Covid-19 boosts e-commerce, resizing US retail

Insights from Morgan Stanley Research

06/07/21

Summary: Social distancing may have kicked online shopping into higher gear—with potentially lasting impact on brick-and-mortar retail margins.

The coronavirus pandemic set in motion many behavioral changes that are likely to stick. In just a few months, virtual fitness classes, video conferences and grocery delivery became ubiquitous—along with a new age of online retail shopping. E-commerce sales for "softlines”, which includes apparel, footwear, linens, and other categories, may have accelerated its shift online by two years.

The upshot: E-commerce giants could stand to gain an even greater share of consumer wallets, at the expense of department stores and specialty retailers that rely heavily on in-store traffic. Wholesale apparel and footwear brands with strong direct-to-consumer businesses face similar pressure, but stand to fare somewhat better than pure brick-and-mortar operations.

A blow to brick-and-mortar

Consumers often prefer to try on clothing, shoes, and accessories before they buy, and spontaneous purchases can make a meaningful difference to brick-and-mortar retailers. While shoppers will eventually venture back to department stores and malls, they may do so less frequently and more selectively.

“Months of lockdown forced more consumers online. For the foreseeable future, will they now think twice before shopping in crowded stores, particularly if they can easily acquire those same goods online?" asks Kimberly Greenberger, Morgan Stanley Research analyst who covers North American specialty apparel and department store retailers.

Given the high overhead of building out and operating physical stores, small declines can erode profit margins, even for retailers that also sell online. “When digital sales cannibalize store sales, it results in less efficient retail margins, as stores wrestle with fixed costs," says Greenberger.

A boon for some brands

Not all retailers will suffer the same fate. Notably, Morgan Stanley Research's analysis excludes clothing retailers that buy excess inventory from brands and department stores. These business models, which are built around in-store “treasure hunts," are hard to recreate online.

Broadly speaking, though, brands with strong wholesale business models could come out ahead, since e-commerce sales tend to be more profitable. In recent years, many leading brands have taken steps to drive more sales to their own websites. In doing so, they've gotten to know their customers better, improved their inventory management and boosted their gross margins.

In the case of one of the world's largest athletic brands, a greater emphasis on direct-to-consumer business is key to its long-term outlook. Morgan Stanley Research’s analysis of this brand suggests the opposite effect as traditional brick-and-mortar, with margin growth for every sale they drive online.

This isn't to say that e-commerce is a slam dunk for all wholesale brands. Winning over consumers requires creating exceptional digital experiences, particularly for softline goods where fit and feel make all the difference. Shoppers may think twice about heading back to crowded stores, but they still care about store design, product mix, and customer support.

Investing considerations

Those who are looking for investing opportunities in e-commerce may look to mutual funds or exchange-traded funds (ETFs).

ETFs and mutual funds are both collections, or “baskets,” of individual stocks, bonds, or other assets—in some cases hundreds of them—all pooled together. When you buy a share of the fund, you own a small piece of this basket of assets. ETFs and mutual funds are similar in that they give you a broad range of investment choices and inherently offer greater diversification than buying a single stock. That said, there are distinct differences in these investment choices. ETFs can be bought and sold throughout the trading day, tend to have lower fees, and are typically passively managed—mirroring the performance of an index. On the other hand, mutual funds trade once a day, typically have higher expense ratios, and are managed by professional fund managers who actively try to outperform a market or index. To learn more about the distinctions between mutual funds and ETFs, check out ETFs vs. mutual funds: Understand the difference.

Bottom line: The shift to e-commerce is here to stay. Investors looking for exposure to this trend may consider exploring ETFs or mutual funds focused on e-commerce giants and wholesale retailers with strong direct-to-consumer programs.

The source of this Morgan Stanley article Covid-19 Boosts E-Commerce, Resizing U.S. Retail, was originally published on June 24, 2020.

 

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