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David vs. Goliath: How E-Commerce Companies Can Win Against Amazon

June 7, 2016

Physical retail is dying—a trend which has been ongoing for years and is now accelerating. According to the National Retail Federation, since the start of 2015, the top 10 physical retailers have lost nearly $85 billion dollars worth of market cap. Some of the largest retailers recently reported Q1 results that underscore this downward trend—Nordstrom dramatically cut its growth forecast from 5.5% down to as low as 2.5%, Kohl’s missed earnings by nearly 17%, and J.C. Penney’s top-line came in below expectations, declining 1.6% from the prior year. Meanwhile, the U.S. e-commerce market continues to grow quickly. The U.S. Commerce Department shows total online retail sales were over $340 billion in 2015, a 14% increase over the prior year.

With these strong tailwinds behind the e-commerce market, why are VCs so wary of investing in the space? According to data from the NVCA, it remains a grossly under-invested category. U.S. VCs invested more than $23 billion into software companies in 2015, while committing a scant $1 billion into retailing. Yet e-commerce is a significantly larger market than software—global e-commerce spending was expected to come in around $1.7 trillion in 2015 versus $340 billion for worldwide enterprise software spending.

A major reason for this apparent contradiction is the dominance of Amazon. Not only are they the largest pure-play online retailer, their lead is increasing. According to Macquarie Research, Amazon is capturing a shocking 51% of all incremental e-commerce spending. That means all other e-commerce companies—from to to—are fighting for the remaining 49%. Analysts estimate that Amazon has invested a staggering $14 billion in warehouses from 2010–2013, making it exceedingly difficult for smaller companies to compete with Amazon on price and logistics.

Nevertheless, there are compelling investment opportunities in e-commerce that are relatively insulated from Amazon. Here are a few:

Vertically-Integrated Commerce

Companies that sell their own branded goods don’t have to compete solely on pricing and logistics.  Some examples of publicly-traded companies include Lululemon and Under Armour. Both of these companies have delivered fantastic returns to public investors, with gains of 350–500% since their IPOs. Robust revenue growth, strong defensibility, and sustained profitability (Lululemon delivers EBITDA margins in excess of 20%) allow both of these companies to trade at attractive revenue multiples well in excess of peer e-ommerce companies. Private company examples that have attracted significant investment dollars from VCs include Stance, Warby Parker, The Black Tux, and Bonobos.


Companies that can aggregate a highly fragmented group of sellers can create proprietary supply, thereby insulating themselves from commoditization. For example, eBay generates operating margins of around 25%, while many online retailers struggle to achieve gross margins at that level. Examples of fast-growing marketplace companies include Poshmark and OfferUp. Both of these companies have a network effect component to their business that creates a competitive moat. In the case of Poshmark, the social aspect of the community keeps users engaged over a long period of time, and OfferUp aggregates enough buyers and sellers within a geographic area, creating liquidity at a local level.

Technology Enablers

In order to remain competitive with giants like Amazon, smaller retailers need to adopt best-in-breed technology solutions, not all of which can be developed cost-effectively in-house. The $2.8 billion acquisition of the e-commerce software provider Demandware by Salesforce on June 1st highlights the strategic importance of the sector going forward. Another example is Signifyd, which provides fraud-management solutions to online retailers. Fraud is inherently a big data problem, and smaller retailers simply don’t have the scale or technology to manage this themselves, nor is it their core competency as a business. Adopting these solutions enable smaller companies to focus on what makes them special and unique—designing and selling innovative products—while allowing technology vendors to leverage best practices and economies of scale across a much broader customer base.

We believe there will continue to be very attractive investment opportunities in e-commerce, despite being under-funded by investors compared to the massive growth in the sector. There are many examples of successful companies with business models that are not taking on Amazon at their own game, a trend that will continue. History has proven that out-of-favor sectors often offer the most attractive investments, and we are still in the early innings of the tech-enabled commerce disruption.