German online fashion retailer Zalando has capitalised on European consumers’ changing shopping habits and love of mobile to become the fastest-growing company in its sector, and Chi Chan, European Equities Portfolio Manager at Hermes Investment Management, expects its scale, aggressive marketing and effective technology to make it a dominant e-commerce vendor.
Berlin-based Zalando sells apparel, shoes and accessories, including in-house designs and products from partner brands, across 15 European markets. It operates in a very competitive market, going head to head with multi-channel retailers such as Inditex, Next, Sports Direct and H&M, as well as pure-play online retailers such like ASOS, Yoox and Boohoo.
Despite the competition, Zalando has been the fastest-growing company in its sector, and is now twice the size of ASOS despite being only half its age. It has achieved this through an aggressive marketing strategy and smart investment in technology.
Tapping the mobile market
Zalando has profited from shoppers’ increasing preference for smartphones over the high-street experience. About 65% of its site visits come through mobile devices, and downloads of its app have doubled in the past 12 months. The number of active customers reached a record 18.8m by the end of Q2 2016, with average orders of 3.3 per year and an average basket value of €68.
Zalando invests in its partnerships with brands, as well as its IT and inventory systems, to protect its competitive advantage. The business continues to build a customer proposition based on convenience, product selection, brand value and mobile. The strategy seems to be paying off: in Q2, it reported a 25% increase in sales to €916m, supported by a 15% year-on-year rise in active customers.
We initiated our position in the company on 10 April 2015. Since then, the stock has risen 39% to outperform the MSCI European Economic and Monetary Union index by 52%.
Critics suggest that Zalando is a specialist retailer which may not be able to compete with generalist giants such as Amazon, but we think this view is misleading. It implies that the business is small-scale, when in fact Zalando operates three of the largest warehouses in Europe using state-of-the-art logistics. It also implies that there is only room for one winner, whereas we predict the market to develop into a handful of larger players taking the majority of market share. We expect Zalando to be one of them.
Bernstein analysts reckon that Zalando will gain market share in the long term as the e-commerce apparel market consolidates. They forecast full-year sales growth of about 26%, which exceeds Zalando management’s expectations.
Although we do not think online clothes shopping will completely replace the bricks-and-mortar experience, we see huge growth potential as e-commerce will be an enduring, complex challenge for traditional retailers.
The barriers to entry are low in the online retail space, but only a small number of businesses will build the critical mass required to become highly profitable. Zalando is already a market leader, and we expect its strong focus on technology and logistics will keep it in vogue for years to come.
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