#148 - Naughty or Nice? - Part 1

Q3 2022 E-commerce Review

Nov 20, 2022

Hi 👋 - The e-commerce industry is having a Groundhog Day moment. Third quarter results were much like the second and first: slowing growth and cutting costs. This week, a look at key themes and trends from third quarter e-commerce results. Part two will dive into how consumer behavior is changing and will be published the first weekend in December (next weekend I’ll have a pumpkin pie hangover 🥧 🦃 🍁). As always, thanks for reading.

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I Got You, Babe

It’s Groundhog Day for e-commerce. Like the first and second quarters, the post-pandemic e-commerce penetration reversion to the mean (this chart, once again) continues to dominate industry trends. Consumers have more options for where to spend – online or offline, goods or services – and tighter budgets as nagging inflation increases the price of essentials like food and gas. As a kicker, the strengthening US dollar is pressuring top-lines for companies with international sales, knocking a few percentage points off of reported growth rates.

With the exceptions of Amazon and Shopify, e-commerce firms either decelerated (Poshmark, The RealReal, ThredUp), declined outright (eBay, Wayfair), or did both (Etsy, Farfetch). It’s not all rainbows and unicorns for Amazon and Shopify either. Amazon’s growth benefited from shifting Prime Day to the third quarter in 2022 from the second quarter in 2021, while Shopify’s GMV includes brick-and-mortar sales, which are outpacing e-commerce.

Source: Company financial reports. Notes: Amazon Online Stores includes only first-party e-commerce. Amazon doesn’t explicitly break out third-party e-commerce growth.

Amazon’s earnings calls are notoriously boring. However, its third quarter call was slightly less anodyne and slightly more cautious. That itself is notable. The company saw growth moderate throughout the third quarter, particularly in Europe, where consumers are feeling glum amid high energy costs, slowing growth, and the war in Ukraine1:

What we saw in Q3 was a really strong July with a great reaction to Prime Day globally. And the resumption of things like in-stock rates are starting to come back, and delivery speed was coming back. And that continued through the quarter, but growth rates started to slow a bit. And primarily in the consumer stores business, it was in international. North America, obviously, it was strong, but it started to slow a bit. But it was mostly in international where we saw the biggest impact, and we think that is tied to a tougher recessionary environment there. Compared to the U.S., it's worse in Europe right now. The Ukraine war and the energy crisis issues have really compounded in that geography.

European softness was a recurring theme, seconded by eBay, Etsy, and Wayfair. While exposure to China is limited, rolling Covid lockdowns there continue to be a nuisance for Farfetch.

Macro, broadly, remains a headache. Challenging, dynamic, headwinds, and uncertain were popular adjectives to describe the current economic environment. Consumers and businesses are becoming more parsimonious, as Amazon CFO Brian Olsavsky described2:

While we are encouraged by our progress across the business, the macroeconomic environment remains challenging worldwide. The continuing impacts of broad-scale inflation, heightened fuel prices and rising energy costs have impacted our sales growth as consumers assess their purchasing power and organizations of all sizes evaluate their technology and advertising spend.

Q4 2022 Outlook – Santa Envy

E-commerce executives kicked off the holiday season with some serious Santa envy. While Mr. Claus has full visibility – he sees you when you’re sleeping, he knows when you’re awake – the e-commerce outlook is nebulous. The fourth quarter could be naughty or nice.

Etsy spoke for the industry when it called out a dynamic and somewhat unpredictable period, with limited visibility into November and December. Here’s Etsy CEO Josh Silverman on make-or-break holiday shopping season3:

The truth is, we don't know whether consumers will spend more or less on gift-giving or whether they'll do more shopping online or in the mall. But the good news is our business with differentiated inventory across our House of Brands and a variable cost model doesn't depend on us taking huge bets on these questions in the same way most retailers or e-tailers must. So we'll keep focusing on the things we can control, delighting our customers, investing with discipline and care and helping our people minimize distractions and get the job done.

Despite limited visibility, Etsy expects to return to growth in 2023 if macro doesn’t deteriorate. That’s a more confident outlook versus the second quarter, when the company said it was too soon to call a bottom. However, the macro assumption is a big one.

By contrast, Amazon was less sanguine. Sales moderated as the third quarter progressed, and the company expects this to continue in the fourth quarter. As CFO Brian Olsavsky noted, Amazon is preparing for a wide range of outcomes given heightened uncertainty4:

So we're very optimistic about the holiday. But we're realistic that there's various factors weighing on people's wallets, and we're not quite sure how strong holiday spending will be versus last year. And we're ready for a variety of outcomes. But we know the consumers when they're looking for good deals, and that positions us well.

Like Amazon, eBay saw a slowdown in October, amid a dynamic and difficult to predict macro environment. Apparel marketplaces also expect further deterioration, with Farfetch, The RealReal, and ThredUp all guided to sharp sequential deceleration (Poshmark didn’t provide guidance due to its pending acquisition by Naver). This is partially due to crowding out by aggressive promotion at retailers who are sitting on excess stock, as ThredUp CEO James Reinhart explained5:

As we shared in our last earnings call, it's been difficult to predict exactly how the consumer was going to behave in the back half of the year with persistent inflation continuing to pinch the budget consumer, a meaningful portion of our consumer base. As we said last quarter, we observed initial deterioration in consumer health towards the end of Q2 as this continued into Q3. In Q4, we're seeing the added impact of a highly promotional environment as retailers are moving through elevated inventory levels, and the wholesale channel is flooded with excess product. While we were expecting a competitive landscape, Q4 is proving to be an even bigger challenge than we had anticipated.

While ThredUp is focused on budget shoppers, Farfetch and The RealReal cater to a luxury audience, suggesting a broad trend.

After quarters of flogging, homegoods demand might be bottoming. While growth rates are still down year-over-year, both Etsy and Wayfair called out stabilizing demand. However, if the housing market continues to deteriorate, this could be a false bottom. Given limited visibility, 2023 outlooks are speculative at best.

Belt Tightening

It’s Groundhog Day for expenses as well. With growth slowing, cost cutting is an industry imperative. Many companies started pulling back in the second quarter, and this work accelerated during the third quarter. With the exception of Etsy, which didn’t go hog wild on hiring during the pandemic e-commerce boom, and Poshmark, which is being acquired, layoffs are the unfortunate norm.

Source: Company filings and earnings calls. Note: Subsequent to reporting third quarter results, Amazon announced a 10,000 person layoff.

Cost cuts were the major focus of Wayfair’s call. CEO Niraj Shah led off with expense management, showing how the topic is top of mind. Typically CEOs will focus on strategy, growth, and pie-in-the-sky stuff, leaving the numbers to their CFO. Wayfair has already executed on $500 million of annual cost savings. These reductions were split 60% headcount, including laying off approximately 900 employees in August, and 40% other operating expenses. Additionally, the company identified several hundreds of millions in additional cost savings. Wayfair’s 2021 operating expense base was $3.6 billion, so they’ve cut that down by more than 15% over the past two quarters. Management committed to reaching EBITDA breakeven in 2023 regardless of macro conditions and is scrutinizing each dollar of spend.

Although other companies haven’t cut expenses as dramatically as Wayfair, hiring freezes, layoffs, pulling back on marketing and R&D, and scaling back project ambitions are widespread tactics. For example, ThredUp reduced headcount, pulled back on capital expenditures by slowing down distribution center construction, cut R&D, and culled discretionary spending not tied to growth. It’s also focused on increasing automation. In total, ThredUp is looking to reduce expenses by $70 million, against a 2021 base of $240 million. Like Wayfair, ThredUp is prioritizing breakeven, as are Farfetch and The RealReal.

While already profitable, Amazon is pulling back as well. During the pandemic, the company doubled its e-commerce distribution footprint. Now it’s working hard to get its delivery and fulfillment cost structure back to pre-Covid levels to ensure that current profitability isn’t the new normal. Here’s CFO Brian Olsavsky6:

As the third quarter progressed, we saw moderating sales growth across many of our businesses as well as the increased foreign currency headwinds I mentioned earlier, and we expect these impacts to persist throughout the fourth quarter. As we've done at similar times in our history, we're also taking actions to tighten our belt, including pausing hiring in certain businesses and winding down products and services where we believe our resources are better spent elsewhere. We aim to strike the right balance between investing for our customers for the long term while driving operational efficiency improvements and accomplishing more with less.

Slowing growth is like a lump of coal in your stocking on Christmas morning. But you can’t control the hand you're dealt, only how you play it. Though they’d like a better hand, e-commerce companies are recalibrating the post-pandemic demand.

In Groundhog Day, Bill Murray’s character Phil is trapped in an infinite loop. Eventually, he gets out. That’s a good reminder after a few quarters of slowing e-commerce growth and belt tightening. This too shall pass.