Disruptive commerce: upending ecosystems and unlocking innovation
Where there is demand, there is opportunity, says Franklin Templeton Equity Group
E-commerce: shifting the river of economic demand
On a fundamental level, our economy is driven by demand, and every part of the system is built to satisfy that demand. An analogy we have used on our team is to think of demand as a river. Over seasons, the river might ebb and flow in strength and volume, but it never fully ceases, and where the river goes, life and biodiversity follow. The same is true with demand in an economy — where there is demand, there is opportunity, leading to innovation, growth and prosperity.
With gravity the river flows downhill, but the path it follows may alter over time due to disruption, bringing life to new areas while leaving the original riverbed dry. For centuries, humans have used technology to divert rivers, either partially or completely, for their benefit. Similarly, the gravitational force of greater convenience has guided demand in the consumer economy, but it is e-commerce that has fundamentally disrupted the economy’s trajectory. E-commerce has created new profit pools, as demand has been channelled away from historical patterns.
Some of these technological advancements are so dramatic that they can rapidly shift huge portions of demand to a completely new market, leaving old markets reeling. Take, for example, the advent and rise of the ride-sharing business model, which sparked protests nationwide as traditional taxi drivers saw their business decline 75% from less than a decade ago1.
Human intervention is not the only way to alter the path of the river — nature can too. Consider the lasting and dramatic effect the pandemic is having on the economy and consumer habits. Though globally devastating, the pandemic has been a tailwind for e-commerce at a level unseen since the advent of mobile phones. In a matter of months, the pandemic catapulted the industry forward, accelerating the adoption of online shopping4, digital communications, website creation and other industry trends at a pace that had previously taken years. If nothing else, Covid-19 serves as a testament to our adaptability, as we are seeing e-commerce expand in remarkable and ingenious ways.
Today, the range of goods and services that can be obtained virtually is dizzying. Of course, cleaning supplies, toys, books, clothing, tools, furniture, cars and groceries are well-represented and available. However, offerings have expanded to include services such as virtual veterinarians, e-learning, digital exercise classes with a social media element, at-home blockbuster movie launches, malls in the metaverse, virtual dating, online live concerts, and new browsing experiences designed for discovery. Or, as one company puts it in their “S-1,” combining “Costco and Disneyland” into one’s shopping experience. We see opportunities everywhere, and yet consumers have only begun to tap the potential of this new global digital marketplace.
As investors and students of innovation, we are constantly looking for change. We are dispassionately appreciative that we cannot change the flow of the river — but we can potentially profit from it. We view change as inevitable, and disruption as indicative of an opportunity ahead.
How the evolution of the internet affected the development of e-commerce ecosystems
We are witnessing a sizeable and lasting shift to e-commerce across the economy, a movement catalysed by a single, revolutionary technological advancement — the emergence of the internet. The internet made it possible for businesses and individuals to buy and sell items and services online, and in a short period of time, consumers had the convenience of almost unlimited selection available to them from the comfort of their homes, 24/7, with just a few clicks of a button.
Books were one of the earliest categories of items sold online, and were in fact the only thing Amazon sold when it went public in 1997. Books were a logical starting category for online retail, as they are mostly the same size, easy to ship, simple to describe using typeface, and a category where virtually unlimited selection mattered. More importantly, books were easy to sell within the constraints of dial-up internet.
All of the early pioneers of e-commerce, whether that was Amazon, eBay, Craigslist, or Etsy, relied on simple web pages that were typically less than 1MB in size to describe and sell their product. Dial-up service, while slow, was sufficient to load these web pages. It was only as internet technology evolved from dial-up service to coaxial cable and fibre that we saw the expansion of e-commerce into many more categories. This included video streaming such as Netflix and YouTube, video advertisements through platforms such as Facebook and Instagram, video calling with Zoom and Microsoft Teams, online education, cloud services, and many others.
All of what we know as e-commerce today was only made possible by the existence and development of the internet, and increasing internet speeds led to expanding possibilities.
But in its infancy, the internet, and thus e-commerce, was not available to all households. Even in 2007, less than 50% of adult Americans had a broadband connection at home2. The invention of the smartphone, or basically the pocket computer, allowed anyone, anywhere to be connected online. Smartphone penetration grew rapidly from less than 11% of the US population in 20073, when the iPhone first launched, to over 80% today4.
About three-quarters of e-commerce purchases are made with a mobile device
Exhibit 1: Global mobile commerce as a share of total global e-commerce
Today, mobile e-commerce, otherwise known as m-commerce, comprises about 70% of total e-commerce sales globally and has more than tripled since 2015.5,6
In addition, smartphone mobility has allowed the internet to move beyond category expansion and into entirely new businesses, such as location-based advertisements and ride-sharing. So, while the internet was foundational to the existence of e-commerce, the smartphone has made accessibility much more ubiquitous to the general population and has made e-commerce as universal as it is today7.
Payments and logistics: critical e-commerce-supporting ecosystems
If the internet was foundational, then payments and logistics were critical. Returning to the analogy introduced earlier, when a river shifts, the diverted water pools in new areas, and in those pools form new ecosystems and biodiversity. Let’s say that after this river shifted, one of the resulting pools became home to trout. For those trout to exist, other life forms — smaller fish, insects, algae, bacteria, and so on — must also develop to play supporting, yet critical, roles in the ecosystem. It is much the same within e-commerce. Big platforms, such as Amazon and Alibaba, exist and flourish because critical infrastructure like payments and logistics evolved to support them.
Today, payments are a thriving area of investment, which benefits both from the shift away from cash — a trend Covid-19 accelerated — and the industry’s unique position in a positive feedback loop with e-commerce. Just as mobile phones helped accelerate e-commerce, e-commerce accelerated digital payments, helping drive demand to build new infrastructure for virtual transactions.
Today, the market capitalisation of the top five public payments companies is nearly $1.5-trillion8. Within the industry, innovation has flourished. Take, for example, Shop Pay, a Shopify service that’s similar to Apple Pay and Google Pay. It allows customers to checkout 60% faster and results in 18% higher conversion rates from returning shoppers due to its one-tap accelerated checkout9.
Another example is the “pay later” checkout option, which increases conversion and allows customers to delay payment instantly, all while using alternative data and artificial intelligence to automate the credit risk assessment. These types of innovations and offerings within payments continue to chip away at customer pain points and drive further penetration of e-commerce.
If payments were pulled happily along in the wake of online buying, then logistics were grudgingly and laboriously yanked along. Logistics and fulfilment are ultimately expensive and complex networks that require significant coordination and planning. The term logistics refers to everything that goes into getting the finished product from the manufacturer to the end destination (and the reverse with returns).
Relative to brick-and-mortar stores, e-commerce requires a 400% increase in spending on distribution centres and transport to the consumers10. In fact, the total fulfilment costs to serve an e-commerce customer is 2.5 to three times that of a brick-and-mortar retail customer.
However, as a result, the number of warehouses, warehouse employees, logistics robotics and technologies that improve warehouse efficiency have seen tremendous growth in the last decade as retailers increasingly shift online. Amazon, one of the largest e-commerce platforms in the world, spends $46bn on fulfilment alone, and these costs grew 34% in 2019 compared with the previous year (due primarily to the shift to free one-day delivery for Prime users) 11.
Not surprisingly, Covid-19 accelerated logistics adoption. Amazon reported a 49% increase in shipping costs in the first quarter of 2020 and hired 85,000 new workers to deal with the increased demand for products on their platform12. Similarly, Honeywell’s Intelligrated, a leader in warehouse automation, increased its order growth by more than 300% in the second quarter of 2020 as companies scrambled to make their warehouse operations more efficient13.
Though difficult and complicated, logistics is an industry that is quickly evolving, as consumers demand greater and greater convenience. This, in turn, increases their willingness to buy things online, driving further e-commerce penetration.
While we have offered two significant examples here, it is important to note that e-commerce has fundamentally changed many more industries, such as social media, online security, customer support, and website development. These symbiotic ecosystems continue to evolve and accelerate the e-commerce trend, pushing our definitions of convenience and spurring further penetration and disruption.
We believe a cohesive view of the entire ecosystem, including supporting platforms, is essential to our understanding of the pace and duration of e-commerce. We also believe that it is this cohesive view that differentiates us from other investors in this space who often have too narrow a purview, isolated and defined by industry sectors as opposed to the underlying trends themselves.
The future: acceleration of e-commerce trends
As we look to the future, we’re encouraged by the trends we are seeing. In many ways, the pace of change is accelerating. Technologies such as 5G and virtual reality drive our optimism and will drive further penetration of e-commerce as well. New businesses and new business models continue to emerge. Globally, countries are leapfrogging the US, as adopting new technologies is more efficient without legacy infrastructure. The pandemic will, in many areas, create lasting change in people’s habits.
Technological advancements such as 5G have historically accelerated e-commerce penetration and we believe will continue to do so. After all, it would be impossible to have media streaming services or cloud services running on dial-up internet.
Today, we are on the precipice of 5G, which promises latency speeds as low as 1 millisecond vs 50 milliseconds in 4G. Longer-term, this will allow for advancements in augmented reality and virtual reality. Lower latency will be integral to industries that require specificity on an individual basis.
Imagine a world in which, using augmented and virtual reality, you could “walk about” the home you’re interested in buying, feel what it’s like to drive a certain car, see how clothes look on yourself without trying them on, and see how a piece of furniture would look within your home virtually. With this technology in mind, we look at the industries that still have very low penetration of e-commerce and we see promising futures — these include real estate, cars, furniture and health care.
Plenty of growth to go: we are early on the S-curve
Exhibit 2: E-commerce penetration in select industries
New business models will emerge The ability of the internet to bring together a vast set of diverse consumers, with a wide range of preferences, instantaneously creates a rich backdrop for new businesses and business models to emerge. For instance, the sharing economy is an economic model that allows users to maximise their assets’ use, therefore increasing economic efficiency. Though made famous with ride and auxiliary home-sharing, these new business models can also extend to primary residences, campgrounds, freelance services, office space, and even clothing and jewellery. Creating a two-sided, trust-based market requires a lot of innovation, including rating systems, more complex distribution, and new forms of customer service.
Another area where we see the emergence of new businesses is in online price discovery. Price discovery has become more efficient as multiple types of auction models emerge, such as the highest bidder auction format; the lowest price clearing auction (Dutch auction) format; and, finally algorithm-enhanced auctions where frequency, relevance and other factors are blended together to produce the best outcome. These new business models have created more powerful competitors within existing industries, expanding their respective addressable markets.
Group buying, social media and influencers are also making shopping more engaging and fun. As we look to the future, we are excited by what additional retail technologies we see emerging on the horizon.
For example, new technology that solves the tremendous complexities of managing individual low price point stock keeping units (SKUs) in an omnichannel environment, allowing online purchases, and returns or exchange in-store. Software has developed to help businesses navigate the 12,000 different local tax jurisdictions in the US in real-time. Same-day shipping, third-party fulfilment, facial recognition, authentication security software, edge computing — all areas of promising new growth.
This Cambrian-like explosion of new businesses and business models in the e-commerce world will create opportunities for investment. That said, we are always aware that the innovators and disrupters of today may one day be disrupted themselves tomorrow. Ever vigilant of this concept, we firmly believe active management is necessary to invest in innovation.
Many countries do not have the equivalent legacy infrastructure as the US. At first blush, this may seem like a disadvantage, but in some cases, the lack of incumbents and existing infrastructure allows them to leapfrog the US. For example, China is the largest e-commerce market in the world. With about $2-trillion in retail e-commerce sales and 36% penetration rates in 2019, it has far surpassed $600bn or 16% penetration rates14,15. Despite a similar geographic size and four times the population, China has only 2.8 retail square feet per person, less than one eighth that of the US at 23.5 square feet per person16. The country’s lack of a legacy retail footprint has allowed it to quickly adopt e-commerce trends at a faster pace than the US.
We see similar dynamics in mobile payments. China never fully embraced the use of credit cards, and this fact allowed it to adopt mobile payments significantly faster than the US by jumping straight from a cash society to a mobile payment society. The same phenomenon will happen in other countries and other emerging markets.
For example, Latin America is only about 4.5% penetrated in e-commerce, with a nearly 22% growth rate. Mexico’s e-commerce penetration grew 35% in 201917. India, the Philippines and Malaysia are three of the top five fastest-growing e-commerce countries in the world. 18 Looking at e-commerce globally, we see the leapfrogging of many countries as further accelerating e-commerce trends.
Long-term effects of Covid-19
Today, there is dramatic acceleration in the secular shift to e-commerce because of Covid-19. This crisis is unprecedented, but like so much of the history that we like to study, we have some parallels. We have witnessed other exogenous events in the past that have had similar accelerating and lasting effects. India’s banknote demonetisation is one such example.
On November 8 2016, Indian prime minister Narendra Modi announced in a live unscheduled televised address that the use of all 500- and 1,000- rupee banknotes — 86% of Indian currency in circulation at that time — would be invalid past midnight. 19
One of the many and widespread effects of this sudden cash shortage was that online retailers saw a noticeable and sustained increase in the adoption of digital payments after the demonetisation. Most consumers maintained this level of usage even after the cash shortage had concluded, showing that macro events can have long-lasting effects on consumer behaviors20,21.
Covid-19 will likely have a similarly lasting effect on our economy. As shelter-in-place continues to rely on e-commerce to fulfil consumer demand, cashless and contactless payments, fast fulfilment, online security and virtual “window shopping” will become an even more integral part of our day-to-day lives, and we believe companies supporting these capabilities will thrive.
On the other hand, as with any sudden shift in demand, some companies will struggle. J.C. Penney, Neiman Marcus, J. Crew and Barneys are just a few casualties filing for bankruptcy in 2020. And as these businesses fade, it will only further accelerate e-commerce trends as their customers will be forced to adapt in an online retail world.
In 1570, a 5.8 magnitude earthquake struck the city of Ferrara in Italy and changed the course of the Po River, moving it 20km to the north. 22 As it turns out, the earthquake was the last of a series of tectonic events — the “straw that broke the camel’s back” — that lifted the southern portion of the Po Valley substantially and shifted the Po River a total of 40km north over 3,000 years.
Where the river shifted, new aquatic life formed where none existed before. Where it disappeared, so too did many incumbent life forms. In time, we may well see the pandemic as similar to the earthquake that moved the Po River. The pandemic shifted consumer behaviour irreversibly. It was an event that created winners and losers in all parts of the economy, and for us, an opportunity.
To learn more about investing in technology and innovation visit the Franklin Templeton website.
About the authors: Matthew Moberg, CPA senior vice-president, portfolio manager; Joyce Lin, CFA vice-president, analyst/portfolio manager; and Will Holding, research associate.
This article was paid for by Franklin Templeton Equity Group.
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- The New York Times, Los Angeles Rethinks Taxis as Uber and Lyft Dominate the Streets, January 12 2020.
- Pew Research Centre, Home Broadband Adoption 2007, July 3 2007.
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- eMarketer, “e-commerce Continues Strong Gains Amid Global Economic Uncertainty, June 30 2019.
- Bandi Chaithanya, Moreno Tom, Ngwe Donald, and Zhiji Xu, The Effect of Payment Choice on Online Retail: Evidence from the 2016 Indian Demonetization, June 27 2019.
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