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Shopping in the Digital Age

Amazon and eBay are the clear online leaders, but brick-and-mortar stores aren’t ready to concede the retail battle.

Basili Alukos, CPA, CFA, 08/14/2013

This article originally appeared in the August/September 2013 issue of MorningstarAdvisor magazine. To subscribe, please call 1-800-384-4000.

More and more shoppers continue to go online to find their wares instead of traveling to traditional brick-and-mortar stores. E-commerce retailers that are well-capitalized and that have a strong distribution infrastructure are proving to be a disruptive factor in the retail industry. In 2012, online sales in the United States totaled $225 billion, with Amazon AMZN representing almost a third of that in terms of gross merchandise volume. EBay EBAY had a gross merchandise volume of about $75 billion. Globally, e-commerce sales are around $1 trillion. But with total global commerce at $10 trillion, e-commerce still only has a small piece of the retail pie. Amazon and eBay both have been enjoying revenue growth of more than 20%, and there’s still plenty of room for these and other e-commerce companies to grow.

To find out where e-commerce is headed, and what traditional retail stores are doing to defend their turf, I sat down with Morningstar retail equity analysts R.J. Hottovy, Liang Feng, and Paul Swinand. Our discussion took place June 6.

Basili Alukos: In what areas is e-commerce making the biggest dent in the sales of traditional retail stores?

R.J. Hottovy: The commoditized retail categories—consumer electronics, office products, toys, books, where consumers don’t care about the shopping experience and just want the lowest price possible—have felt the most pressure from Amazon and other online players. Amazon is able to undercut pricing of traditional retailers, simply because it doesn’t maintain a physical storefront and historically hasn’t had to collect sales tax online. These reasons give Amazon and other Internet players a pricing advantage.

Add in expedited shipping, a wide selection of products, and an emphasis on customer service, and you have an extremely powerful force disrupting the direct-retail-sales model in a lot of those categories. Amazon continually scores number one in customer service among all retailers.

Liang Feng: Still, there are pockets in retail where having a store is a benefit. We’ve assigned a narrow Morningstar Economic Moat Rating to a few of our specialty retailers, because we believe they will be able to generate excess returns during the next 15 years. One question we ask is whether a retailer can still bring consumers into the door. Some items are more obvious than others— clothing, for example. Many consumers still prefer to try clothes on, and shopping for clothes is a leisure activity.

What specialty retailers tell us is that once the consumer is inside the door, they’re willing to pay a modest premium. It is still inconvenient— although that is changing—for consumers to take a picture on their smartphone, go back home, and order it online. So, they are willing to pay a modest premium to buy the product in the store. Where “showrooming” comes in is for big-ticket items such as a large-screen TVs. People scout out products in a store and then buy them online from another retailer. Being able to save 5% or 10% on a $500 product by buying it online is worth the effort. This is why Amazon has had a lot of success with consumer electronics at the expense of Best Buy BBY. Conversely, convenience stores and dollar outlets are able to charge hefty premiums because people pay less attention to deviations in prices of things that don’t cost that much.

Basili Alukos, CPA, CFA, is a stock analyst with Morningstar.

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