The Impact of COVID-19 on E-commerce

Typically, one can expect tomorrow to resemble today. However, certain days — such as December 7, 1941, or September 11, 2001 — stand out as transformational. As Nassim Nicholas Taleb notes, history progresses in leaps rather than through linear paths. Extrapolation, by its nature, overlooks critical turning points, which are bound to occur over extended periods, even if they remain unpredictable.

The COVID-19 pandemic caused two significant shifts in the e-commerce landscape. Initially, with physical stores shuttered and consumers confined to their homes, e-commerce experienced unprecedented growth in 2020 and 2021. However, this surge has since reversed, and penetration rates are returning to pre-pandemic trends.

The current state of e-commerce can best be illustrated through the accompanying chart. In response to the initial surge in demand, companies increased their workforce, expanded marketing budgets, and boosted investments. Now, as demand diminishes, these expansions are being rolled back.

Tobi Lütke, the CEO of Shopify, aptly described the challenges that operators face:

> "When the COVID pandemic hit, virtually all retail transitioned online due to shelter-in-place mandates. Demand for Shopify surged... Before the pandemic, e-commerce growth was consistent and predictable. Was this spike a fleeting effect or a new standard? Based on what we observed, we decided to take a gamble: that the proportion of sales moving through e-commerce would advance by 5 to 10 years. We couldn't know for certain, but we felt that if there was a chance it was true, we needed to expand our company accordingly. Now it's evident that this gamble did not pay off. We're seeing the mix revert to levels that pre-COVID data would have suggested. It's still growing steadily, but it wasn't the significant leap forward we anticipated... Ultimately, the decision to place this bet was mine, and I miscalculated. Now, we must make adjustments, which unfortunately means letting some of you go, and I am truly sorry for that."

Shopify, which announced a 10% workforce reduction in July, is not alone in this situation. Cost management became a central theme in the earnings reports of many companies during the second quarter.

Belt Tightening — A Universal Approach

In light of tepid demand, many companies are tightening their budgets across various sectors.

• Amazon faced rising costs throughout 2022. In the first quarter, inflationary pressures (including shipping costs, fuel prices, and wages), decreased productivity, and reduced fixed cost leverage led to an additional $6 billion in expenses compared to the previous year. By the second quarter, this figure dropped to $4 billion as the company curtailed hiring, optimized staff levels for better efficiency, and slowed the expansion of its fulfillment network. Amazon's workforce decreased by nearly 100,000 sequentially, largely due to not replacing departing employees rather than outright layoffs.
• Etsy significantly slowed its hiring process and cut performance marketing expenditures by about 20% year-on-year. For online marketplaces, performance marketing is a major expense that can be adjusted quickly with minimal disruption compared to workforce changes.
• Farfetch is using the slower growth phase to reorganize its structure, aiming for a more efficient operation when demand picks up. The company plans to reduce headcount by eliminating redundant roles while seeking cost savings and reallocating investments to projects that promise quicker returns.
• Poshmark began restructuring its spending in the second quarter, reassessing its cost framework to identify ways to achieve more with less while aiming to cut costs in the latter half of 2022.
• Similarly, Shopify had anticipated that the heightened demand during COVID would be enduring. As e-commerce penetration trends return to pre-pandemic levels, the company is recalibrating its expenditures. In July, Shopify implemented a 10% workforce reduction that affected various departments, particularly recruitment, sales, and support. The company also slowed hiring, reduced spending in non-essential areas, and redirected sales and marketing resources toward initiatives with quicker payback times. In a noteworthy move, early September saw the announcement of a new CFO, Jeff Hoffmeister, taking over from Amy Shapero, who had been with the company since March 2018, following third-quarter earnings.
• The Real Real undertook minor layoffs in its corporate divisions, slowed hiring for support roles, and cut discretionary spending during the second quarter. Additional cost reductions are planned for the third and fourth quarters as the company aims for EBITDA breakeven while conserving capital.
• ThredUp is rigorously managing its variable costs and prioritizing efficiency, having laid off 15% of its corporate staff during the second quarter and scaling back on new distribution center construction to mitigate cash burn. It also reduced research and development expenses and discretionary spending, closing one processing facility.
• Wayfair focused heavily on cost reductions during its earnings call. The company froze hiring in May, pulled back on planned investments, and canceled non-strategic projects. Following its earnings report, Wayfair laid off 870 employees, amounting to 5% of its total workforce. CEO Niraj Shah indicated that the company's priorities are shifting from growth to operational efficiency, a trend echoed throughout the industry.

Hiring Trends — A Freeze or Worse

As demand decreases, interest rates rise, and investors become more focused on margins rather than growth, the technology sector has entered a significant hiring slowdown. E-commerce companies are at the forefront of this trend, with five out of the eight companies analyzed in this report conducting layoffs, while the others are slowing hiring and reducing open positions. This is evident in the disproportionate impact on recruitment roles during Shopify's recent layoffs.

Capital Preservation — Seeking Breathing Room

Cash is the lifeblood of any business. As Warren Buffett famously stated:

> "Cash is to a business as oxygen is to an individual: never considered when it is present, but the only thought in mind when it is missing."

During the second quarter, e-commerce companies began placing a greater emphasis on cash flow. While cost-cutting measures are pervasive, some companies are in particularly precarious situations. The Real Real, ThredUp, and Wayfair are facing the most significant challenges, all prioritizing capital preservation.

The rationale is straightforward: at their current burn rates, these companies have a runway of only four to seven quarters, which understandably raises concerns for CFOs. ThredUp concluded the second quarter with $149 million in cash, a drop from $206 million at the end of 2021, indicating a 25% reduction in just two quarters. This cash burn was approximately split between operational losses and capital expenditures for distribution center developments. The Real Real also saw its cash reserves dwindle, finishing the quarter with $316 million, down from $418 million at the end of 2021. Despite a 30% year-on-year revenue growth, its unit economics are shaky. ThredUp's situation is relatively more concerning, with $90 million of its $100 million cash burn stemming from operations. Pausing construction projects is less complex than restructuring operational processes and stabilizing unit economics. Similarly, Wayfair ended the second quarter with $1.8 billion in cash, down from $2.4 billion at the year's start, amid significant year-on-year revenue drops as consumers prioritize travel and dining over home spending.

While this analysis is somewhat static and simplistic, all three companies are actively reducing expenses, which should lower cash burn rates. For instance, ThredUp anticipates that its cost reductions in the second quarter will save around $30 million in the latter half of the year. Additionally, they may seek further cash through capital markets. Recently, Wayfair announced the issuance of $600 million in convertible notes, maturing in September 2027. Some proceeds will be allocated to retiring existing convertible bonds due in 2024 and 2025. By raising cash and extending maturities, albeit under less favorable terms, Wayfair is affording itself more operational flexibility while waiting for a rebound in furniture demand.

Changing Priorities — Survive, Then Thrive

As the industry transitions from exuberance to a hangover, the focus has shifted from growth to survival, a sentiment echoed among tech investors. This shift is particularly pronounced at ThredUp, The RealReal, and Wayfair.

> Disclosure: The author holds shares in Shopify.

ThredUp's primary objective is to reach EBITDA breakeven. The management outlined three operational principles, two of which emphasize cost control: sustaining robust gross margins and diligently managing variable expenses (the third principle centers on maintaining customer engagement). Likewise, The RealReal is prioritizing profitability over growth, impacting its operations as it moves away from owned inventory, which consumes cash, and focuses more on consignment. Lastly, Wayfair's foremost operational tenet for navigating uncertainty is enhancing cost efficiency. In the second quarter, the e-commerce sector's attention shifted from growth to ensuring survival.

More Good Reads and Listens

Explore Shopify CEO Tobi Lütke’s communication regarding the company's 10% workforce reduction in July. Also, check out Lütke’s insights on mean reversion, and listen to discussions on Etsy’s pandemic success and strategies for weathering economic downturns.

> Disclosure: The author owns shares in Shopify.

> Originally published at https://kjlabuz.substack.com on September 11, 2022.