February 2019 - I have vivid memories of my parents lugging me quite unwillingly from store to store as they shopped for everything from clothes to groceries when I was a child. Families today can accomplish what seemed then like a Herculean task simply by clicking a few buttons. Indeed, consumer-facing businesses have been impacted by technological advances more so than many other sectors of the economy over the past two decades, largely to the benefit of the consumer and the detriment of most of those businesses. Free delivery has essentially brought the store to the consumer, pricing power has been eroded by transparency and social media has changed the ways in which brands communicate with customers.
The most visible impact of this disruption has been seen in general retail. While consumer spending has remained buoyant, driven by low unemployment, moderate wage gains and a personal tax cut, the past two years have seen former retail stalwarts of the American economy severely shrink their footprints or even close their doors entirely. These companies were mostly victims of unsustainable leverage from ill-timed leveraged buyouts, but the lesson is clear; adapt to the new reality or face an extremely uncertain future. But retail isn’t the only consumer sector facing a changing sales environment; the impact of technological disruption can be seen across the consumer landscape, as restaurants have faced sagging sales and rising costs to differentiate their offerings, and consumer staples firms have struggled with shifting tastes and more nimble competitors. Yet, despite these challenges, technology has also created unprecedented opportunities for nimble brands to connect with their customers and generate loyalty. Below, we discuss the ways in which technology has altered the broader consumer landscape and how we at AMI believe we have positioned ourselves to benefit from this disruption.
It would be naïve to think that the convenience and choice afforded by online retail haven’t changed the broader retail industry in perpetuity. The last two holiday seasons have provided a clear look at the challenges faced by retail businesses: weak sales caused many pundits to call for the end of retail entering the 2017 season, only to have sales numbers roar back this past year as companies invested in new online offerings and improved the in-store experience. However, it soon became apparent that all these improvements came at a cost. Many new acronyms have entered the retail lexicon over the past few years such as BOPIS – Buy Online, Pickup In Store – initiatives that have created strain around infrastructure that was built to exclusively support in-store traffic. While we reject the idea that brick and mortar retail will soon disappear, we do believe that certain types of retailers have been forced to become structurally less profitable in order to compete.
It is important to remember that the term “retail” applies to a broad swath of businesses. At AMI, our strategy has historically led us to avoid apparel retail as we leave that to those with a better fashion sense. However, the dislocation in retail has created sizable opportunities. Companies that can combine a compelling in-store offering to drive traffic with the convenience of an online offering, which is easier said than done, will be the winners in this new age of retail.
Restaurants are facing similar disruption, as the proliferation of third-party delivery services is changing the footing on which restaurants compete. While pizza delivery has been a staple of American food culture for decades (and drove Domino’s Pizza from one store in Ypsilanti, MI to a $10 billion business with more than 15,000 locations worldwide), it is unclear just how incremental delivery can be to other types of food offerings. The myriad of challenges facing making food delivery profitable and palatable – i.e. keeping the food hot, trusting the delivery person not to sample the product, etc. – is not preventing most businesses from continuing to expand in this area. The reality is that it is extremely challenging, if not impossible, for a restaurant to compete simply on the strength of its food offering. There are too many restaurants and, when combined with inflating labor costs, the outlook for a run-of-the-mill chain is not fantastic.
What some restaurants have been able to do is separate themselves by investing in how they interact digitally with their customers. Brands with loyalty programs and apps have data that can be used to understand what customers want from their food-away-from-home options and push them offers and promotions that drive traffic. At AMI, we are generally pessimistic on the outlook for most public restaurant businesses. However, we feel that those brands with experiential (i.e. non-food) offerings, such as restaurants tied to daily routines (coffee is the best example) and those that are growing digital penetration will be able to grow as the market shakes out over the next few years.
Over the past twelve months, consumer products companies (e.g. Proctor & Gamble) have alternated from old economy, out of favor, no-growth monoliths only good for a dividend to saviors in a time of economic uncertainty. There is no doubt that the advent of online shopping for consumer staples has changed the way large consumer firms operate. These companies are no longer able to simply use scale to pay up for favorable shelf positioning. The “infinite shelf” offered online has made it much easier for smaller brands to establish a foothold with customers. Consumer focus on eating better has undermined the automated processing and shelf-stable ingredients that led to stellar margins and forced firms to pay steep prices for “on-trend” brands that unfortunately are too small to really move the needle.
While these concerns are valid to an extent, we feel that negativity over the growth prospects of consumer staples does not reflect the actual fundamentals. Brands still matter, and while private label will remain a key cog of any retailer’s growth strategy, it is almost always in concert with brands, especially those that have shown the ability to grow. Staples brands have started to more meaningfully focus on innovation, as opposed to slightly changing the ingredients in canned soup. These companies are expanding outside of core markets to face disruption head-on, such as Constellation Brand’s stake in cannabis company Canopy Growth, or Proctor & Gamble introducing new bolder marketing, such as the “Toxic Masculinity” ad for Gillette.
While one may not agree with Proctor’s message, they do deserve some credit for taking a new approach to stemming the severe market share losses Gillette has experienced to lower cost competitors like Harry’s and Dollar Shave Club. It is important to remember that, just like retail, there are many consumer products firms selling a wide variety of goods, with some companies in much better positions than others. It is also easy to forget the protection that Consumer Staples provide in economic downturns, especially during times when growthier companies are leading the market.
There is no doubt that the consumer landscape is changing, driven by new technologies and a new cohort of consumers with preferences far different from their parents. While some companies have been caught off-guard, others have been able to adapt and are much stronger for it. At AMI, we remain vigilant and focused on investing in consumer companies with brands that have competitive advantages and relevant value propositions which can evolve along with their core customer.