A strange thing happened a couple months ago. My co-worker had eight boxes of shoes delivered to his desk. When I inquired as to why one would order so many pairs of shoes, he replied that he only intended to buy one pair, but wanted to try out several different types before making the purchase. He would send the other seven pairs back to the retailer. It turns out this was not so unusual after all and seems to be a trend that is picking up momentum with consumers.
The process of consumers returning unwanted merchandise is known as reverse logistics. It originates from the consumer for many different reasons, making it far more difficult to predict, and thus, problematic for retailers. In 2014, a transportation management company estimated that reverse logistics can often cost traditional brick and mortar stores three to four times as much as forward outbound shipments while the National Retail Federation estimates that US retailers lost approximately $260 billion in sales in 2016 due to returns. As shown in Exhibit 1, e-commerce (ex-Auto and Gas) has increased from approximately 4% of total retail sales in 2007 to approximately 10% in 2016. With e-commerce sales expected to grow at a double digit growth rate annually, it is likely that consumers will increasingly order more items than they actually intend to purchase. This will increase the use of reverse logistics by both traditional brick and mortar retailers and e-commerce retailers.
Exhibit 1: E-commerce penetration as a % of retail sales
Source: Bloomberg, Jefferies
Few traditional retailers are set up to handle the increased frequency and costs of processing returns associated with e-commerce, which is creating investment opportunities in logistics companies as more of this type of supply chain management work gets outsourced. Some of these logistics systems are enabling customers to track equipment, people, inventory units, while increasing automation in order to streamline the process. At a recent investment conference, a large logistics company commented that currently about 25% of the supply chain is outsourced in Europe while the opportunity in North America is even larger with only about 15% currently outsourced. Further evidence of this opportunity was seen in December 2016, when the largest package delivery company formed a strategic partnership with a technology company that helps retailers and manufacturers manage, process, and sell returned and excess inventory.
Darwinism has come to the retail space, and brick and mortar retailers have to either adapt or die in order to deal with the rise in e-commerce. Many retailers are falling by the wayside as US retail store closings are on pace to be the highest in 20 years, but many others are adapting by increasing their e-commerce capabilities. We see investment opportunities from several different angles. We believe disruption from e-commerce is creating investment opportunities in transportation companies with reverse logistics capabilities, companies that provide inventory tracking technologies, and new technologies that increase the frequency with which companies can introduce “fresh” product. Additional opportunities could occur in companies with warehousing capability, as Jefferies estimates that e-commerce requires as much as three times the warehouse square footage for every dollar in revenues compared to brick and mortar. With e-commerce expected to continue to grow at a double-digit rate, many of these themes could still be in the early innings.
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