Business is in an arms race to use technology, with companies from apparel retailers to automobile makers to insurers to restaurants spending more and more not to be the next victim of Amazon.com (AMZN) or Uber Technologies.
The surprising result of that battle is that some industries you might expect would be in trouble, like retail, may end up turning out better than you thought.
That is the view of analysts at Evercore ISI, who today offer up a group report on the sweeping phenomenon of “digital transformation,” a buzzword that’s earned increasing currency as a kind of catch-all for how businesses use tech.
Tech analysts Anthony DiClemente and Kirk Materne partnered with their colleagues covering nontech industries to understand what that transformation thing means.
The authors sifted through thousands of conference call transcripts from public companies’ earnings calls back to 2012, and found the number of references to “digital transformation” by executives has soared in the last six years from almost none in 2012.
So it’s being thrown around a lot. But the notion has some real meaning. As the authors explain, digital transformation can be described as follows:
This includes using real time data collected from mobile devices, connected sensors and digital commerce with technologies around analytics to drive decision making for businesses. Digital transformation also describes the automation of traditional line-of-business processes to drive greater business efficiency, as well as investment in e-commerce capabilities for new revenue streams.
A survey the authors conducted among corporate chief financial officers shows that companies are spending more on technology than anytime since Evercore started asking them about the matter, the authors relate. So the jargon about digital actually pertains to real spending on technology.
The analysts lay out the basic fear driving this arms race, as they see it: “digital” is a term that these days equates to either being put out of business by Amazon, or surviving.
One only needs to look at the impact Amazon has had on the retail industry or Netflix’s impact on media or Uber’s impact on the transportation sector to understand how the transition to digital has completely reshaped the competitive landscape in various industries.
For every company, that digital threat means it’s not enough to just be good at having product, they point out:
Having the best product is no longer good enough as consumer expectations are constantly changing based on new technologies and brands now have to be able to differentiate through “experiences.”
So who will make it? The authors pick 12 public companies they think could thrive in this new world. Amazon is, in fact, one of the winners—no surprise—along with a couple other tech names, cloud-computing giant Salesforce.com (CRM) and automotive parts supplier Aptiv (APTV), graphics chip maker Nvidia (NVDA), and Iqvia Holdings (IQV), the company that resulted from the combination of IMS Health and Quintiles, and which does things such as applying data science to billions of patient records to find meaningful patterns for health-care companies.
The other potential winners are JPMorgan Chase (JPM); French apparel maker Kering (KER.France), which owns the Gucci and Yves Saint Laurent fashion labels; home builder Lennar (LEN); insurance giant American International Group (AIG); oilfield-services firm Schlumberger (SLB); Mastercard (MA); and Starbucks (SBUX).
In all, the authors actually found 37 names that they might like, but then narrowed that down to the dozen above “that we like on both a fundamental basis and also benefit from this broader trend towards digitization.
“What’s unique about this list,” they observe, “is it cuts across twelve different industries and includes both growth and GARP/value ideas.
“Further, we believe this list also helps illustrate that new ‘winners’ can emerge from non-tech industries as these companies implement new digital services and experiences[.…] The point was to try and have a more diversified basket of ‘digital winners.’”
An example of how “transformation” can save an industry comes in a companion report from Evercore analyst Omar Saad, who follows the stock of Kering and other retailers and apparel makers, such as Macy’s (M).
Saad wrote in a note yesterday that investors are a little too obsessed with the “death of retail.”
“The market is still married to the sensational ‘retailpocalypse’ narrative which assumes that Amazon and other digital disruptors will continue unabated in their assault on traditional Softlines players, a viewpoint with which we no longer agree,” wrote Saad.
He thinks “rampant discounting, pricing pressure, elevated inventories, and overall P&L pressure across the sector since 2014 has been broadly misinterpreted as digital disintermediation,” but actually, it’s just the traditional brick-and-mortar retailers building inventory for both their stores and for e-commerce sales at the same time, while also cutting back some in-store inventory.
In other words, Saad sees retail’s woes as just the kind of digital transformation his colleagues are discussing. He thinks retailers are going to come out on the other side in better shape, by “centralizing” inventories, allowing them to carry less inventory overall but also miss fewer sales than they would traditionally.
He cites the example of Target (TGT), which “recently began testing replenishing stores and digital orders from the same pool of inventory with one of its distribution centers in the Northeast and saw a 33% reduction in back room inventory for these stores while also reducing stock-outs by 50%.”
In fact, the switch to centralized inventory is key to his switching his view on Macy’s from “short” to “long”:
Shifts over the last decade saw department stores going from regional chains in the 1970s–1990s that stocked and curated assortment for their local markets to big, centrally managed national chains causing product offerings to become homogenized. Today, we believe retailers are quickly developing the ability to offer consumers the best of both worlds: a central view of localized assortments that can be bought, tested, returned on-line or in stores. Because demand is neither homogenous nor simultaneous, servicing an increasing percentage of the market-wide demand from a centralized pool of inventory (i.e. ecommerce) is significantly more efficient to serve national demand than old-world model of small, standalone, decentralized inventory pools (i.e. physical stores). A centralized pool of inventory will enable Macy’s to service the same (if not more) demand with less inventory, an incredibly healthy dynamic. In recent years, Macy’s has been implementing processes to improve inventory flow and management by: using stores to fulfill online orders; rolling out buy-online-pick-up-in-store (BOPUS); and creating a single view of inventory by merging warehouse stock for stores and online. And these efforts are just starting to pay off, with inventory continuing to decline over the past year while retail gross margins held relatively steady and finally inflected to positive in 1Q18.