Since the pandemic, many businesses have accelerated their adoption of digital tools, leading to a significant improvement in operating efficiency. Offline retail is one of the sectors that feel the most impact. We review this ongoing development and conclude the implications in the following. 

Retailers' full-blown digital transformation Traditional offline retailers have lost market shares to online rivals for more than a decade, notably Amazon. While Amazon grew more dominant, it seems impossible for any single company to challenge the status quo. Traditional retailers realized that they must collaborate closely with technology companies to redefine the entire value chain to fight back. It's a revolution, not evolution.

Technology vendors, such as public cloud giants Azure and GCP, also seized retailers' mind shift and poured tremendous resources into building retail-specific cloud solutions. SaaS companies like Salesforce and Shopify developed end-to-end retail-focused software tools, from opening online stores to digital marketing to data analytics. Fintech companies such as PayPal and Square integrated their solutions into the retailer's omnichannel strategy, providing customers with new shopping experiences like BNPL/QR code. Short video platforms such as TikTok and Snapchat leveraged AR/VR to help retailers design innovative marketing campaigns.

Structural margin improvement for early adopters For early adopters of digital transformation, the pandemic allowed them to taste the first-mover advantage. They managed to increase eCommerce penetration, optimize physical stores, and reduce operating expenses simultaneously. As such, they ended up emerging from the pandemic as more profitable businesses, structurally. 

For example, Nike and Lululemon made an early bet on developing DTC eCommerce, which paid off enormously during the pandemic. In 2020, Nike's digital business revenue doubled, accounting for 20% of the total sales. The high eCommerce penetration helped Nike improved its EBIT margin from 12% to over 15%. Similarly, Lululemon's eCommerce sales also doubled and accounted for 52% of the total revenue. Its eCommerce EBIT margin of 45% is significantly higher than the 28% margin of offline stores. Even as Lululemon's physical stores reopened, management still expects eCommerce to generate the most profits in the future.

In the restaurant industry, Chipotle orchestrated an impressive turnaround under the new CEO Brian Nicol in 2018. They partnered with DoorDash to boost delivery services, rolled out loyalty programs, and invested heavily in digital marketing campaigns. The digital turnaround was successful: Chipotle's digital sales share increased from 10.9% of the total in 2018 to 49% in Q2'21. With higher digital sales, Chipotle's store economics improved significantly, whose "adjusted unit volume" (AUV) increased from $2 million in 2018 to $2.5 million as of now. Management also set a goal of $3 million for the next few years. The most incremental revenue is expected to flow to the bottom line, suggesting a higher return on invested capital (ROIC). 

Nike, Lululemon, and Chipotle are just a few examples of how digital transformation has helped turn early adopters into long-term compounders. We encourage our readers to study digital transformation cases in Walmart and Target in broad-line retail, Home Depot and Restoration Hardware in home furnishing, and Abercrombie and Victoria's Secret in apparel, to glimpse the changing dynamics of the U.S. retail sector.

Digital advertising and logistics are also beneficiaries As retailers become structurally more profitable, they re-invest to upgrade their technology stack, creating a virtuous circle for many digital enablers. The adjacent industries also benefit from this new trend, such as digital advertising and logistics. Because of the strong demand from retail brands, advertising costs surged in the first half of 2021, benefiting digital ad platforms such as Alphabet and Facebook. While some believe the cost surge is only temporary, we reckon it could be more structural. As far as we are concerned, the management of brand retailers all see the current ROI as "attractive" and plan to increase their advertising spending for the rest of the year.

Logistics is another industry that we expect to attract significant investment from retailers. Consumers' demand for faster deliveries has intensified, and some groceries already offer on-demand delivery within 15 minutes. Their supply chains need to be redesigned entirely for traditional retailers to cope with this new competitive landscape. We expect "robotic automation" and "micro-fulfillment" to be the best growth opportunities ahead.