by Stephen Dover, Executive Vice President, Head of Equities, Franklin Templeton Investments
Powerful retailing disruptors are reshaping expectations about shopping and shipping by digitising retail markets across the globe. New conveniences such as ordering groceries with a simple voice command are upending the old-world order. In this excerpt from the latest edition of FT Thinks: âThree Technology Titans Reshaping Retail,â senior equity analysts across our Growth, Value and Emerging Markets teams compare how three retailing giants tailor technology to fit local customs, lifestyles and payment abilities.
Reshaping Retail on the Global Stage
To say that Amazon has shaken up US retailing is almost a clichĂ© at this point. Looking globally, we see powerful tremors from seismic shifts in retailing driven by Alibaba in China and MercadoLibre in South America. These firms, however, arenât cookie-cutter versions of Amazon. Whereas Amazon spent years building state-of-the-art warehouses and logistics infrastructure, Alibaba and MercadoLibre didnât need to because they didnât own inventory. Both firms initially had more in common with eBay, allowing merchants to sell goods on their online marketplaces.
Over time, these distinctions have blurred. Alibaba and MercadoLibre have been investing in logistics infrastructure
to help ensure deliveries reach customers on time. Meanwhile, over half of Amazonâs online sales now come from higher margin third-party sellers, which list their products directly alongside Amazonâs own warehouse inventory.
Amazonâan Advertising Powerhouse
Amazon is big, and its disruptive impacts are far-reachingâjust as its name implies. But it has only recently become a profitable disruptor. That change has been driven, in part, by becoming a powerhouse in online advertising. At the core of Amazonâs advertising services is a rich pool of data it keeps on the shopping habits of its estimated 410 million active users globally.
Amazon knows what customers browse for and buy and what they are willing to pay, giving them an information advantage over platforms that donât facilitate transactions themselves. And because Amazon visitors are primarily there to make a purchase, Amazon ads convert to sales at 3.5x higher rate than Google ads.1 Going forward, our US Growth team believes Amazonâs ad revenues will remain a significant profit stream.
Amazon hasnât had a straight line to success since going public in 1997. And thatâs perfectly fine with Jeff Bezos, chief executive officer (CEO) and founder of Amazon. In his view, being a game changer requires experimentation, a willingness to fail, and a long-term orientation that means capital investments can take five to seven years to bear fruit.2 This approach has led to some surprising breakthroughs, like Amazonâs Echo smart speakers, powered by Alexa, the cloud-based voice assistant. But itâs also produced disappointments that unnerved shareholders, like the Fire Phone, and mounting losses from failed efforts to compete in China.
Alibabaâs Retailing Ecosystem
Two years after Amazon went public in 1997, Chinaâs Alibaba launched a business-to-business (B2B) website for small manufacturers looking to export overseas. Alibabaâs birth as an online retailing giant, however, didnât really happen until four years later in 2003, the year eBay acquired Chinaâs Eachnet.com. Countering eBayâs move, Alibaba quickly launched an online marketplace called Taobao, connecting fledgling merchants and small entrepreneurs with Chinese shoppers.
In just two years, Taobaoâs share of Chinaâs market of small businesses selling to consumers approached 60%, forcing eBay to close down Eachnet.com in 2006.3
Most shoppers in China didnât own credit cards, and many were suspicious that online products might arrive as something less than advertised. Alibaba developed Alipay to resolve both issues. It creates an escrow service in which cash received for a sale isnât released until the product arrives in satisfactory condition.
Alipay was quite lucrative as a standalone business, but it also gave Taobao a leg up over eBay, which didnât offer an Alipay-like service. Today, Alipay processes 80% of all transactions across Alibabaâs ecosystem of online marketplaces and 60% of Chinaâs total mobile transactions.4
Taobaoâs rapid growth and ability to outmaneuver eBay were extraordinary by any yardstick, and it became hugely profitable. Like eBay, Taobao didnât own or hold inventory in expensive warehouses.
Taobaoâs strong operating margins come from consumer data, and the advertising services it sells to merchants eager to stand out from the online crowd. Long before Amazon bought Whole Foods, Alibaba was investing in retail chains, including a Costco-like market called Sun Art, department-store operator Intime, electronics retailer Suning, and its own homegrown grocery chain named Hema Xiansheng.
By integrating offline and online retail, Alibaba wants to deliver products to shoppers by whatever route they preferâordered online and delivered home, pre-sorted for in-store pick up, or neatly displayed so consumers can touch and experience new brands in person.
Behind the scenes, Alibabaâs new retail strategy aims to digitise the entire supply chain, both online and offline, and collect more detailed consumer data. The ability to follow and analyse vast quantities of product and consumer data helps Alibaba eliminate inefficiencies with smart logistics, digital inventory management, anticipating evolving consumer trends and personalised shopper experiences.
MercadoLibreâs Evolution from eBay to Amazon
Ten years ago when investors called MercadoLibre the eBay of South America, they were halfway correct. CEO Marcos Galperin started the company in eBayâs image with his Stanford business school classmates in 1999. Theyâve since transformed the company from an internet auction site into Latin Americaâs leading online marketplace on par with Amazon.
Our Global Growth team sees two key ingredients to MercadoLibreâs early success: 1) a heavy emphasis on advanced technological infrastructure and, 2) tailoring its websites and payments services to fit South America. Understanding Latin Americaâs specific local context was key to avoiding the missteps eBay and Amazon made in China.
In its early days, MercadoLibre gave merchants the option of listing products at fixed or auction prices. It quickly discovered the majority preferred fixed prices. MercadoLibre also changed the way merchants interacted with buyers.
Shoppers couldnât interact directly with sellers the way eBay allowed, because MercadoLibre rightly understood that would likely cut it out of the transaction entirely. Instead, it developed Q&A message boards, which buyers found helpful.
Over time, to attract more merchants to its busiest online marketplaces in Argentina, Brazil and Mexico, MercadoLibre developed logistical shipping solutions through its MercadoEnvios division, helping ensure merchant deliveries arrived on time for a better shopping experience. It also generated powerful synergies through MercadoPago, a payment services division.
Itâs MercadoLibreâs push into new financial technologies that holds significant promise in our Global Growth teamâs eyes. Half of Latin Americaâs population remains without bank accounts (or credit cards), and its economies are still largely cash-based. One side effect for cash-based entrepreneurs is that banks wonât issue working capital without a history of verified bank transactions.
MercadoLibre, on the other hand, has the data to determine creditworthiness by tapping into its online sales history and customer reviews. Spurned by banks, more merchants are turning to MercadoLibre for loans. Interest-free loans offer tremendous value to shoppers, given high interest rates in Latin America. This ease of doing business also increases customer loyalty.
These new approaches to financial services are one of the reasons our Global Growth team thinks MercadoLibre offers an efficient way to gain exposure to online retailing in South America. As more internet users migrate to online and mobile commerce in Latin America, we believe MercadoLibre has the opportunity to capture a majority of these shoppers.
Pathways to Sustainable Cash Flows
Across our equity teams, we evaluated recent company operating margins side-by-side so we could compare and contrast each firmâs accomplishments from growth and value perspectives. What struck us right away was the impact Amazonâs capital-intensive business model has long had on its profit margins. Compared with Alibaba, Amazon looks anemic. Also noticeable are Alibabaâs declining margins and recent negative margins for MercadoLibre.
Amazonâs Profits Gain Momentum
Since going public, Amazonâs heavy investments in technology, logistics and new products have long dampened its operating income. Bezos must constantly balance between deploying capital to build future growth and holding back to boost near-term profits.
Itâs for this reason our US Growth analysts think traditional valuation metrics like price-to-earnings and enterprise value/EBITDA arenât good yardsticks for Amazon.5 Simply put, these metrics arenât a reliable snapshot of Amazonâs long-term profit potential, in our analystsâ views. Our US Growth analysts think Amazonâs margin expansion story is finally taking root.
Alibabaâs Data-Centric Ecosystem
Unlike Amazonâs recent positive profit momentum, Alibabaâs operating profits have faced headwinds from spending on businesses outside its core China retail marketplace. Agile competitors with deep pockets mean Alibaba needs to spend to keep existing customers happy and to lure new ones.
So how does Alibaba steer margins back in an expanding direction? Our Emerging Markets team sees a couple of avenues, starting with growing its cloud computing business in China. Alibaba also aims to help more brick-and-mortar retailers digitise their own back office supply chains through smart logistics, and by boosting front-end traffic by tapping into Alibabaâs deep pool of consumer data and cloud analytics. We see Alibaba less as a collection of e-commerce marketplaces and offline retail hubs, and more as a data-centric ecosystem that drives profits through digitisation and technology, while generating better customer experiences.
MercadoLibre: Building Warehouses to Stay on Top
MercadoLibre is investing in shipping logistics and consumer incentives to shore up its commanding lead over competitors like Amazon. Taking a page out of Amazonâs playbook, MercadoLibre is building new warehouses to serve as cross-docking locations.
Costs to build these fulfillment centers, plus free shipping incentives, have taken a noticeable bite out of profit margins in the past year. Nevertheless, our Global Growth team is confident these investments can pay off by improving the customer experience and by attracting more merchants.
The Retail Revolution is Accelerating
The reality of todayâs digitised marketplace means that not only has shopping changed dramatically in just a decade, the rate of change also continues to accelerate.
Itâs now easier for shoppers to get tailored items and access products more quickly and conveniently than ever before. Technology pioneers like Amazon, Alibaba and MercadoLibre are largely responsible for setting new standards in the worldâs biggest marketsâcontinually improving customer experiences by anticipating their preferences, lowering prices and delivering items faster.
Plowing vast amounts of capital into new innovations (sometimes to the detriment of near-term profits), these companies are raising the bar for everyone by reshaping customer expectations. We believe each company bears close watching to understand where the retail landscape is heading next.
You can read even more views from our investment teams in the latest edition of FT Thinks: âThree Technology Titans Reshaping Retail.â
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