#127 - An Ecommerce Recession - Part 2

Q1 2022 Earnings Themes

Jun 12, 2022

Hi 👋 - This week, digging into category trends, geographic trends, and how inflation is impacting e-commerce companies. If you’re new to Below the Line this week (welcome!), here’s part one of the Q1 2022 e-commerce recap. Thanks for reading.

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Everybody Cut Footloose

In the first quarter, heels, cocktail dresses, party decorations, and yurts were hot. Furniture wasn’t. E-commerce category performance reflected the fact that consumers are out-and-about. Apparel marketplaces like The RealReal, ThredUp, and Poshmark clocked the fastest growth (they also had easier comps). Luxury fashion marketplace Farfetch was the exception, due to its high exposure to China, where Covid lockdowns strangled growth, and Russia, where it suspended operations. In contrast, demand for furniture and home goods was particularly soft as evidenced by revenue falling 14% y/y at Wayfair. Large, diversified marketplaces like Amazon and Etsy demonstrated the tough operating environment for e-commerce, with sales declining modestly off difficult comps.

Source: Company filings. Note: Etsy Q1 2022 growth rate for Etsy.com only and excludes Elo7, DePop, and Reverb. Etsy’s consolidated GMV, including recent M&A, was 3.5% y/y.

Reopening categories performed well. For example, Etsy saw strong demand for travel-related items like tote bags and passport cases, party supplies for baby showers and birthday parties, and wedding items like party gifts and decorations. Apparel and jewelry demand was also strong. In contrast, Etsy’s Home & Living sales which include declined relative to Q1 2021 (however, the Garden & Outdoors subcategory was strong as were yurt sales). From a category perspective, Etsy was a microcosm of e-commerce broadly.

Source: Etsy, Q1 2022 Earnings Presentation, May 4, 2022.

Events-based shopping was another bright spot, reflecting the shift in spending towards experiences. Occasions like travel, weddings, proms, and a return to office were cited across earnings calls as driving demand. For example, Poshmark, a social commerce marketplace for clothing and accessories, saw accelerating apparel growth and a rebound in event-based shopping with items for proms and weddings growing 75% y/y and 39% y/y respectively. Similarly, fashion resale site ThredUp saw the same dynamic, with work apparel and wedding items like cocktail dresses and heels growing 50% y/y.

The flipside of more events and more travel is that shoppers are spending less on their home. Like Etsy, Wayfair saw soft demand for furniture.

Inflation Is Real

Cocktail dresses and high heels weren’t the only things running hot in the first quarter. Inflation is approaching Death Valley levels, creating headaches for operators everywhere. For e-commerce, inflation impacts both demand and cost structures, another double whammy.

On the demand side, surging prices for necessities like food, gas, and housing leaves less for discretionary spending on items like party decorations and yurts. In the US, a tight labor market and several rounds of fiscal stimulus have bolstered household balance sheets. Padded savings accounts provide some buffer, but if prices continue rising faster than incomes, spending will eventually slow. Inflation is also dampening consumer confidence, which trickles down into spending decisions.

On the expense side, higher energy, labor, and shipping expenses are depressing margins. Given its 1.6 million strong workforce, mammoth logistics fleet, and overall scale, cost pressures were most acute at Amazon, where a mix of external and internal factors depressed profitability.

Externally, shipping and wage inflation weighed on first quarter results. Here’s Amazon’s CFO Brian Olsavsky on shipping inflation1:

Line haul air and ocean shipping rates continue to be at or above the rates in the second half of last year, which were already much higher than pre-Covid levels. Some of this is due to the impact of the Omicron variant in China and labor shortages at point of origin, and the start of the war in the Ukraine has contributed to high fuel prices. For example, the cost to ship in overseas containers more than doubled compared to pre-pandemic rates. And the cost of fuel is approximately 1.5x higher than it was even a year ago. Combined with the year-over-year increases in wage inflation, these inflationary pressures have added approximately $2 billion of incremental costs when compared to last year. While we will continue to look for ways to mitigate these costs, we expect they will be around for some time.

Internally, Amazon is seeing lower productivity and lower fixed cost leverage on its fulfillment network, which doubled over the past two years. Consequently, the company is reducing its e-commerce capex and is looking to sublease warehouse space in overbuilt markets like California, Georgia, New Jersey, and New York2. Ultimately, inflation added an additional $6 billion in expenses to Amazon’s e-commerce operations in the first quarter versus the year prior. (Higher costs also weighed on IRL retailers like Target and Walmart in Q1 2022.)

The last bout of serious inflation in the US predates the internet. You need to go back to the 1980s - when Paul Volcker ran the Fed and Duran Duran was on the radio - to find a time when inflation was running as hot in the US as it is today. A confounding variable is that few (if any) e-commerce executives have prior experience managing through an inflationary period. They’ll need to write the playbook and execute it at the same time. Mistakes will happen.

Source: The Wall Street Journal, U.S. Inflation Hit 8.6% in May, June 10, 2022.

Similar to Amazon, fuel, shipping, and labor inflation pressured gross margins at Wayfair, which sells and delivers bulky furniture. Rising freight and labor costs also pressured margins at ThredUp. The company is also adjusting its pricing algorithm to reflect rising prices at retail, partially offsetting hither labor and shipping costs.

For companies like Amazon, Thredup, and Wayfair that own distribution and fulfillment infrastructure, higher shipping costs directly translate into lower margins. For online marketplaces where shipping is a passthrough (Etsy for example), inflation is a headwind to conversion rates, resulting in fewer sales. In instances where sellers provide shipping, their margins are being crimped. When it comes to shipping inflation, there’s no free lunch.

It’s not all bad though. Some companies believe that inflation is enhancing their value proposition, though this feels a bit like whistling past a graveyard. For example, luxury resale site RealReal thinks that it’s a beneficiary of an inflationary environment as consumers seek value. Similarly, Amazon believes that its great prices are a draw for consumers looking to stretch their budgets.

USA, USA, USA

From a geographic perspective, the US outperformed Europe. eBay flagged that war in Ukraine slowed traffic growth and dampened European demand. Historically, Russia and Ukraine account for less than 1% of eBay’s sales, so the softening is from knock-on effects, rather than direct exposure. Here’s eBay CEO Jamie Iannone on trends in Europe3:

Since late February, when the war in Ukraine began, we have seen lower e-commerce traffic, inflation in gas prices and home energy costs and historically low consumer confidence, particularly in the U.K. and Germany. As we look forward to the rest of 2022, we find ourselves in the most dynamic macro environment I have seen since returning to eBay as CEO. We expect more near-term headwinds to e-commerce growth rates this year.

In contrast, Farfetch had high exposure to Russia. In 2021, it was the company’s third largest market, accounting for 6% of GMV. Like many Western companies, Farfetch suspended operations in Russia following its unprovoked invasion of Ukraine. Additionally, China is another top market for Farfetch. Here, Covid lockdowns in Shanghai and elsewhere put a lid on demand. In contrast, the company saw strong demand in the US and Middle East.

Wayfair saw weakness in Europe too, with US revenue falling 10% y/y while international revenue - mostly from the UK and Germany - was down 31% y/y. Etsy also called out headwinds in Europe, including the war in Ukraine.

What Comes Next

E-commerce companies exited the first quarter to the most challenging operating environment in recent memory. In 2020 and 2021, growth came easy. That’s no longer the case. With lockdowns over, there’s been a shift from durables to consumable and travel. Additionally, competition from offline retailers is intensifying. Consumers have more options where to spend their money. At the same time, inflation is pressuring discretionary spending budgets and the macro outlook is getting twitchier. The discrepancy between e-commerce’s long-term potential and current demand environment is stark. While consumers buying cocktail dresses, e-commerce executives are donning flak jackets.