#162 – A Knife Fight In Mud

2024 Q2 E-commerce Review

Sep 08, 2024

Hi 👋– It’s been a while. I hope that you had a nice summer. As we enter the third quarter, the gap between e-commerce winners and losers is widening. With titans like Amazon and Shopify consolidating market share, smaller players are left fighting for scraps. Below, key themes and trends from second quarter e-commerce earnings. As always, thanks for reading.

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Same Industry, Different Vibes

Things keep chugging along. In the second quarter, revenue growth rates were largely stable compared to the first quarter. ThredUp was an outlier with sales deteriorating due to the unfortunate troika of European struggles, self-inflicted wounds from failed acquisition and retention marketing tests, and mounting stress on low-income households.

Source: Company financial reports. Notes: Amazon doesn’t explicitly break out e-commerce growth in one clear number. However, Amazon online store revenue (first-party e-commerce), third-party seller services (third-party e-commerce growth and changes in seller services penetration and priding) and paid unit growth give a composite picture of above-market growth.

While the overall demand picture was hazy, squint and two trends emerge as drivers of financial performance. First, market share dynamics. Second, category exposure.

The performance gap between the winners and losers is growing. US e-commerce sales grew 7%1 in the second quarter, powered by juggernauts like Amazon, Shopify, and Walmart who all posted double-digit growth. With market share consolidating at the top, everyone else was left fighting for scraps.

Growth also needs to be assessed in the context of category exposure. Notably, high dependence on discretionary spending remains a liability. In contrast, everyday essentials like health and beauty and foodstuffs continue to sell, benefiting everything stores like Amazon and Walmart. While granular disclosures are rare, Etsy’s category breakout illustrates the choppy demand by category.

Source: Etsy, 2024 Q2 Earnings Presentation, July 31, 2024.

Home & Living remains particularly challenged. Notably, Wayfair called out the worst furniture market since the Great Financial Crisis. Here’s CEO Niraj Shah2:

Customers remain cautious in their spending on the home and our credit card data suggests that the category was down by nearly 25% from the peak we saw in the fourth quarter of 2021. This mirrors the magnitude of the peak to trough correction that the home furnishing space experienced during the great financial crisis, according to U.S. Census Bureau data. Importantly, this calculation is on nominal dollars. Adjusting for inflation suggests we're now in the midst of a correction in excess of 35% and an unprecedented level of pullback in our sector. We see three clear factors behind this correction. One, the malaise in the housing market; two, overspending in 2020 and 2021 that has warped the historic replacement cycle; and three, a slowing U.S. economy.

It’s worth pointing out that Wayfair is gaining market share by declining less than the overall online furniture market. They’ve got a good market share position in a temporarily bad market.

In contrast, here’s a mic drop from Shopify President Harley Finkelstein3:

I do know that there are a lot of people out there talking about softening consumer spend, and we hear that, too. I think from us, the key point is we are working with our merchants to help them be very successful in this environment. We didn't see any significant deterioration or improvement throughout the quarter...It played out essentially exactly as we expected going into the quarter. So I recognize and hear the commentary from others out there in terms of what they're seeing. I just think we're – from our vantage point, we're not seeing that the data in terms of our merchants having issues. We're – I think we're just simply taking share, I think is the best way to say it.

That’s what a winner sounds like. Shopify saw strong same-store-sales growth, solid results in Europe, and healthy new merchant acquisition. In contrast to Wayfair, Shopify benefitted from category diversification with “robust performance” in health and beauty and food and beverages and “solid growth” in apparel and accessories, its top category.

The big are getting bigger and the rich are getting richer. Same as it ever was.

Q3 Outlook – Stable-ish

Third quarter guidance suggests a stable-ish environment. On the margin, are things getting worse? That’s unclear. It’s probably more accurate to say that things aren’t getting materially better. Like second quarter results, there’s high variance by company, with market share dynamics and category exposure being important considerations.

Source: Company financial reports. Note: Q3 2024 growth rates reflect the midpoint of guidance.

This comment from Etsy CEO Josh Silverman exemplifies the overall mood4:

While we continue to face stiff macro headwinds, we're making meaningful improvements to the customer experience, which we believe are beginning to inflect the curve along our journey to get Etsy back to growth.

Unlike the rising-tide-lifts-all-boats operating environment during the pandemic, today’s climate is much less forgiving. Companies need to create their own luck. As always, execution matters.

Consumer Behavior – Groundhogs Day

There was more of the same on the macro front: inflation-weary consumers; staples outperforming discretionary categories; shoppers looking for deals; and big ticket purchases being deferred.

Amazon saw a more discerning shopper. The consumer bellwether noted that buyers remain cautious on price and were trading down where they can. Discretionary purchases remain strained, with big-ticket items like computers and TVs growing slower than normal. Amazon also saw average selling prices decrease. This was due partially to shoppers shying away from big-ticket purchases, partially due to them trading down, and partially due a mix shift to lower-priced everyday essentials enabled by faster shipping speeds. This cautious behavior is expected to linger into the third quarter. Despite the subdued mood, Amazon’s enormous selection and market share gains resulted in healthy growth. Others weren’t so lucky.

Another recurring theme was that lower-income households are struggling. eBay called out more stress on less affluent customers. The company saw sales of used and refurbished items once again outpace new items, suggesting a cost-conscious environment. At the same time, eBay’s luxury category5 grew for the sixth consecutive quarter. Similarly, although luxury fashion resale marketplace The RealReal saw GMV growth accelerate, it noted a slight uptick in price sensitivity and a preference for discounted products.

ThredUp, which has the highest exposure to budget consumers, sounded the worst regarding consumer health, as inflation continues to grind down the purchasing power of its core customer base. The company was blunt that their shoppers were more challenged in the second quarter versus the first quarter. (Self-inflicted wounds on customer acquisition and testing didn’t lighten the mood.) Here’s CFO Sean Sobers6:

Finally, our core customer is feeling the multiyear impact of compounding inflation. They are incrementally more discriminating in their purchasing, resulting in a highly competitive consumer discretionary environment. We expect this dynamic to persist in the balance of the year and could potentially worsen.

Wayfair felt pain too, but this was driven by category exposure and not demographic issues. With the housing market in the tank, executives sounded more downcast compared to recent quarters. In particular they called out that shoppers were acting like it was a recession.

If all this sounds similar to the past few quarters, that’s because it is.

P&L – Frugally Finding Balance

Businesses continue to harvest gains from cost reductions and reorganizations in 2022 and 2023. For example, The RealReal reported accelerating revenue growth and expanding margins, while Wayfair posted its best quarterly result for Adjusted EBITDA and free cash flow in the past three years, despite shrinking sales. But this is no time to stand still. Four P&L trends that stood out are: continued frugality; a more balanced approach to capital allocation; increased promotional intensity; and a growing love affair with AI.

Embracing Frugality

To generalize, 2020 and 2021 were about surfing the wave of e-commerce demand. Anticipating a new normal, companies hired and invested with abandon. (One of the most dangerous phrases in finance is, “this time is different.”) Eventually the clock struck midnight. The party was followed by a hangover. 2022 and 2023 were characterized by reversion to the mean for demand and companies resetting their expense bases to reflect this sober reality. The parsimony has carried over into 2024. While major layoffs and cost reductions are largely in the rearview mirror, companies continue to optimize.

Amazon is a prime (lol) example. Last year, the company reorganized its US fulfillment network. Now it’s focused on network optimization which means moving supply closer to customers, increasing the number of units per box, reducing the number of boxes shipped, and having shipments travel fewer miles. If successful, the net effect will be lower cost to serve. Other cost savings opportunities under consideration are increasing automation and the use of robotics, building out a same-day delivery network, and regionalizing inbound fulfillment. These initiatives will play out over quarters, but should drive improved margins for its retail business. Amazon continues to count pennies. That’s a good thing.

ThredUp provides a more extreme example of the new operating mindset, with the company intending to divest its European business, which it acquired in 2021. Management determined that the time and capital required to turn the business around would be too much and that doing so would diminish focus on the more successful US business. ThredUp deserves credit for avoiding the sunk cost fallacy. While refocusing efforts on the US means a smaller company, it should translate into a better growth profile and structurally higher margins. This feels similar to the way that The RealReal revamped its commission structure and unit economics last year, trading off lower growth for higher margins. These moves produced short-term pain, but are paying off today. For Thredup, it could be a nice example of addition by subtraction.

A More Balanced Approach to Capital Allocation

Companies are also shifting their posture from a defensive crouch to a balanced stance. Some are getting back on the offensive with selective investments. For example, here’s eBay CFO Steve Priest7:

Given our execution to date, we are exploring opportunities for incremental investments to drive durable long-term growth.

Similarly, Etsy acknowledged a shift in product development philosophy from incremental improvement to bigger bets like Gift Mode and launching a loyalty program. Here’s CEO Josh Silverman8:

Given larger scale and crowded and promotional e-commerce landscape, now devoting significant resources towards bold, integrated initiatives that combine product improvements and marketing in novel ways.

For Etsy, my suspicion is that this new philosophy is being driven by necessity. After a good four year run of stacking up incremental win after incremental win, their previous produce development philosophy may have hit the wall of diminishing returns.

This balanced approach goes beyond e-commerce. Here’s Amazon CEO Andy Jassey on AWS growth drivers9:

We're continuing to see three macro trends drive AWS growth. First, companies have completed the significant majority of their cost optimization efforts and are focused again on new efforts. Second, companies are spending their energy again on modernizing their infrastructure and moving from on-premises infrastructure to the cloud…And third, builders and companies of all sizes are excited about leveraging AI.

Given its scope and size, AWS has an excellent read on corporate and start-up technology spending.

AI – Throwing Spaghetti At The Wall

We remain in a throwing-spaghetti-at-the-wall phase of AI deployment. That’s not meant to be pejorative. Below the Line is a big advocate of testing, tinkering, and experimentation. Rather it's a comment on the infancy of AI adoption.

Mega caps, including Amazon, continue to invest tens of billions of dollars per quarter in AI-related capex. Most e-commerce companies are investing in AI too, announcing features for both buyers and sellers. To highlight a few, Amazon’s AI functionality includes virtual try on, helping sellers to create listings faster, and autonomously uncovering defective products in fulfillment centers before they reach customers (cutting down on refunds and customer service). eBay is using AI to help customers shop the look (image search), speed up listings for sellers, and improve photo quality (a conversion booster). Etsy even added a slide to their investor deck about AI:

While the buzz is real, the benefits from these features remain difficult to quantify. That’s not uncommon, given how nascent they are.

Intensifying Promotional Landscape

As Etsy noted above, with fewer discretionary dollars to go around, winning business is becoming a knife fight in mud. As consumers became more discerning, several companies acknowledged an increasingly promotional environment. Amazon noted that consumers are responsive to low prices. ThredUp saw the promotional landscape intensify in the US starting in mid-April. The company had to sweeten discounts by about 20% to coax shoppers to whip out their credit cards. Similarly, Wayfair saw that promotions drove customer engagement and the shoppers were pulling back on non-promotional periods. As a consequence, it is dropping prices in hopes of gaining market share in the third quarter. This could manifest in downward pressure on gross margins or higher marketing intensity. Another reason for companies to keep counting pennies.