Branding or Revenue Boost: What’s Motivating Amazon’s Move?

By FOXBusiness

Amazon (NASDAQ:AMZN) reportedly has plans to open its first brick-and-mortar storefront in Midtown Manhattan ahead of the busy holiday shopping season.

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A spokesperson for Amazon didn’t deny the plans, telling FOX Business, “we have made no announcements about a location in Manhattan,” but would not comment further.

As investors mull the idea, two questions come to mind: Why a storefront and why now?

According to the original report in the Wall Street Journal, the online-marketplace behemoth is slated to open its first retail store on 34th Street across from the city’s iconic Empire State Building. Rather than a retail store in the traditional sense of the word, Amazon’s new digs would most likely act as a kind of mini-warehouse stocked with limited inventory for same-day delivery within the city.

When it comes to numbers, in the company’s July-ended fiscal second-quarter, Amazon’s bottom-line result matched expectations with an EPS loss of 27 cents, compared to the 2-cent-per-share loss it logged in 2Q 2013. Amazon said for its fiscal third quarter it expects to see an operating loss between $410 million - $810 million, compared to a year ago, when losses came in at $25 million.

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While the company’s losses are deepening, its top line paints a completely different picture. Amazon logged fiscal 2Q revenues of $19.34 billion, up from $15.70 billion from the same time in 2013. Moreover, the e-commerce giant expects net sales to surge 15% - 26% in the holiday quarter to somewhere between $19.7 billion and $21.5 billion.

So given Amazon's success through offering low prices and quick delivery, does a move to brick-and-mortar make sense?

Location, Location, Location

When it comes down to it, there are two ways people shop: Online and in-store. The more technology progresses, the easier it’s become for consumers to get the products they want when they want them. And the ease of placing an order for same-day delivery on your smartphone has increasingly blurred the lines between traditional and online forms of retail.

Ron Klein, retail and consumer practice director at PricewaterhouseCoopers, said a decision like the one from Amazon is all about experimentation.

“What you see now is (retailers) trying to figure out what model makes economic sense,” Klein said. “A customer’s willingness to pay same-day delivery doesn’t match cost (for the retailers). We’ve found customers might be willing to pay an additional $5, but the actual cost to the transportation provider could be up to $15 - $20.”

The bottom line, Klein said, is just that: How do these lower costs affect a retailer’s profit margins? In the end, those companies want to develop and construct an infrastructure for themselves that manages to cut down on cost for that last mile of the transaction process.

Moving from online-only to adding a brick-and-mortar to retail portfolios began with smaller startups like Warby Parker, Bonobos, and most recently, Birchbox which made the move to physical retail this summer in New York City. Now the trend is catching on for giants like Amazon who are trying to figure out exactly where they fit in the ever-changing landscape.

While part of the decision to expand into the physical space comes down to branding, a lot of it, Klein said, has to do with the holiday shopping season – especially as big cities like New York City see temporary “pop up” shops opening all over. He said it’s a way for the company to get a sense of what their consumers want more: The convenience of touching, holding, feeling, smelling a product before they buy it that day to take home, or saving cash and time spent hunting down the product and opting instead to buy it online and receiving it a few days later.

More than that, though, Klein noted the continued spike in online shopping for the holiday season is also a bigger motivator than you might think. And it’s pushing companies like Amazon in a way you might not expect.

“The primary reason a customer shops in a physical store (around the holidays) is the fear they won’t get the product on time,” Klein said. “The last few seasons, there’s been a surge in online shopping, and that’s impacted delivery by Christmas morning.”

Last year, with a 9% increase in online holiday shopping, according to ComScore, delivery companies including UPS (NSYE:UPS) and FedEx (NYSE:FDX) had trouble meeting the spike in demand. Coupled with severe winter weather across the country, it added up to many disappointed families whose packages and gifts were not under trees, but waiting in cold delivery trucks on Christmas Day.

The more a company is able to ensure on-time delivery, the more likely a customer is to choose to finalize a transaction with them. This guarantee becomes even more essential since PwC research shows 41% of shoppers for the upcoming holiday season plan to increase the amount they spend in online venues.

For companies expanding their footprint to both online and in the physical world, another number becomes important: 29% of shoppers consider themselves “transitionalists,” meaning they shop online for some items, but generally prefer traditional stores, while 32% consider online as their “go to” shopping experience.  The almost even split, which together accounts for more than half the shopping population seems to present a challenge for retailers to figure out the best way to cater to both segments of the population at the same time.

“For marketplaces selling other people’s products, it’s really about selling themselves as an e-tailer to bring convenience to the shopping experience and making that order easy to pick-up and obtain,” Klein said.

Where Consumers and Investors Converge

It’s almost a double-edged sword for retailers, though. Where it becomes complicated is in the business model and how companies like Amazon choose to define themselves. Klein said he doesn’t foresee companies like that setting up shop to compete with big department and club stores simply because it changes their business model.

“The question for e-tailers trying to get close to their consumer is will they hold inventory on-site. If not, the model stays intact. But the minute you get closer, you’re blurring the line between e-tailer and retailer. And Wall Street might say wait a minute, you’re looking like a traditional brick-and-mortar, how can we give you multiples on what your business is doing?”

To that point, RJ Hottovy, senior equity strategist at Morningstar said right now, he’s not too concerned with an imminent change in business models for retailers like Amazon.  He said if anything, he sees the move more as a marketing ploy to allow companies to show off their products before customers decide to buy – much the same way Apple uses its retail stores as showrooms. The in-store sale is almost a second thought.

“If they made a more aggressive push into brick and mortar, it might add trouble because it’s adding a layer of cost to a company that, not maintaining a physical retail store, has been a big part of the value proposition over time,” Hottovy said. “I would be concerned if they got more aggressive with it, but if it’s a way to facilitate – like acting as more of a mini fulfillment center, in small doses, it’s a worthwhile experiment.”

He said Morningstar’s view of the stock is overall still pretty positive. It sees a $400 fair-value estimate on solid top-line growth thanks to key drivers including more expected subscribers for the company’s Amazon Prime service, other web services, and fulfillment of digital content sales plays.  To put worries about continuing razor-thin margins to rest, Hottovy said the firm sees margin growth expanding from 1% to 4%-4.5% over the next five-year period.

“I see the move as more of a learning process,” he said. “I view it as a smaller version of a fulfillment center: If it’s something they can do to see volume, then it becomes a worthwhile endeavor. I don’t think it changes perception, it enhances the overall proposition to get products to customers quicker.”

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