e-commerce business models are operating at uneconomic levels, uh, if not completely non-profitable.

And so, in light of an environment that we're in today where you're seeing cost of capital increasing and when, not if, the capital markets demand profits over growth, there will likely become a point in time where rationalization takes place. But even having said that, this is structural, it's permanent, we all have to come to grips with it.

Article by The Royce Funds

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