- Next’s third-party aggregation business is a resounding success
- Company’s hiking “take rates” to strengthen online earnings
Owning the shop, not the goods is not new in ecommerce. Two of the marketplace model's biggest proponents Amazon (US:AMZN) and eBay (US:EBAY) have been running since the mid-1990s, and have built retail empires by charging third-party sellers fees to use their platforms. The asset-light, diversified nature of these earnings have appealed to investors, along with their potential for driving growth. Frasers (FRAS) is obviously a fan of the model, buying into marketplace specialist MySale (MYSL) at the end of June. The Aim-traded company – proudly a cut-price platform – last week reported improved gross margin for the year to 30 June, rising from 39.4 per cent the year before to 42.3 per cent despite supply chain volatility.
Frasers is likely just following the customers: research from strategy consultancy OC&C predicts that by 2025, spending through leading online marketplaces, such as Amazon, eBay and Expedia, will overtake direct ecommerce sales in the west, growing at a clip of 15 per cent a year. Although marketplace margins are typically lower, more and more retailers are trying out the model online as a remedy for stagnating revenue growth.
Li Ka-shing-owned pharmacy Superdrug is due to launch its own online marketplace in September. Next (NXT) opened an online third-party aggregation business, Label, in 2015, which has stormed ahead with sales growing 79 per cent to £777mn in the last two years. "[FY2022] UK sales were hugely driven by Label," said Next chief executive Simon Wolfson.
Over the next five years, the clothing and homewares stalwart is banking on Label growing by 11.5 per cent a year to offset its physical division, which is expected to decline by 6.1 per cent annually.
The company’s last annual report states that Label’s profit margin was just over 14 per cent – which is still lower than the 21 per cent margin it earns when selling its own Next-branded products online. It refers to the design, sourcing, pricing and management of its own stock as the 'buying' side of the business, whereas its third-party aggregation division is the selling side. Next acknowledges that the buying side makes higher margins and high returns on capital, but these come at a much higher risk.
The selling side, on the other hand, is capital intensive and lower margin, though much lower risk. “This is because it is able to spread the risk of fashion volatility across many different brands and product categories,” the company explained in its annual report. It has also cut down its commission on sales multiple times. "Once we've made our profit and our returns, our aim is to keep passing back the benefits to the clients," Wolfson said in March.
Upturn/downturn
Does the wide nature of their product offerings mean online marketplaces are better placed to weather an economic downturn than direct-selling brands? That partly depends on the take rate – the amount a marketplace charges its users. Etsy (US:ETSY), an online platform focused on vintage and handmade items, recently hiked its seller transaction fee from 5 per cent to 6.5 per cent. The move helped to offset a fall in the dollar value of sales on the platform in the first half of this year. But like with any price rises, demand destruction can follow.
Like Etsy, eBay has also upped its take rate, from 10 per cent in the fourth quarter of 2020 to 12.1 per cent in the first quarter of this year. But this wasn’t enough to keep revenue from falling by 6 per cent in the three months to the end of March. The gross merchandise value (GMV) of goods sold through the site also fell 20 per cent year on year, although the company said the impact of this was partly cushioned by the hike in the take rate.
The problem, according to analysts at UBS, is that the vast majority of spending on eBay’s site is discretionary and therefore vulnerable in a recessionary environment. “We do not see any single category where we could say it will not be impacted in any downturn,” they wrote in a recent note. “Even in our conversations with the company, while they acknowledge some likely benefit from being a ‘value’ oriented platform, the messaging is volumes will get impacted.”
Ultimately, not all marketplaces are created equal. Shopify (US:SHOP), a platform that helps companies build and customise their online stores, made 10 per cent of its workforce redundant last month. Its shares are down almost 80 per cent this year after the lifting of Covid-19 lockdown restrictions lured some consumers back to bricks-and-mortar shops.
Simply building a marketplace does not guarantee that shoppers will spend, especially amid a cost of living crisis. According to OC&C, the firms in the strongest position are the ones that command higher take rates, either because they’re dominant distribution channels with limited competition, or because they offer value-added services such as fulfilment and advertising.
Amazon’s half-year results showed that its online stores segment declined 4 per cent year on year – proving that even the biggest marketplaces are likely to see weakened consumer spending as the economy slows. However, Next’s success with its model should show investors that lower-margin sales can drive earnings as well.
