SUV Report - ScaleUp Views - Ecommerce Fulfilment

Venturing Inside Fulfilment

Globally, e-commerce volumes have been impacted by slowing consumer demand and falling online penetration. In the public markets, many legacy 3PLs have lowered their 2022 outlook, while venture-backed fulfilment firms have mostly seen slowing growth from the 2021 highs. Based on our analysis, we believe the SME fulfilment market remains underserved, expect some near-term consolidation in both Europe and the US, and would anticipate the demand for outsourced logistics to benefit from supply-chain challenges and rising cost pressures. The key takeaways from our latest ScaleUp Views report - which explores the e-commerce fulfilment ecosystem - are as follows:

Online growth

High inflation, negative real wages and low consumer confidence are creating short-term headwinds, but we believe that the long-term rise in online penetration will be supportive.

Business model preference

According to McKinsey, logistics costs are expected to rise to 25% of sales, from 12% to 20% currently. In particular we would identify two operating models: i) pure-play e-commerce fulfilment (capital-light and asset-heavy), and ii) robotic automation, which potentially has the ability to address rising cost inflation for SME merchants.

Attractive unit economics

We believe integrated fulfilment providers (own software & warehouse operators) can derive take rates up to 20% to 25% of GMV - around 50% of these net revenues are redistributed to couriers. Firms generating the highest cash gross profit per package with geographical scale may be best positioned.

Increased private capital flows

Global invested private capital in ecommerce fulfilment increased rapidly in 2021 to over $3 billion - more than 2x ahead of the prior year. In 2022, investment has slowed but the run-rate remains ahead of pre-COVID levels. An increased balance between the demand and supply of private capital may present an attractive opportunity for venture & growth investors.

Likely M&A activity

We expect scalable, well capitalized operators to attempt to deepen their competitive position and try to take advantage of the valuation arbitrage between category leaders and sub-scale companies. We believe that the top-decile companies could potentially raise equity funding rounds at robust valuations, consolidating mid-tier players and expanding geographically.

Geographical preference

From a geographical perspective, in our view the earlier stage of the fulfilment market in Europe potentially offers most upside.

This document has been prepared by Lazard & Co., Limited ("Lazard") solely for information purposes and is based on publicly available information which has not been independently verified by Lazard. The information contained herein is preliminary and should not be relied upon for any purpose. No liability whatsoever is accepted, and neither Lazard nor any member of the Lazard Group (being Lazard Ltd and its direct and indirect subsidiary and associated undertakings) nor any of their respective directors, partners, officers, employees, representatives or other agents is, or will be, making any warranty, representation or undertaking (expressed or implied) concerning the accuracy or truthfulness of any of the information, ideas, forecasts, projections or of any of the views or opinions contained in this document or any other written or oral statement provided in connection herewith or for any errors, omissions or misstatements contained herein or for any reliance that any party may seek to place upon any such information. Nothing contained in this document constitutes, or should be relied upon as, (i) the giving of financial, investment or other advice or recommendations by, or the issuance of research by, Lazard, or (ii) a promise or representation as to any matter whether as to the past or the future. Lazard undertakes no obligation to provide the recipient with access to any additional information or to update or correct any information contained herein. Interested parties should conduct their own investigation and analysis of the companies and information referenced herein. You undertake to keep this document confidential and to not distribute it to any third party, or excerpt from or reproduce this document (in whole or in part), without the prior written consent of Lazard. Lazard, which is a regulated financial adviser, only acts for those entities whom it has identified as its client in a signed engagement letter and no-one else and will not be responsible to anyone other than such client for providing the protections afforded to clients of Lazard nor for providing advice. Recipients are recommended to seek their own financial and other advice and should entirely rely solely on their own judgment, review and analysis of this document. Lazard or another member of the Lazard Group may have acted in the past, or act currently or in the future as adviser to some of the companies referenced herein, may receive fees in connection with any such advisory engagements and may at any time be in contact with such companies in order to solicit them to enter into advisory engagements.

Introduction

Across industries, Covid-driven demand was extrapolated forward by management teams and the financial community. However, many companies have since experienced a ‘hard landing’ as revenue slowed, leaving firms forced to right-size their cost base to match a lower level of demand. Digital-advertising, streaming, video gaming, digital fitness, and online food-delivery businesses have been similarly affected.

E-commerce fulfilment is another area which benefitted from strong capital inflows through the pandemic, but now faces headwinds as retail spend shifts offline and consumer spending decelerates.

Our fulfilment report explores seven key areas:

Macro backdrop
Market opportunity
Key demand drivers
Value chain and key stakeholders
Unit economics
Private capital flows
M&A outlook

1. A challenging macro backdrop

Following above-trend consumer expenditure in 2021, the macro-economic outlook has deteriorated. Falling aggregate demand and challenging supply-side dynamics have sustained inflation at high levels. This creates a challenging backdrop for the consumer, e-commerce players and fulfilment providers, especially in Europe.

Rising inflation and higher interest-rate expectations: CPI inflation has reached double-digits in some developed markets.

Negative real wages: Inflation now exceeds nominal wage growth across developed markets, meaning that real wages have turned negative. In the UK, nominal wage growth has remained around the mid-single digits despite the unemployment rate reaching cyclical tights.

Lower discretionary spending: Rising food and energy costs appear to have had a negative impact on discretionary income, which seems to particularly be the case for those in the lowest age brackets. According to the Asda Income Tracker published last month, UK consumers under 30 saw a 22% annual contraction in discretionary spending in July 2022, and further falls may be expected as energy-price increases take effect from October 2022.

Credit-card data: Consumers have started to run increased credit-card balances as interest rates have risen. In the UK, net credit-card lending is now 13% higher year-on-year as of July.

Consumer confidence: Globally, sentiment seems to have re-adjusted with consumers possibly even more cautious than they were during the global financial crisis.

E-commerce: After an acceleration in online sales through the Covid-19 pandemic, e-commerce penetration has generally fallen as economies have reopened. Penetration has tapered from highs of 35% in the UK (16% in the US) to 25% (14% in the US) according to the most recent monthly data.

The impact of a challenging economic backdrop and a slowdown in e-commerce has created a more difficult environment for fulfilment and logistics providers who benefit from periods of volume growth.

2. Market opportunity between $500 to $800 billion

We define the e-commerce fulfilment market as logistics costs as a share of online retail sales. As set out below, we estimate the current opportunity is around US$800 billion globally, and it is likely that the market will continue to grow. To derive the current potential market size for pure-play fulfilment providers, we focus on the SME contribution which equates to around US$500 billion.

We calculate the potential addressable market opportunity as follows:

First, we take global retail sales which reached around $26 trillion in 2021.
Second, we take the portion for e-commerce. Global e-commerce sales reached almost $5 trillion in 2021, implying online penetration of just below 20%.
Next, we overlay logistics costs. According to a recent McKinsey report, logistics as a share of sales runs between 12% to 20% currently.
Finally, we multiply the SME contribution to overall retail sales. According to the OECD, SMEs’ contribution to GDP is between 50% to 70%. We would note that SMEs are typically less digitized than larger companies.

3. Demand drivers continue to expand the market opportunity

We see three main drivers of demand in the SME fulfilment market: i) e-commerce penetration, ii) the fragmentation of retail categories, and iii) fulfilment cost inflation.

E-commerce penetration tapers near term, but long-run growth anticipated

Driven by smartphone adoption and the digitization of enterprise, e-commerce penetration has grown from the low-single digits in 2008 to reach the mid-20s in some developed markets. The category mix is more nuanced, with high e-commerce share in electronics and household goods offset by much lower penetration in areas like grocery, for example.

However, the Covid-induced growth in e-commerce has retrenched to its pre-pandemic trajectory, as Shopify noted in a recent press release (July 2022):

”Our belief was that the channel mix, the share of dollars that travel through e-commerce rather than physical retail, would permanently leap ahead….with people shopping in stores again, e-commerce is trending back to a more normalized growth curve.”

The impact of further economic challenges on the near-term channel mix is unclear. However, the market expects long-run penetration to continue to rise, which should provide a tailwind for fulfilment volumes.

Fragmentation of retail categories supportive of SME e-commerce volumes

Over the last 10 years, the growth in concentration of digital-advertising dollars and the proliferation of e-commerce platforms has facilitated newly formed businesses reaching targeted customer segments more quickly. The subsequent growth in DTC brands has created a tailwind for SME e-commerce volumes and has created an opportunity for logistics providers.

Rising fulfilment costs increase propensity for SMEs to outsource logistics

According to McKinsey, logistics costs have increased by 5% as a proportion of e-commerce sales since 2010 – possibly due to rising consumer expectations and increased complexity. Logistics costs are expected to rise from 12% to 20%, to 25% of sales in the near future.

Rising warehouse labor costs are a key element of increased overheads, with year-on-year wage growth running in excess of 20% over the last two years in the US. This has risen from a 5% to 10% range from 2000 to 2015.

As a result of increased costs, we expect SMEs may increasingly outsource their logistics, to attempt to reduce cost volatility and increase focus on front-end customer experience. Some industry reports suggest only around 30% of fulfilment is outsourced currently, providing a potentially long runway for growth.

4. E-commerce fulfilment central component of the value chain

In order to assess the fulfilment value chain, we first need to examine two areas: types of customers and fulfilment models.

Multi-client may provide 7% to 9% cost savings

The choices available to e-commerce customers range from single-client fulfilment – typically suited to larger retailers who can take up 100% of warehouse space – through to multi-client, a model more accessible to SMEs.

Multi-client models share operational efficiencies between customers. According to a recent McKinsey study, multi-client fulfilment has the potential to achieve cost savings of around 7% to 9% when compared to dedicated fulfilment models, which could improve fulfilment profits by 5% to 10%. The main drivers include shared scale benefits, less seasonality in inventory flows, and reduced margin volatility.

CFCs to MFCs to Micro-Hub

There are two main fulfilment models which can be used by both single and multi-use clients - centralized and micro fulfilment.

Centralized fulfilment centers (CFCs) are large warehouses used to fulfil orders. A hub-and-spoke model is used to redistribute centrally picked orders to local holding sites ahead of delivery. CFCs are typically positioned the furthest from consumers but offer greater opportunity to benefit from cost-out automation.

Micro-fulfilment centers (MFCs) operate in reverse, where CFCs cross-dock inventory into smaller MFCs for order preparation. This model typically generates higher throughput and offers closer proximity to the end consumer, but lacks some of the operational efficiencies achieved by CFCs.

In addition to CFCs and MFCs, there is also an emerging sub-theme, the more dedicated ‘micro-hub’ model’. The micro-hub operates a larger fulfilment site but compartmentalizes the floor space into MFCs. In our view this model has three potential benefits for SMEs:

Access to a more dedicated fulfilment process
Scalability without high levels of fixed costs
Broader inventory distribution and shorter lead times via the network of fulfilment sites.

Legacy 3PLs have traditionally served larger retailers. More recently, Amazon has gained a strong foothold in offering multi-client services to SMEs. Private-capital investments have been focused on pure-play fulfilment providers, encouraging innovation within the SME sector.

Logistics profit pool distributed across value chain

We have identified three main sections across the fulfilment value chain: sales channels & marketplaces, order fulfillment, and last-mile delivery.

Sales channels and online marketplaces capture the front-end customer journey and aggregate order volumes. Marketplaces generate revenue through applying a take rate to each order – usually ranging between 20% and 30%. Seamless integration of multi-channel sales is a key enabler for fulfilment providers.

Order fulfillment can be split into software providers and fulfillment operators. Order and warehouse management systems – the software layer – provide end-to-end visibility for both the merchant and operator. These applications improve operating efficiency and provide a dashboard to assist operators from inbound, to picking and packing, to outbound. Warehouse operators use either in-house applications, or integrate third-party software. Hardware such as robotics and automation are often used to take cost-out of the labour intensive fulfilment process.

Fulfilment providers generate net revenue per item inclusive of inbound and outbound costs, with additional add-ons for storage and returns. Fulfilled by Amazon (FBA) take rates are typically between 16% to 18% excluding commission and advertising, with Shopify take rates nearer 25%.

Last-mile delivery is dominated by 3PLs, with legacy players such as Fedex and UPS integrating upstream into fulfillment. Amazon also provides fulfilment and last-mile delivery services. Courier aggregation has been a further area of innovation, whereby SMEs may share improved courier terms. Aggregation may be less effective in the US (vs. Europe) where courier share is more concentrated. It is also possible fulfilment providers may choose to bring delivery services in-house when they reach sufficient scale.

Key Stakeholders

Across the three aspects of the value chain, there are various stakeholders.

Consumers have progressively shifted to purchasing online, providing steady growth in e-commerce volumes.
Retailers have mostly reacted in two ways; first, by improving their own online capabilities, and second, by using third-party marketplaces to increase sell-through.
Marketplaces typically charge retailers around 20% of gross merchandise value (GMV) for each product sold. Marketplaces are volume-based, benefiting from the two-sided aggregation of e-commerce supply with the demand of consumers (B2C), or other businesses (B2B). Globally, the top marketplaces by GMV include Amazon, eBay, and Alibaba.
Fulfilment software providers use integrated warehouse management systems which optimize fulfilment functions such as order handling, resource allocation, labor productivity, inventory management, quality control, and security. Together, software and hardware typically derive take rates of around 20% of GMV.
Operational fulfilment is guided by the software layer and relates to the manual functioning of the warehouse facility. The use of automation varies across warehouses, with centralized single-client fulfilment offering an opportunity for machine-handling-equipment providers such as AutoStore (OSL: AUTO, market cap US$5bn). Rising cost inflation is likely to reduce the payback profile of automation.
Couriers represent the largest cost item for each package at around 10% of GMV. The integration of routing optimization software helps improve drop densities, with the reduction in delivery time integral to meeting rising consumer expectations. Innovation in courier management applications help aggregate volumes and share improved terms with merchants.

Fulfilment has been penetrated by each segment of value chain

There are three groups of players who operate across the fulfilment layer:

E-commerce marketplaces include Amazon through FBA, and Shopify via both the Shopify Fulfilment Network and also more recently, through Deliverr, which it acquired in May 2022 for $2.1 billion. These players have vertically integrated downstream into fulfilment.
Pure-play fulfilment providers have entered the market through a capital-light or asset heavy approach. Capital-light approaches include either i) direct to courier (e.g. Sendcloud) – which is more suited to smaller merchants; or ii) owning the warehouse software layer. A full stack asset-heavy solution combines both software and warehouse operations.
Legacy 3PL players have traditionally operated on long-term, single-client contracts, but are now becoming increasingly interested in SME e-commerce fulfilment.

Early stage pure-play fulfilment players have focused on the underserved SME e-commerce segment, attempting to aggregate multiple sales channels and share fulfilment scale benefits with SME clients. Similar models have emerged across geographies, some of which are outlined in the table below.

Company Profiles

ShipBob (US) is a pure-play fulfilment provider integrated across the software and hardware layers, owning and operating the fulfilment network. Provides real-time inventory visibility to the merchant. The company operates a network of sites across the US, Canada, and more recently in Europe.

Sendcloud (NE) provides a capital light sales channel integration and courier aggregation platform, targeting pre-dominantly SMEs. The company optimizes the shipping journey, aggregating volumes and sharing cost savings from a typically concentrated courier network. Sendcloud operates across Benelux, DACH, France, Spain and UK, and is based in Eindhoven, Netherlands.

Shippo (US) operates a direct-to-courier model - similar to Sendcloud - recycling SME demand benefits and delivering improved courier terms to customers. Shippo is based in the US, but expanded into Western Europe earlier in 2022.

Huboo (UK) operates a full-stack solution using proprietary warehouse-management software and optimizes fulfilment through a micro-hub model. The company effectively operates dedicated MFCs within its network of eight fulfilment centers in UK, Spain, the Netherlands, and Germany. The micro-hub model uses hub managers to manage the customer journey end-to-end from picking and packing through to front-end sales communications.

Byrd (AT) operates an asset-light fulfilment network across Germany, the Netherlands, Italy, Spain, France, UK, and Austria. It applies its proprietary software platform to integrate a broad range of sales channels, support warehouse partners, and aggregate shipping volumes, to reduce cost and delivery times.

Cubyn (FR) operates an on-demand logistics and fulfilment platform. It offers the option to pick and pack, and ship to any destination globally with multi-channel integrations.

ShipHero (US) provides warehouse-management software for SMEs who want to ship from their own facilities, or to outsource fulfilment through ShipHero's owned and operated warehouses. ShipHero targets mid-large e-commerce merchants.

Hive (GER) offers full-stack fulfilment from five centers across Europe to SMEs, as well as to larger merchants, for whom they fulfil partial volumes. The company operates a hybrid model, operating fulfilment centres, and also supplying exclusively software to local warehouse operators.

Alaiko (GER) operates a capital-light business model, with its management operating system supplemented by onsite support to warehouse operators. The company aggregates SME e-commerce volumes across 15 fulfilment centers, with plans to expand geographically. The company is targeting increasing penetration of software solutions and value-added services.

Fulfilled by Amazon (US) operates a full-stack fulfilment proposition from sales channel to delivery. FBA provides access to a global network of nearly 200 fulfilment centers.

Deliverr (US) operates a capital-light model, acting as a marketplace between merchants and warehouse owners. The company uses AI and machine learning to predict demand, and then helps retailers split their inventory, and pre-position goods across multiple sites. The company was acquired by Shopify in July 2022.

5. Unit economics

Providers derive 20% to 25% take rate with around 50% re-distributed to couriers

Logistics may be viewed as a low-margin business and therefore understanding scalability and financial profile is important. For fulfilment providers, we discuss the unit economics in two ways - first, on a per-item basis, then, per client.

Per package: Using a $100 package to illustrate, we expect the cost profile to be split across a number of cost buckets. To derive net revenue, we apply a 20% to 25% logistics take rate to GMV, with around 50% of net revenue attributable to delivery. Direct labor and rent are the two other large expenses. We estimate a mark-up of around 5%, akin to EBITDA margins of c.20%.

We have set out below possible indicative per-package economics using our estimate for a typical fulfilment center operating at maturity.

Per client: However, our preferred approach to value fulfilment businesses is based on marginal customer economics. This method focuses on the customer lifetime value to acquisition cost ratio. We provide illustrative economics below assuming a client generates $750k of GMV per annum, with a 25% take rate, a 2% monthly churn rate, and customer acquisition costs of around $25k per client.

In our view, the key growth levers can be distilled down to i) customer growth and ii) better economics, leveraging the underlying fixed cost base.

Financial Drivers

Revenue: Providers have a number of potential options to assist them to generate top-line growth. For the overall customer profile, revenue drivers include: i) the size of annual client volumes; ii) serving B2B or B2C clients (or both); iii) the category and product mix; iv) geographical distribution; and v) the pricing structure, which can range from per-item to a monthly subscription.

On the cost side, we can break expenditure down into variable and fixed costs. Fixed costs predominantly relate to the warehouse rent and overheads. Variable costs can be bucketed into courier, labor, and other.

Variable costs are exposed to warehouse-staff inflation, and therefore optimizing inventory flows and/or removing costs through automation are increasingly important. Variable costs typically run at 5% to 8% of GMV.
Fixed costs are mainly driven by the supply-demand dynamics in the real-estate market. We believe three areas are important here, first, third-party warehouse take-up rates; second, prime rental yields; and third, the amount of invested capital in logistics space as an asset class.

We include three key charts from CBRE’s 2022 logistics report below, identifying that UK warehouse vacancy rates fell to 1.2% in 1H22. If we take the UK as an example, take-up rates have increased, yields have compressed, and invested capital has risen. Therefore, rental costs have seen upward pressure and currently run at 2% to 3% of GMV.

6. Private capital raised

Invested private capital in fulfilment and logistics services increased rapidly in 2021, more than 2x ahead of the prior year. It is likely higher consumer spending driven by pent-up demand and fiscal support, and rising online penetration provided a high-beta backdrop for the industry. In 2022, private capital investment in the area appears to have slowed but the run-rate remains above pre-COVID levels.

European pure-play fulfilment providers attract funding through COVID

The five largest European fundraises by fulfilment providers have occurred in the last 18 months, with Sendcloud’s US$177m million raise in September 2021 the largest to-date. We have identified that other fulfilment players who have derived high levels of funding primarily operate in the UK, France, and Germany. In our view, first-mover advantage and geographical scale are key.

US players typically raise larger rounds and are later stage

The US has attracted a higher quantum of investment in the class compared to Europe, with companies typically later stage. Deliverr raised the largest round of US$250 million in February 2022, ahead of being acquired by Shopify. Micro-fulfilment technology companies such as Fabric and Locus Robotics have also attracted high levels of funding.

7. M&A Outlook

Following a period of strong consumer spending and accelerating online penetration, 2022 has seen more challenging conditions for e-commerce volumes. This has resulted in many current year sales and earnings estimates being revised lower across the logistics landscape. We believe that there has been a shift to an alpha-driven environment, where the most efficient fulfilment providers, with a clear value proposition, may be more likely to show resilient growth. In our view, the top-decile assets may continue to attract possible funding, leading to a potential period of market consolidation for mid-tier players.

In the figure below we explore four strategic growth levers: horizontal consolidation, private fundraising, software capabilities, and other objectives.

Consolidation: We expect companies with the strongest cash gross profit per package to potentially enter a buy-and-build phase, adding order volumes and geographical coverage. Entering new geographies with a capital-light model (software-led) may make sense in markets with large geographical coverage like the US. This is because software is more nationally scalable, whereas warehouses are often locally operated. For those expanding into neighboring European countries, offering both warehouse management and operating fulfilment could be an attractive option.

Fundraising: Providers who can deliver strong top-line growth and demonstrate a clear path to profitability are potentially best-placed for possible further investment. We expect scalable, well-capitalized companies to attempt to deepen their competitive position, and try to take advantage of the valuation arbitrage between category leaders and sub-scale players.

Additional software capabilities: In our view, three main areas of software advancement are likely to exist for fulfilment providers. First, deepening sales-channels integration to help existing customers add volumes into the fulfilment provider, for example, UK-based Huboo acquired Roseta in January 2022. Second, aggregation of couriers may help drive efficiencies in the largest cost segment of the logistics value chain at around 10% of GMV. Third, adding embedded finance tools such as package insurance, inventory factoring, and revenue-based financing options may also be potentially attractive as fulfilment providers look to expand margins. Given these capital intensity dynamics, we may see providers operating as a partner channel for pure-play lenders.

Other strategic options may include entry into the more protected B2B fulfilment space, given the challenging consumer backdrop.

Conclusion

E-commerce volumes appear to have been impacted by slowing consumer demand and falling online penetration, which has affected most companies across the logistics value chain. The related macro-economic challenges of high inflation and rising interest rates may also be a cause of investors shifting focus away from growth at all costs, to companies who demonstrate a clear pathway to profitability.

Financing conditions have now tightened following a period of strong private capital flows into the logistics value chain throughout 2020 and 2021. As such, it is possible that the leading fulfilment operators may leverage their access to capital and consolidate a fragmented market. From our analysis, we expect this theme could potentially be more prevalent in Europe where companies are typically less mature than the US. In our opinion, the fulfilment market could also benefit from increased SME demand for outsourced logistics, given the P&L volatility generated by supply-chain challenges and rising cost pressures.

In summary, the current more balanced profile between the demand and supply of private capital may, in our view, present a possible attractive opportunity for venture & growth investors.