E-COMMERCE M&A IN A POST-COVID ERA
Note: For Hahnbeck’s latest insights into post-COVID online retail and M&A see the report in our Insights section. The post below was from 2021.
The COVID-19 pandemic has changed the consumer sector forever. In the west, vaccines are enabling most countries to begin to imagine a post-COVID future. And while some parts of the economy will return to “normal”, retailers are embracing a future that doesn’t look all that much like the past.
The onset of the pandemic in 2020 saw a sudden acceleration in the shift from brick & mortar to online retail, the pace of which surprised almost everyone. In the US, consumers spent $861 billion online in 2020, an incredible 44.0% increase compared to 2019. Many of these consumers were new: data from the UK show that in 2020 almost half (46%) of all consumers purchased something online for the first time which they had previously only ever bought in a physical store. Of these, almost 32% said they are likely to continue to buy the item online post-pandemic. The figures are even higher for older adults, who have crossed the threshold of providing card details to an online retailer for the first time.
Even in China, which had experienced it’s “pandemic e-commerce moment” back in 2003* and already had very high e-commerce penetration, the 2020 COVID-19 pandemic had the effect of increasing the e-commerce share of retail even further.
* In 2003 the SARS outbreak in China required people to work from home en masse, causing an enormous shift in consumer behaviour towards e-commerce. This helped launch TaoBao.com and converted JD.com from a brick and mortar retailer to an online retailer. China has been by far the world’s largest e-commerce market ever since.
The COVID-19 crisis has increased the share of e-commerce in total retail. Source: OECD
Value of retail sales at current prices, seasonally adjusted, Great Britain, Index Feb 2020=100. Source: Office of National Statistics
In the west, Amazon has been arguably the greatest beneficiary of this shift, with 40% growth every quarter compared to the previous year since the start of the pandemic. The firm added $100Bn in sales to its marketplaces division in 2020 – 50% growth over the 2019 level. Third party sellers now contribute approximately $300Bn of Amazon’s $490Bn GMV.
However, the year was not without its challenges for Amazon. It’s highly prized FBA logistics model became its greatest weakness in March 2020 when it prioritised the storage of only essential and high-demand products, resulting in sudden stock-outs for the many products not in these categories. This was tough on consumers (average review scores dropped to the lowest in Amazon’s history during these three months), but even tougher on its marketplace sellers who watched as their products ran out of stock while inventory sat outside Amazon FCs waiting to be accepted. Third-party sellers were forced to quickly adapt to Amazon’s reduced storage limits, with many signing up to 3PLs for the first time.
BEST YEAR EVER
Despite this, the past year was generally a great time to be an Amazon marketplace seller. Hahnbeck’s experience with clients in the UK, EU and US is that for most e-commerce operators, including Amazon marketplace sellers, the past 12 months were the best ever. New sellers continue to join their ranks, with Amazon adding a further 1.3 million new seller accounts during the past year.
Etsy was a surprising star of the pandemic. Capitalising on the international policy shift towards mandatory face coverings, Etsy alerted its sellers to the opportunity and encouraged them to start selling masks. The platform for unique and hand made products attracted almost 3 million new sellers in the last 12 months, doubling its GMV. However, with face coverings responsible for 25% of this growth, it is a feat that Etsy will be hard-pressed to ever repeat.
Direct-to-consumer (DTC) brands focused on selling primarily via their own websites also had a banner year. Shopify, the Canadian company which powers the websites of many DTC brands, grew its GMV by almost 100% over the year, driven by both increased sales for existing sellers and a boom in the number of new sellers joining the platform.
However, small e-commerce businesses (and the marketplaces and software that power them), were not the only beneficiaries of the seismic shift in consumer retail. Major retailers with a pre-COVID plan to expand online, such as Target.com and Walmart.com, also saw substantial growth. Walmart, which had acquired Jet.com a few years earlier, was already building out its own “Walmart marketplace” competitor to Amazon in the US, and the surge in online demand provided fuel for its expansion. This division saw number of marketplace sellers double, albeit from a very small base. In truth most of the growth in GMV for Walmart.com came from click-and-collect (“curbside”) purchases of groceries and in-store product lines. But its direction is clear: with a new fulfilment arm and a growing marketplace division, Walmart is gunning for Amazon in the US market.
The explosive growth of online retail during the pandemic has even enabled newcomers and startups such as the UK’s OnBuy to gain substantial market share from the online giants – an impressive feat. All of this means that despite Amazon’s growth, it has actually lost market share online.
BRICK AND MORTAR RETAIL: BETTER LATE THAN NEVER
It’s obvious that those firms who were already focused on e-commerce have benefited enormously from the shift to online purchasing habits in during the COVID-19 pandemic.
But something interesting has happened in the traditional retail sector also: brick and mortar retailers have finally abandoned the idea that e-commerce can be ignored. This fundamental shift is a permanent change in the consumer sector, and will have far-reaching implications.
For those of us focused on e-commerce it is easy to forget how much larger the rest of the consumer sector is: for every $1 spent purchasing goods online $6 is spent in physical retail stores (£3 per £1 in the UK). These stores are not going away – for a myriad reasons, consumers will continue to make at least some (and probably the majority) of their purchases in brick and mortar retail shops. But until COVID-19, many of these retailers, including some of the largest, had paid very limited attention to the online channel.
IKEA famously did not seem to care for e-commerce at all, fulfilling only a fraction of its catalogue online, and using its website as more of a showroom for products to be purchased in-store. The firm’s unique brand and in-store experience enabled it to hold ground against competitors for years, but the lack of a decent e-commerce function was beginning to hurt the retailer, a situation that was highlighted when the COVID-19 pandemic struck. The firm has finally taken steps to improve its online retail experience, testing an app in selected markets, and even launching on TMall in China. While some of these initiatives began in 2018 with the appointment of the company’s first ever Chief Digital Officer, CEO Jesper Brodin has stated that IKEA’s experience during the pandemic has accelerated its push to improve its e-commerce capability.
“Brick and mortar retailers have finally abandoned the idea that e-commerce can be ignored”
Many other large brick and mortar retailers saw their business models invert during the pandemic, with a previously small online channel exploding while their stores remained closed. In the UK, John Lewis had a reasonably large online presence responsible for 40% of sales, but saw this increase to almost 70% in 2020. The company has now committed to focusing even more on e-commerce in future, “supercharging its investment in online”, according to Mike Sackman, John Lewis’s Chief Information Officer. The Kingfisher Group, which owns retail chains including B&Q and Screwfix, saw online sales grow by 158% throughout the pandemic, with 10 million new customers shopping online with the firm. Group CEO Thierry Garnier has indicated that rather than being a temporary blip, this change represented a new direction for the group, saying “The digital customer adoption we have seen makes us even more confident in the growth opportunities that lie ahead”.
A successful strategy for most of the aforementioned retailers during the pandemic was click-and-collect (AKA “curbside pickup” in the US): allowing customers to order online and collect from their local store. This trend was building well before the pandemic, as retailers sought ways to leverage their giant retail footprint. Allowing customers to order online but collect in-store has many advantages besides convenience, including cross-selling opportunities and the logistics savings associated with fulfilment-from-store. During the pandemic, click-and-collect came into its own and enabled stores to provide a COVID-friendly service to customers even without letting them inside. The success of this approach has highlighted the opportunity for these retailers, many of whom will now invest more heavily in it post-COVID.
With the sleeping giants of traditional retail now very much awake to the opportunities in e-commerce, we expect to see much more investment in online retail from these firms in future. Stores will always exist, but they will be leveraged differently, as retailers use them not only as showrooms but as mini-warehouses. And with a greater reliance on the e-commerce channel, the retail behemoths will become more competitive online. While pure e-commerce operators will always have a cost advantage, they will face more direct competition online from larger firms with well-recognised brands.
WHAT’S NEXT
The online retail landscape is shifting very rapidly, and as the COVID-19 pandemic (hopefully) starts to subside, e-commerce businesses will be affected in different ways. Sellers in categories like businesswear and high fashion suffered terribly during the pandemic, and can look to a brighter future ahead. Conversely, those selling goods that were more popular during the pandemic (home exercise equipment and DIY products, for example), will likely not be able to sustain their current growth levels and in some cases may start to decline. Online retailers of products like hand gel and masks, such as the aforementioned Etsy sellers, will have to pivot to new product lines as demand for these products declines in a post-pandemic world. The majority of sellers whose products were not directly impacted by COVID (either positively or negatively) will have experienced a step-change upwards in demand, and will continue to grow, although arguably not as quickly as over the last 12 months.
“Most sellers have experienced a step-change upwards in demand, and will continue to grow, although not as quickly as over the last 12 months”
The way online retail is conducted has also changed considerably. Amazon’s ever-increasing restrictions on storage, now at an ASIN level rather than product level, have forced many sellers to start using 3PLs, and not only as a middle-man en route to the Amazon fulfilment centre. While 80.5% of Amazon sellers currently use FBA, storage restrictions are forcing an increasing number of them to fulfil products themselves. The proportion of sellers stating that they use FBM at least some of the time has risen to 43%, up one third from the previous year. For these FBM sellers, attaining the Prime badge is not as easy as it once was. Amazon has de-prioritised its seller-fulfilled Prime (SFP) programme, and for those who are enrolled, it continues to set performance targets higher and higher. Providing a good experience to customers via FBM, and staying in stock with FBA, both require much closer attention than they did in 2019.
As the smaller marketplaces gradually eat into Amazon’s market share, sellers will increasingly look to operate on multiple platforms simultaneously. While Amazon, with its high customer intent, is still arguably the best place to launch and grow a new brand, established brands will increasingly look to other marketplaces for further growth. Enabled by technology such as Sellbrite, Codisto, Merchant Spring and many others, sellers will find it easier to run their businesses on multiple marketplaces simultaneously. Similarly, while Amazon’s fulfilment network is still by far the most extensive, the emergence of alternatives (such as Deliverr in the US) is enabling sellers to provide 1 and 2-day deliveries for seller-fulfilled stock from multiple marketplaces.
It will also be increasingly valuable to have a profitable DTC channel, and successful marketplace sellers will devote more attention to this as competition on marketplaces intensifies. Many Amazon sellers focus so intently on Amazon that they only devote a small percentage of their marketing budget to “off-Amazon” ad spend, and in many cases this is used to drive traffic back to Amazon using strategies like the typical “search-find-buy” approach. Driving profitable traffic to a DTC website, and converting customers when they get there, is enormously challenging for those who have until now been Amazon purists, but many will find that developing a profitable DTC channel will help to protect them from competition and drive stronger margins. However, with rising PPC costs due to new competition from traditional brick & mortar retailers, creating a profitable DTC funnel will be more challenging than ever.
Technology continues to provide new ways of reaching customers. Social media channels like TikTok exploded in the pandemic and were quickly utilised by savvy brands to drive large volumes of traffic. While it remains true that those with the largest budgets have the greatest opportunities in the world of influencer marketing, small brands can sometimes achieve outsized results. Established social media platforms also continue to innovate. “Shops on Instagram”, launched during the pandemic, allows users to shop and checkout without leaving the app. Social media referrals have a strong impact on purchase intent (71% of consumers say they are more likely to purchase if referred to a storefront from a social media source), and will be an increasingly important part of the marketing mix for e-commerce businesses from now on.
POST-COVID MERGERS & ACQUISITIONS
While the COVID-19 pandemic generally placed downward pressure on valuations in the economy at large, reducing the number of transactions in the past year, the opposite was true in e-commerce.
Amazon FBA merchants’ best year ever coincided with the emergence of a large number of new, well-funded acquirers of FBA businesses. With more than $4Bn in new capital entering the space to acquire Amazon FBA merchants, valuations have risen substantially over the past year. Other e-commerce businesses are experiencing stronger valuations too, as investors from outside the space compete with the existing buyers of these firms. Successful DTC brands, in particular, are highly sought after. But undoubtedly the strongest surge in demand has been for Amazon FBA businesses, for which there has never been a better time to sell.
Valuations of these firms are based on their last 12 months’ earnings. As we move further into 2021, we will for the first time start to see the highly profitable months from the beginning of the pandemic in the comparator year rather than being counted in the trailing 12 months. While many of these firms are still growing, their most recent 12 months will not show such explosive growth, and this will start to have an impact on valuations.
UK & EU sellers are still being affected by Brexit and the new headaches involved in selling across the English channel. These will all eventually be resolved, but the short term loss of sales that many sellers are experiencing will also have an impact on profitability and hence valuations.
Deal structures will also start to reflect the new reality. With both buyers and sellers expecting less growth than in the previous 12 months, we expect earnouts to be based on slightly less optimistic projections. A simple “share of all profits above last year’s level” will be less common. Instead we expect to see more deals that include lower “floors”, more easily achievable targets, guaranteed minimums and revenue (rather than profit) sharing arrangements. In those cases where the earnout structure does not change in this way, sellers will expect less of their total consideration to be received in the earnout, and thus argue for a higher proportion up front. All of this comes down to negotiation of course, and is affected by the balance of power between buyer and seller, as well as the way the process is handled. Those who are negotiating on their own will not get the best outcomes.
The market will remain strong, but less frenzied. We have already heard several stories from Amazon FBA sellers of unprofessional tactics being employed by acquirers during due diligence – something that would rarely happen in a true seller’s market, where every deal is scarce. The largest acquirers have been able to generate a lot of deal flow and are becoming a little more selective. In this market it is even more important that sellers are represented by corporate finance firms like Hahnbeck who can protect their interests, get them the best deal, and monitor proceedings during due diligence.
We will likely also see consolidation among the acquirers, as the larger firms utilise some of their capital to acquire the portfolios of smaller firms. At least one of them will go public, generating even more liquidity to drive further acquisitions. These firms will also start to look beyond Amazon – some of them are already actively seeking TMall and TaoBao sellers, for example, and more of them will start selling their brands across multiple platforms. Furthermore, they will start to look beyond acquisitions, building their own brands from scratch. Many of the largest FBA acquirers have stated that this is part of their business plan, and some have already started to execute on it.
Over the longer term, as more and more small private label businesses are acquired, the remaining merchants will increasingly find that they are no longer just competing against small businesses, but against multinational e-commerce giants who have acquired them. While it is true that thousands of new small merchants join Amazon every day, the most serious competition will come from larger players who are developing an increasing presence in hundreds of small niches. Amazon sellers will have to continually improve to compete in this landscape.
The beauty of e-commerce is the level playing field it provides to smaller businesses, who can compete head-to-head with retail giants. Experienced, independent e-commerce operators will continue to be successful, and new independent brands will continue to grow to huge companies in the online retail space. But for many, the option of selling their business to a competitor, instead of competing head-to-head, will become an increasingly attractive option.
$4 billion is a lot of capital to be dedicated purely to buying Amazon FBA businesses, and the need to deploy this capital will continue to drive acquisitions in this sector. It should be noted that the majority of this capital is debt rather than equity, and debt must be serviced by profitable revenue, thus constraining valuations on average. There will be exceptions though, with some firms selling for less than their true worth, and others selling for multiples well above the price that buyers ideally like to pay. The firms in the latter category, who achieve the absolute best result when they exit, will be represented by specialist firms like Hahnbeck. Rather than managing the process themselves and being happy just to receive offers, they will hand the process over to professionals and do it properly, with a well-managed competitive bidding process, and an advocate protecting their interests.
Hahnbeck is a global M&A advisory specialising in e-commerce. If you have an e-commerce business and you would like to discuss your plans to exit the business, we would be happy to help.
Just send us an email at info@hahnbeck.com or give us a call on (+44) 203 669 1654.