The Art of Retail I

These days, I’m opening up Facebook a lot more. By that, I don’t mean opening Facebook once daily, I’m finding myself opening Facebook 10-20 times daily. It’s a problem. But while on Facebook, I’m not posting an comments on dog pictures or liking posts, rather I’m heading to Facebook Marketplace to scour for the next deal on second hand speakers, plants, and everything in between.

Before, outside of Messenger, I rarely used Facebook. Facebook content was mind-numbing and life was more vivid than mechanically scrolling through the feed. But after moving to my new apartment this past year, I’ve been on a hunt to upgrade my furniture. After searching all the local furniture stores, I turned to Facebook Marketplace from a friend’s recommendation. A $3,300 leather couch? On Marketplace, only $900 in cash and a uhaul. A $600 sit-stand desk? Like new for only $300. Or even a $1,000 coffee table? $150 and a drive up to South SF. Soon I had fully decorated my apartment. Yet, every so often, I would find myself typing “face”, enter, and scrolling through Marketplace. Previously, I had been on a mission to furnish my apartment. Now, I’m mindlessly scrolling through listings in search of a deal.

In fact, there are plenty of people like me. Looking at data on Google Trends, Facebook Marketplace is at its all time peak in popularity. Growing steadily over the years, the only significant decrease came at the start of the pandemic, losing ground that was quickly made up and more this year.

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For Facebook, Marketplace is the exact kind of bet that fully leverages the social network’s existing advantages. Buying and selling things on Facebook is almost as old as likes. Soon after leaving universities, buy and sell groups on Facebook started to pop up like wildfire. In the Bay Area alone, there are roughly ~50 different groups with over 10k members. These groups have names fromBay Area Buy/Sell/Trade(~100k members) to Santa Clara Buy & Sell (17k members) to other combinations of location + buy/sell/trade.

Back in 2016, Facebook introduced Marketplace hoping to centralize all this activity. At first, it was hard to tell that Facebook’s efforts were going to be successful. The influence of previous companies like Craigslist and Facebook’s own internal buy and sell groups cut away at Marketplace’s potential audience. Rather than an overnight success, Marketplace turned into a long slog in attracting the two sides of the marketplace, buyers and sellers. But overtime, these buyers and sellers did come and more importantly, they stayed.

Later in 2018, Facebook pushed through groundbreaking changes to Marketplaces. First, Facebook added AI personalization by building a product index through both image and language classification. This allowed the marketplace feed to be personalized to each user based on past data. Other peer to peer marketplaces like Craigslist relied on simple time based rankings and rarely could they transition to Facebook’s model without massive investment in both machine learning and energy. Facebook had already built the infrastructure for this model through the personalization of ads and main Facebook feed. Second, Marketplace doubled down on categories like vehicles and furniture, even inviting local dealerships to list on the platform.

Further, Marketplace had a symbotic relationship with the Facebook app. Rather than alienating previous users that enjoyed the unique atmosphere of buy and sell groups, Marketplace was built in addition to these groups. Whenever a user posted an item to a group likeBay Area Buy/Sell/Trade,one is prompted to choose whether to cross-post to Marketplace to gain access to more buyers, who can easily move between Marketplace and various groups on Facebook. Today, Facebook Marketplace is the fifth most popular online marketplace, behind only Amazon, eBay, Etsy and the Walmart marketplace.

However, making forays into retail isn’t unique to only Facebook. Google has its own Shopping Actions program that count Walmart, Target, Home Depot, and Target among its backers. Shopify rose to become Canada’s second largest public company, second only to the Royal Bank of Canada. Etsy stock skyrocketed from just above $30 to $231 earlier this year, capping a roughly 600% increase. Even those indirectly working in retail like Pinterest and Square have seen massive gains this past year.

With so many winners, who lost?

At first glance, it’s not really clear. Offline retailers like Walmart, Target, and Costco are also enjoying all time highs. And even Barnes and Noble stock has gone up roughly 6x since the pandemic started despite horrible financials.

The landscape of retail is both fascinating and complex. At the center of it today are consumers that are increasingly drawn online with logistics and fulfillment operations struggling to keep up. Yet, the growth of online ecommerce is only a corner of the entire retail industry. The rest of this series will flesh out the history of retail, what it is today, and where it might lead in the future.

A quick history of retail

Earlier this year, I had the chance to read books written about Amazon (The Everything Store), eBay (The Perfect Store), and Walmart (Made in America). While each of the companies found success through drastically difference methods, their success centered in a dance between supply and demand. For the sake of time, I’ll start the story of retail at the end of WW2.

The Blank Slate

Post WW2, retail in America was a giant free-for-all. With years of depression and war time production, retail retail was annihilated by massive poverty and rationing. The hardest hit areas were often the small towns of America that were disproportionately impacted by the Great Depression. This led to a gradual retreat from these towns by retail corporations that saw their profit margins and even revenue shrink to nothing.

After the war, this blank slate was a natural opportunity for local entrepreneurs, either families or veterans returning from war. These entrepreneurs quickly opened local variety stores that catered to the growing prosperity of Americans. With few competitors, these stores quickly picked up their local demand. The only problem facing them was supply. The average store during that time had roughly 250-450 items and would only do $100,000 to $500,000 across those different inventory lines. As a result, none of the stores individually had the sway to approach suppliers directly.

To bridge that gap, a complex system of franchises supplied by central management companies began to develop. The central companies would work out deals with suppliers in bulk and effectively act as an distribution engine to their franchises. Further, the central company would lend its brand name and even provide operational training to franchise owners. In return, the central companies would mark up the merchandise that was sold to franchises and take a profit. This strategy was simple yet incredibly effective.

There was another side benefit of operating in small towns, monopoly status. Franchises often operated in low volume towns where few competitors existed or would enter. The lack of market potential in these low volume towns was enough to turn away both large corporations and new entrepreneurs. This meant that franchises could price products at their discretion. For central management companies, they now had plenty of room to mark up the products that the franchises would still accept. One of the most successful central management companies of this era, Ben Franklin, had over 2,500 stores nationwide.

The Discount Era

While this model worked out quite well in the beginning, structurally, it exploited the lack of sophisticated operators working in retail. In other words, when strong players like Sam Walton of Walmart and Harry Cunningham of Kmart could find cheaper supply and use those saving to generate demand, the game shifted from supply to demand.

The new era would be dominated by discount stores, or dime stores. These stores were fueled by latent demand by American consumers whose own fortunes had risen with the booming economy. This meant that while they were still cost conscious, they also had a lot more to spent. Dime and discount stores took full use of that. Pricing items at half or less than competitors, these discount stores drew huge crowds and often sold multiples more than variety stores. Thus, even though the profit per item was lower, the net profit for the store would be much higher than before and in the process, suck up all the demand in the area.

For variety stores, this was disaster. Most variety and early discount stores relied on central management companies to work with suppliers and thus, price matching the new generation of discount stores that built their own supply relationships was nearly impossible. In fact, companies like Walmart first started as Ben Franklin franchises before converting to a full blown discount store in Rogers, Arkansas in 1962.

While obvious in hindsight, this realization was only taken by a few people in this era. Most retailers believed in fixed demand where local geography determined the potential customers and these customers had fixed spending habits. Instead, the reality was that demand was elastic and depended on price. And slowly, the variety and general stores across the country either converted to become discount stores or were competed out.

Even discount retailers didn’t realize how much latent demand there was. Discount stores soon took over retail retail in America, even sometimes edging out established department stores in crowded cities. Chains soon began to take over among the discount stores to squeeze supplier margins and discount products even further. And in the pursuit of lower prices, retailers soon turned their attention to the last bulwark, logistical costs.

The solution to reducing logistical costs came in two unique retail models, the supercenter and the wholesale club. Supercenters essentially functioned as giant marketplaces, stocking everything from groceries to tires to bank branches under one roof. Wholesale clubs were consumer facing warehouses that had razor thin margin on inventory sales. Rather, they charged club membership fees to subsidize their costs. Both of these models had one thing in common, they were roughly twice as big as the average discount store and could therefore eliminate much of the last mile shipping that kept costs stubbornly high for discount stores. As a result, consumers flocked to these new stores in droves and each one had an effective radius much larger than previous discount or variety stores.

Today, as the leading offline retailer, Walmart has a mix of supercenters and wholesale clubs.

The Peer to Peer Era

With prices near rock bottom, the equation swept back towards supply.

For a long time, there existed a long tail in the retail market of second-hand items. Everything from the lawn mower gathering dust in the garage to the old dolls that were passed down by grandma has a potential buyer out there. The problem is that it was simply too much hassle to sell these items. With each item unique and generally one of a kind, it would be a nightmare for a large scale institution to source, value, purchase, distribute, and sell them. The only companies that found success in the market were local pawn shops and thrift stores that could push prices low and resell at a higher valuation. This meant that there was little incentive for sellers to seek out these local stores and most of these items would end up donated or trashed.

Enabled by the internet, eBay was in the perfect position to unlock this supply. Building a global marketplace that brought together both buyers and sellers across geographies, timezones, and languages solved the pricing disparity between that plagued the second hand market. eBay also put the problem of distribution into the hands of their users. When each auction was finished, the duty of shipping and handling fell to the seller, saving eBay the hassle of warehouses, logistics, and much more. And finally, eBay’s auction format and uniquely goofy logo appealed to many who were using the internet for the first time. Both with internet being a premium service and eBay’s community forums, there was enough trust for first time users to feel confident in both listing and purchasing one of a kind items on eBay. While the prices online were rarely competitive to offline wholesale or superstores, eBay wasn’t really interested in selling toilet paper or shirts. Rather, they catered to the long tail of demand, selling everything from sports memorabilia to rare accordions.

Craigslist took eBay’s model one step further. Some items like second-hand furniture weren’t worth the shipping costs and yet still had an innate value to them. Craigslist was the internet’s 24/7 yard sale. Now, rather than having to clean out closets, put up posters and then spend the whole day harking used goods to strangers, people could simply list onto Craigslist and find local buyers. This tested the discovery power of the internet, would there be enough accumulated demand and supply in local geographies? The answer was a resounding yes with Craigslist traffic taking off exponentially.

For a while, this seemed like the ultimate business model of retail. With no inventory or logistics costs, eBay boasted profit margins that were the envy of traditional retailers. Walmart’s gross margin is in the 20-25% range. eBay’s gross margin was higher than 85%. And Craigslist, the other winner of in this era, was generating $1 billion/year with a team of only 50 people.

The Internet Era

However, this cycle of supply eventually played out and demand once again stepped back in.

Overshadowed by eBay and Craigslist in the dotcom bubble, Amazon quietly invested all of its profits back into supply chain. Amid all the news about peer to peer and high profit margins, the internet also provided another crucial benefit that was often overlooked in the early day, convenience and selection. If an average supermarket had space to stock 40,000 items, Amazon’s virtual shelves could stock 400,00 with ease. However, for most of the history of the internet, this advantage was offset by shipping costs. The “convenience” of the internet costed upwards of $15 dollars and a week’s wait. While these costs were negligible in the case of eBay that sold antiques and items far below MSRP, for the case of Amazon, staples could not wait a week.

It was the introduction of Amazon Prime that changed everything. With a flat $80 per year, Amazon Prime members were given free 2-day shipping. Instead of being a barrier to checking out, shipping became a motivator. Customers that were looking to get full value from their membership were incentivized to shop more and take full advantage of the free shipping. With this, the paradigm of ordering online with a couple of clicks finally became more convenient than driving to the local supermarket.

Like in the discount era where cutting prices was obvious in hindsight, investing in shipping infrastructure was not readily obvious at first. The massive investments heavily cut into Amazon’s profit margin and public opinion of Amazon was a stark contrast to high-flying companies like eBay. A corner of Amazon’s massive infrastructure are the global fulfillment centers. Starting with two fulfillment centers in Seattle and Delaware, Amazon built an empire of 185 fulfillment centers near high volume cities around the world. These local warehouses near high volume cities worked in conjecture with partnerships with UPS, Fedex, and local carriers to minimize costs. Along the way, this incredible supply chain allowed Amazon to build forward looking businesses like FBA (Fulfilled by Amazon), where third party merchants pay Amazon to store, pack, and ship their items, and other divisions like Amazon Trucking and Amazon Air. Combined together, Amazon took another of its major cost center and turned it into multiple revenue drivers.

From these foundations, Amazon was able to quickly take the reins of ecommerce. Two day shipping became the rallying cry for Amazon that competitors simply couldn’t match. Today, Amazon is leagues above its closest competitors in ecommerce.

The Rise of Rebels

In the shadows of Amazon’s dominance is a new competitor was rising on the supply side. Shopify.

Shopify is essentially an online platform that merchants can use to build their online presence. Shopify handles the process of creating a website, itemizing inventory, handling payment, and countless other details involved in setting up an online shop. In return, Shopify charges a flat fee of $50/month. While plenty of platforms from Amazon to Etsy to eBay have tools to help offline merchants sell online, they sandbox within the scope of their respective platforms. In other words, independent merchants never get the chance to build their own audience. Customers identify with the platform rather than the individual store. And leveraging this power, platforms can pull various levers to push customers to stores of their choosing. The worst abuse of this power is in the unilateral power of the platforms to shut down any store that they find non-compliant with their policies.

Over time, this meant that stores selling with platforms competed in a market of perfect competition where any upstart could skip the painful process of trust building and compete directly on price with established brands. So while offline stores and brands knew that their customers were increasingly moving online, there weren’t any attractive options for long term success.

In comes Shopify. Instead of having to spin up a technical team to launch an online store, Shopify helps offline merchants go online at a fraction of the cost without giving up any control over their audience. The byproduct of such a low cost in going online was that entrepreneurs who excelled in marketing and product could now also go into retail. Exploiting price differences, these entrepreneurs would go into dropshipping or even create their own brands based on factories in countries like China and Vietnam. The net sum of all this activity meant that there was an explosion of supply online.

Today

Today, the era of the rebels is still being played out. Companies are continually looking for faster ways to help offline stores come online whether through intermediate services like Wechat or Instagram or even branching into live-streaming. These efforts lower the barrier of entry for retailers and continually increase the supply in the market. Compared to when we started our story with brick and motar franchises, all a merchant needs to start selling today is a phone.

With that, we’re finally caught up to speed on the history of retail consisting of an intricate dance between supply and demand. Many of these periods are also a gross oversimplification, consisting of both micro-periods and trends in both demand and supply. For now, we’ll gloss over these details and instead, we’ll take a deeper look about these trends in later parts. In part 2, we can finally start to explore the intricacies of retail today and guess what might come next for the state of retail.