Rick Rieder explains the economic implications of “the Amazon effect.”
Some characterize the current economic climate as one lacking demand-driven pricing power, but we think that is a misapprehension of dynamics at play today. Rather, we think we’re in the midst of one of the greatest supply-side-driven cost revolutions of all time: the critical force being largely driven by technology’s influence on the economy. Indeed, we’re watching cash flows shift at an extraordinary pace and are seeing powerful disinflationary forces at work. In brief, a large part of what’s on display here could be described as the “Amazon effect,” which holds a powerful deflationary impact on large swathes of the goods economy.
Indeed, service sectors have seen balanced growth in quantities and prices. Yet, in the goods-producing arena quantities have held up, while weakness has been driven by prices (see first graph). When taking a close look at the data, the influence of technology on some of the goods sectors is incredible, with innovation, lower production costs and added efficiency weighing on price. Of course, while a positive development for consumers’ quality-of-life, this dynamic is disrupting entire industries, weighing on corporate profits and shifting cash flows in a manner that greatly concerns investors.
This story began when Amazon started opening consumers to the long tail of books that otherwise would not have made it to market, essentially by making every title available online. That shift redistributed market share and eroded the pricing power of bestsellers, deflating the price of all books in the process. Over the years, the influence of this dynamic expanded to many other product categories. Today, premium brand value is being eroded in virtually every consumer goods sector that is subject to significant online penetration. In turn, the value of the distribution center in the traditional retail sales model (the brick-and-mortar store, shopping mall) began to be impaired due to selection constraints, the deterioration of brand value and the ease and low cost of online alternatives.
In sum, those consumption categories that display some of the highest degrees of online penetration (consumer electronics, books) are also those areas that have witnessed the greatest level of deflationary pressure. In contrast, those market segments that have resisted online penetration (for example, over-the-counter drugs and pharmacy segments), either due to regulatory or other factors, have tended to have higher rates of inflation. Still, we think it is these latter areas that are most at risk of future disruption and subsequent price deflation, and investors would do well to heed that fact.