By Garrick Brown, Vice President of Retail Research, Americas
Ever hear of the Clever Hans effect? Clever Hans was a German horse in the late 19th/early 20th century that became a popular culture sensation in Europe. Clever, it was claimed, could do arithmetic and other intellectual tasks. His trainer, William Van Olsten, began showing Hans to the public in 1891 and earned a healthy sum of money doing so for most of the next 20 years. Van Olsten would ask Clever, “What is the sum of three plus one?” Clever would respond by tapping his hoof four times.
Van Olsten and Clever became immensely popular in Europe, touring the continent and performing in venues of all types. Obviously there were a few other intellectual feats that Clever would perform in this stage show… all of which centered on him clomping his hoof in response to questions from his master that had numerical answers. The public was enthralled.
What can I say? There wasn’t much to do before we invented all these gadgets to simplify our lives. And it apparently didn’t take much to entertain folks… One of the most popular entertainers of the era (preceding Clever Hans by only a few years) was a French gentleman by the name of Francis Pujol, who went by the stage name of “Le Petomaine.” He was one of the highest earning and most popular performers of the day and he made his fortune with an act that was comprised completely of farting. I am not making this stuff up.
Clever and Van Olsten toured Europe and remained in demand for years. Their popularity only began to wane in 1907 after psychologist Oskar Pfungst was allowed to study the pair and demonstrated that while Clever was clearly a highly intelligent and beautiful animal… he wasn’t much of a mathematician when Van Olsten was around. Pfungst demonstrated that Clever was, in fact, responding to involuntary cues in the body language of his trainer. Further, Pfungst believed that the trainer was completely unaware of these cues… hence; the trainer’s belief in the horse’s ability to compute mathematical problems was real and likely another factor behind the act’s believability.
So why do I bring up the example of people looking to a horse clomping his hoof four times in response to a math question? Simple… because it’s political season and that is about the extent of intelligent analysis of the economy that I was treated to by two political hacks arguing with each other on one of the news networks this morning. It might as well have been, “stamp your foot three times if you think GDP of 1.2% is a problem,” or “stamp your foot if you think that job creation over the last few years has actually set records and that all indications are that it will remain strong, if not robust, heading into 2017…” Both statements, by the way, are true… but no big surprise that in election season you are bound to get nothing but spin and bluster and absolute nonsense. All of which is generally aimed towards an audience that doesn’t know better, or that should… but are too entrenched in wanting to believe the lies being told to them. That being said, let’s just say that I am a big believer in the notion that the lies being told to you by “the other side” aren’t the ones you really need to worry about. It’s the lies being told to you by “your own side” (i.e. the ones you want to believe) that are the dangerous ones.
But that’s enough ranting from me. There is actually a pretty good piece on TheStreet.com that tries to tackle the dilemma that weak GDP + otherwise positive economic indicators paints for anyone trying to forecast what lies ahead. Check out Marco Mazzocco’s excellent piece, “The GDP Data Tell Us the Economy is Not Valued Property,” by clicking here.
The challenge of keeping a balanced outlook (much less embracing a scientific approach to forecasting) continues to rear its head in the marketplace.
Shelly Banjo at Bloomberg did a fascinating story, “Restaurant Recession? Pizza Party,” in Bloomberg a couple of days ago. In it, she cites a Stifel analyst who believes we are on the verge of a restaurant recession. If you have been reading my column you have seen me pointing out that the restaurant failure rate has been on the increase for a number of months now and you have probably read where I have pointed out minimum wage increases will eventually take its toll on the bottom of the (literal) food chain simply because far too many franchise models have been based on unrealistic long-term labor costs. But you’ve never heard me use the word recession when it comes to this trend for a couple of reasons… the biggest one being that I simply don’t agree.
According to tracking from the Census Bureau and US Department of Agriculture, as of June 2016 Americans had spent $393.2 billion (year-to-date) on food expenditures away from home. During the same time, they spent $388.1 billion on food at home. That means we spent more eating out than at the grocery store. April 2016 was the first time we saw this metric favoring eating out and the monthly tallies have favored eating out since then. Many major chains, however, are seeing lower same store sale comparables and a number of major restaurant operators have been citing declining traffic. This is likely true for all of these concepts, but the data DOES NOT suggest people are eating out less and the economic data (I will be doing a big piece on this in the next issue) supports that the US consumer is actually in a fairly strong position right now.
So why declining sales for many chains? Simple… restaurants, on a unit basis, have been the strongest growing sector of retail for going on six years straight. The problem IS NOT Americans dining out less… the problem is consumers have more choices than ever before. The market is saturated people… that’s the issue. Market saturation DOES NOT mean recession is imminent. It probably means a shakeout is imminent, but even I don’t see that happening before next year. And the shakeout will largely start with the weakest franchise players. In the meantime, planned restaurant growth (check out our 2016 North American Retail and Restaurant Expansion Guide) remains at roughly the same aggressive levels we have seen since 2010. So what’s ahead for restaurants? A recession? No, not unless the overall economy veers that way and that’s fairly unlikely for now. Instead, a game of restaurant musical chairs is most likely what is to come. High rents and rising employment costs will continue to be a challenge for restaurant operators and higher rates of failures will create issues for some landlords. But, for now at least, there is a deep reservoir of potential replacements out there. The real question the market should be asking is not whether a restaurant recession happens in the near-term but whether landlords will adjust rents to ensure the survival of struggling concepts in their properties.
The other big news of the week surrounds Amazon’s phenomenal quarterly numbers… Check out our Top Five for some great pieces on it. This didn’t come as much of a surprise to me. In fact, what’s always surprised me over the past few years was how many people would jump on the “but Amazon is not that profitable” bandwagon over the past few years. The reason for that is simple… they were, but they were sinking all of that money into their secret weapon… their distribution chain. In just the past few years they have closed deals on well over 30 million square feet of new eCommerce fulfillment space. If you are having trouble conceptualizing this, that is the equivalent of one building the size of 625 football fields. And my numbers are actually probably a bit on the low side and don’t include Amazon Fresh warehouses and a number of other things. They are still building out that distribution chain (the one that is now capable of next day delivery to about 90% of the US), but as they near maximum capacity their costs are dropping significantly. Hence, in one day Amazon leapfrogged Exxon to be the world’s fourth most valuable company and Jeff Bezos became the world’s third-richest man.
This, of course, prompted someone at a recent presentation I gave to ask me the question, “How long until Walmart is toast?” Again… as human beings we have a tough time processing big news and then turning it into clear, forward-looking analysis. The answer is not any time soon (if ever)… And it probably goes a long way to explain why Walmart is reportedly in talks now to acquire Amazon’s upstart competitor, Jet.com…
To explain more on what is happening with this deal I am going to leave it to our resident expert Ben Conwell. Ben is the Senior Managing Director and Practice Leader for Cushman & Wakefield’s eCommerce and Electronic Fulfillment Specialty Practice Group for the Americas. Prior to joining us, Ben was Director of North America Logistics Real Estate for Amazon Fulfillment Services, the logistics and operations subsidiary of Amazon.com. His wealth of experience from the occupier perspective comes from having led the largest and fastest expansion of network capacity in Amazon’s history, doubling the size of the logistics footprint. Ben has been at the forefront of locating and building leading-edge electronic fulfillment and eCommerce facilities throughout North America. He managed a fulfillment network of 90 facilities comprising 60 million square feet and led the delivery of 28 million square feet of high-tech build-to-suit projects and over five million square feet of repositioned existing buildings.
Ben volunteered to share his thoughts on the potential acquisition of Jet.com by Walmart with our readers and here is what he has to say on the topic:
“In short, a Jet.com deal would be Walmart’s largest acquisition to date to shore up its online offerings. Walmart is currently the #2 ranked online retailer with approximately $15B in annual eComm sales, representing 3.0% of total revenue. In spite of continuing to invest significant capital in the online business (announced $2.0B of spend over the next 24 months), Walmart has seen consistent slowing of YOY online growth each of the last nine quarters to only 7.0% in the latest quarter.
For context, Amazon’s online retail revenue is approximately 5x Walmart’s and has been growing at approximately 20-25% YOY in recent years. Overall US online sales have recently increased approximately 15% per year. The challenge Walmart is facing to make up ground on the market leader is all the harder when the market leader is growing top-line 3.5x faster with no signs of slowing, and the entire US market is growing more than 2x faster.
Walmart CEO Doug McMillon has made no secret of the fact management and the board view its online business as not growing fast enough. The company is aggressively investing in:
- Development and launch of a more competitive two-day shipping offering associated with its Shipping Pass (to counter the explosive growth and loyalty of Amazon Prime)
- Improvements to technology and the online user experience
- Continued increases in the breadth of products available online
- Expanding its third-party marketplace offerings
- Growing its fulfillment center network, and
- Broadening its already dominant grocery position to include curbside pick-up and same day delivery.
Note: Some of these initiatives suggest some interesting alignment with what a Jet tie-up might help provide.
Of considerable impact globally, last month Walmart announced a complete recapitalization of its presence in China with the sale of its Yihaodian operation to China market leader JD.com. When completed the deal will result in Walmart owning 5.0% of JD.com. Like Amazon, Walmart has struggled and failed to gain significant share in China in the face of dominant leaders JD.com and Alibaba.
So who is Jet.com and why would Walmart be interested? Jet.com launched a year ago and is started and led by former Quidsi.com founders (who sold their online business to Amazon in 2010). Many characterized Jet.com as the “anti-Amazon.” Originally promoted as a combination of membership club and low-price online retailer, the company dropped the membership fee structure a few months after launch. The focus today is on being the lower-cost alternative to Amazon and other online marketplaces. The company says its goal is to be the lower cost leader for customers who are willing to trade faster delivery for lower prices.
Privately held Jet has raised over $500M in venture capital from investors including, among others, Google Ventures, Goldman Sachs, Fidelity, Accel Partners and interestingly enough, Alibaba. At the reported valuation of $3.0B, Walmart would be buying Jet at a significant premium to the estimated valuation at the time of the last VC round of approximately $1.4B.
Jet operates a hybrid marketplace whereby it fulfills customer orders both through its own network of three fulfilment centers in the US, and relying on suppliers for a more significant share of orders on which the company earns commissions. Jet reportedly is adding 350k shoppers per month, shoppers whose mean annual household income is $68k, or $10k higher than Amazon’s, per Kantar Research.
Jet reports that it is averaging 3.1 items per box, which is reportedly 50% greater than Amazon’s average. The company is spending heavily on marketing and promotion to build the brand. Some analysts estimate a cash burn rate of $200M-$400M per year for the current and next three years as an independent company. Jet projects that it expects to reach both breakeven and $20B in annual gross merchandise value (“GMV”) by 2020. Amazon’s GMV today is approximately $180B (due in large measure to 50% of its volume being comprised of third party, marketplace sales).
Valuations and deal flow into start-ups in the greater online commerce space are moderating in recent quarters. Jet has been successful in attracting significant capital from leading VCs. Given the current funding trends, however, companies such as Jet may find the market for follow-on rounds to be quite different going forward.
Jet could bring Walmart a small, but significantly high potential future growth engine to help it compete more effectively with Amazon over the long term. At a speculated $1B+ annual run rate, Jet’s top line will not even begin to move the meter for Walmart’s current $483B in sales. We shouldn’t view such a deal as being earnings or cash flow accretive. Rather this would be play to buy technology and talent.
What Walmart could benefit from in a Jet deal would include:
- All-important customer shopping data and the technology to capture and analyze more such data; the “secret sauce” for all online retailers
- Leading edge technology in dynamic pricing developed by Jet to calculate savings in real time as customers add items to their orders
- Three additional dedicated online fulfillment centers and associated technology to supplement Walmart’s network of eComm FCs developed over the last three years
- Some degree of much needed brand buzz to bring some cache to the current Walmart brand, if or for at least as long as Walmart elects to keep the Jet brand identity
- Recognized top talent with proven records of success in building both Quidsi and Jet; no doubt a Walmart deal would include ongoing involvement by key execs for as long as Walmart can secure them.
In its all-out offensive to build its online offerings to meaningfully compete with Amazon, Walmart needs to continually innovate and build scale both organically and through acquisitions. Granted, Jet.com is a small, still not yet fully proven offering in a space dominated by Amazon. It alone would not solve Walmart’s challenges to be sustainably competitive with Amazon. It could, however, be one of many acquisitions and strategies Walmart can benefit from in its quest for online significance.
Why a transaction now? How do you value the contributions Jet could provide Walmart? That’s a multi-billion dollar question. The list of potential purchasers with both the required deep pockets and motivating needs is a short one today. Operationally Amazon doesn’t need to buy Jet. And I don’t anticipate the Jet owners being too willing to sell a second business to Amazon. I see Walmart as a logical Jet buyer at some point. It could be a smart, complementary pick-up. And I don’t see advantages to Walmart waiting.
Why would Jet.com be a seller at this time? It would be reasonable to think that a combination of facing significant capital needs in the years ahead as an independent company, current uncertain trends for future funding rounds and significant premiums offered by a highly motivated Walmart would be enough for the founders – and VC investors – to consider being sellers at this point. On the other hand, to what extent do Jet’s entrepreneurial founders see cultural fits for themselves and their team in the Walmart world? Deals like these are rife with trade-offs.
Jet is a unique company with an intriguing value proposition at a critical time in the evolution of online commerce. At the reported pricing, this would be a multiple the VCs would be hard pressed to pass up.
Who knows if a deal gets done at all, or at what valuation? Speculation around such a deal is still more indication that we live in very interesting times – especially in the rapidly changing world of eCommerce. But I can’t wait to get to the next chapter! Stay tuned.”
–Benjamin D. Conwell Ben,Conwell@cushwake.com
OK… this has been another massive Russian novel of a Newsline and you’ve already read way too much without even checking out the top news of the week yet. But before I go, I would love to invite you to an event that I will be speaking at. Later this month I am going to be out in Nashville for the ICSC Tennessee/Kentucky Idea Exchange. This is always a great dealmaking event at an incredible venue in one of the nation’s coolest cities. The event itself will be Wednesday, August 24th and Thursday, August 25th at Music City Convention Center. I am going to be speaking to the General Session on Thursday morning at 8:30 AM on the topic: Cool Streets of America: Can Hipster Concepts Save Mid-Market Retail? If you can make it, please come check it out. I promise an enlightening and entertaining session and, hey… it’s in Nashville.
By the way, if you haven’t seen our recent report on the Cool Streets of North America, click here
You can also check out our accompanying and ongoing video series; Cool Streets. More episodes are coming but you can click on the below links for…
Additionally, you can check out our latest Q2 2016 National Shopping Center Report by clicking here… And if you need any of our research reports, whether global or local, on any commercial real estate sector check out our research page by clicking here. Thanks—have a great week and enjoy the Olympics!
This post is commentary from the latest weekly edition of our Cushman & Wakefield Retail Newsline, which you can subscribe to for free by e-mailing email@example.com.
Garrick serves as Vice President of Retail Research for the Americas. He speaks frequently at industry events and has been a keynote speaker at symposiums, conferences and market forecasting events for groups like the Appraisal Institute, Urban Land Institute, CREW, ICSC and PRSM. He is also a member of Lambda Alpha International, an invitation-only land use society for those who are involved in the ownership, management, regulation and conservation of land, but also those who are involved in its development, redevelopment and preservation.