Portfolio Manager Charlie Dreifus looks at the impact of e-commerce and how it’s affected his investments in small-cap retailers.
How has the growth of e-commerce affected how you invest in retail?
Growth in e-commerce has certainly affected my investing overall, not only in retailing. I took notice watching the 2015 annual meeting of Berkshire Hathaway in which Warren Buffett said that when Berkshire Hathaway considers moving into a market or acquiring some new company, the first thing they do is discuss the Amazon effect.
There's an enormous price transparency and competition for customers. The common denominator is heightened competition. The retailer has to be very savvy in either working with some of these disrupters or having their own platform that has something that engages customers and causes them to shop there. Because for the traditional brick and mortar retailers, and the U.S., unfortunately, has had for decades way too many brick and mortar stores. We're way overstored.
So, the brick and mortar stores, in order to gain customers, people through the door have resorted to price promotion. And price promotion will work if you do it and your competitors don't follow.
Unfortunately, that's not what’s gone on. So, once competitors follow and prices are down in that category, you probably haven't gotten more traffic and customer sales, but you have gotten lower margins. So it's a difficult situation that is going to take quite a while yet to clear.
Are there business models that can resist e-commerce?
Well, there are companies that have worked either with the disrupters and/or have had good platforms. I have one that I think meets that characteristic in the portfolio. It's been in the portfolio for a while a company called Children's Place. They have been selling their product on Amazon now for a couple of years. They'd gone from 400 SKUs, items that they sell to Amazon, to between three and four thousand.
But they're not resting on that because, obviously, they can't necessarily count on Amazon continuing to do that.
What they've done is they've really worked very diligently on their accessing customers through digital media and mining their databases. So, they've gotten to the point, it's truly engagement.
And what Children's Place has done, they've gotten to the point now where they can send out to a customer, reminding them, a year ago you, for Christmas you bought your daughter a size six dress. We think we have a wonderful assortment of new dresses for this season. Your daughter is probably a size seven now, so, here we're sending you examples of these things, and why don't you consider buying them.
Is e-commerce disruption a case for active management?
Oh, very much so, because by definition, when you go passive, you're buying the entire index or section of the market. Hopefully, that active engagement in doing the research, that active management entails is able to separate between those that get harmed and those that don't get harmed. And, by definition, that's active management.
Do you think as a result there'll be more losers than winners in retail?
I actually think that we're going to see a big shake out in retailing. And there will be many losers over time. And, to the degree to which the road to normalization gains steam, meaning that we have higher interest rates that will exacerbate that because many zombie retailers that were kept alive by low cost of financing, will go by the wayside. There's a rough patch ahead, particularly in retailing, but a lot of weaker companies are going to have issues if they haven't addressed the e-commerce platforms.
Article by The Royce Funds