FEATURING:

Jayesh Kannan, CFA
William Blair Global Research Analyst

18
Connected Commerce

March 4, 2021 | 31:42

The world is not just being recreated click-by-click instead of brick-by-brick; it is being reimagined. In the second installment of our Convergence series, which examines five growth themes that are shaping the future of investing, Hugo speaks with William Blair Global Research Analyst Jay Kannan, CFA, about what we call “connected commerce,” which covers the entire architecture of the digital economy.

Meet Our Moderator

Hugo Scott-Gall, Partner
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SHOW NOTES
00:48 Host Hugo Scott-Gall introduces his guest, Jay.
01:19 Hugo has Jay define connected commerce.
03:55 Who is in the middle of the connected commerce architecture?
06:05 Where are there pain points in e-commerce and what is the growth opportunity?
08:44 The difference between emerging and developed e-commerce markets.
11:32 Understanding online consumer behavior.
15:41 Where do you find growth in tech?
21:18 Jay talks about where growth may be underestimated.
23:38 Hugo asks Jay about lessons learned in connected commerce.
26:27 Jay discusses technology moonshots that could radically change the economy.
Transcript

Hugo Scott-Gall: Today, I’m joined by my colleague, Global Research Analyst Jay Kannan, to discuss connected commerce in the next installment of our Convergent series, which examines five growth themes that are shaping the future of investing.

In this episode, we’ll cover connected commerce, which basically covers the whole architecture of the digital economy. Jay covers small cap technology, media, and communications services companies. Jay, hello. Welcome. It’s great to have you here.

Jay Kannan: Thank you, Hugo. It’s wonderful to be here.

Hugo Scott-Gall: Good. Well, we both agree on that. Let’s get started. I had a goal, very briefly and no doubt inadequately, to describe and define connected commerce. You can do much better. What is connected commerce?

Jay Kannan: Hugo, we think of connected commerce as an integrated shopping experience. We think about it as anytime, anywhere shopping. Now, what used to be two discrete and disparate experiences, one offline and one online has now come together in an omnichannel world, which one might rather refer to as bricks and clicks for that matter, so bringing together bricks and mortar as well as clicks and the connected commerce environment.

Now, why this is important is essentially this connects the end-to-end consumer journey across both offline as well as online mediums and then collects the data and then uses learnings and insights from that data in order to affect future consumer behavior in order to link back to payment systems. Much of these insights are then fed back into the dropper funnel, which then creates a flywheel effect of sorts, which can drive even more monetization for merchants, can drive a happier and more enjoyable experience for the customer, and can create reduced friction in this process.

Hugo Scott-Gall: That all makes sense. I guess the reason we’re talking about this is because it is quite new. I think, and you were going to agree with me, the assumption that what we just took the system, the architecture from the old, physical world and just re-created it click-by-click instead of brick-by-brick in the digital world. It’s actually wrong. This is a new way of doing things or a new way of organizing things. Is that right?

Jay Kannan: I think that’s fair, Hugo. One would say that we bring together the best of both of the offline as well as the online journeys and experiences and then connect them in a way in which they can talk to each other. They can share insights from what a consumer likes offline to what he or she may like online. If you prefer a paddle of a certain brand or a certain size offline, there’s a good chance you’ll likely want a similar experience or have similar interests online as well.

What used to happen disparately when both of these systems or ecosystems didn’t talk to each other is now coming together with an ecosystem or an architecture, and we can go into that shortly, where they talk to one another and where we can drive insights and drive learnings and therefore drive predictability in what the consumer might want in both these systems.

Hugo Scott-Gall: If we think about the whole architecture, who is really sitting at the middle of this? Who has got the big, central role or the must-have pipes that it all has to go through?

Jay Kannan: If you think about the value chain here in connected commerce, we can think about merchants at one end. We can think about consumers at the other and perhaps a wide set of intermediaries in the middle who often facilitate interactions or connected commerce between the merchant and the consumer.

When we think about the merchant, probably the new age infrastructure involves enablement type software or services, so allowing them to understand what the consumer likes, allowing them to track consumer journeys offline, use those insights online, and then a lot of software that just helps reduce friction. Enablement in terms of a digital point of sales, enablement in terms of connecting with financial ecosystems, and then of course customer management; this can be a traditional CRM system, but it can also be managing loyalty systems, tracking what consumers do across other websites, and targeted advertising.

At the other end is the consumer. For the consumer journey, why this is important is so that they can then have pipes or payment intermediaries, so the same way they pay offline is a way they pay online. If that is not the case, especially given regulatory constraints or countries in which these ecosystems operate, then that can change using intermediaries.

Intermediaries, finally Hugo are essentially the payment platforms or other forms of value chain intermediaries. These can be logistics, they can be credit, they can be simple pipes or rails in different countries. Think of them as either payment-type platforms that enable payment transactions to take place or even mobile e-wallets in certain types of countries, which are enablement for consumers who do not have access to credit cards, debit cards, and the traditional banking ecosystem.

Hugo Scott-Gall: You touched on it a bit there, but I’m very interested in the question of, is this all now done? Certainly, digital commerce, the online economy feels very smooth and frictionless versus how it used to feel. One of the ways we always like to think about growth is by asking the questions of where there were still frictions, where there were problems to solve.

Will we look back, 10 years’ time and say, whew; the system back in 2020-2021 was pretty antiquated? It had these frictions, these pain points. It was slow. How is it going to change? How will you know when it’s done? What are the still-big problems and pain points to deal with?

Jay Kannan: I believe we’re still at the early innings when it comes to either online or omnichannel penetration of the commerce opportunity. Now, if we look back perhaps 11 or 12 months, we’d say that the current environment, especially when many of us were at home, accelerated the pace of many consumers transacting online for the first time ever. Even having said that, less than a fourth or a fifth of global commerce is conducted over the internet.

It’s funny, but I remember what the CEO of Stripe, which is a large payments company, often says which is, their mission as a company is to increase the GDP that is transacted over the internet. I’m paraphrasing here, but essentially what that means is that there is a lot more here to go when it comes to connected commerce and the online experience.

Now, what can we think of when the jobs that are done by these either intermediaries or platforms going forward and how that can change? Well, the simple low-hanging fruit here is reducing friction. Irrespective of what we think, there is increased friction between either the different platforms, the types of authentication we need, the types of payment methods, the commissions that are paid, and simply the leakage in many ways of a dollar that is spent by a consumer versus the residual part of that dollar that actually reaches the merchant.

To the extent we can create more efficiencies across the system, the consumer and the merchant can probably transact at a price that is much closer to each other than what it is today. Both can have a more enjoyable experience, more insightful experience where you can have more targeted products and services at consumers who can then purchase them either cheaper, efficiently, or faster in a more enjoyable manner.

Hugo Scott-Gall: So far, we’ve talked of this in a generalized way, but I’m wondering if you can talk a bit about the difference between developed markets, emerging markets? By that we mean Europe and the U.S. versus kind of the rest of the world, but certainly Asia, how the architecture looks different and why it looks different. I suppose here I’m already getting at this idea of leapfrogging, where you didn’t have to disrupt something that wasn’t there. It’s a lot easier.

Jay Kannan: That’s right. One easy analogy here that would be a good point, too when thinking about how this opportunity set might play out in developing countries or in emerging markets versus those that are developed is to look at the spread of telecommunications services over the past three or five decades. We had fixed-line telephony in developed markets, which is essentially a landline that you could use at home or in the office. Then, that transitioned towards mobile phone penetration, which at the first instance were just feature phones where you could either text or make voice calls, and the finally the advent of data.

Now, in emerging markets we leapfrogged much of that, so we went from absolutely no connection, maybe snail mail or telegram services, or for the most part connectivity that wasn’t first-rate to smartphone data. The availability of cheap data, the availability of fast data, and what was often populations which either didn’t have access to much of the online world now coming online for the first time ever; as they say, although consumer wallets are different in different parts of the world, willingness, the ability to engage, perhaps even transact in front of a screen is likely not different at the most primal level when we think about humans, our intent and much of our needs and wants.

When we apply that analogy to connected commerce, I think what has largely changed or allowed for this leapfrogging is the smartphone revolution. Whether it be increased smartphone penetration, the availability of cheap as well as access to fast data, 4G for the most part today, but likely 5G in the future, and then of course new and differentiated form of payments. Now, in the emerging world, much of the population is either on the bank or unbanked for the most part, which means that credit cards, usage of systems like PayPal is not something that those markets are essentially used to.

What we’ve seen is new, innovative technologies. We think about mobile wallets, we think about easier payment access, anti-fraud systems, which are unique and differentiated in terms of what they target, who they target. A lot of these connections with the online ecosystem, online shopping experience, logistics infrastructure that it’s connected to is very differentiated in emerging markets.

Think about last mile access, non-standardized logistics infrastructure, so on and so forth. Those are two or three examples where one needs more specific, geography-specific use cases as opposed to perhaps global, cross-border payment providers or technology platforms, enablement software.

Hugo Scott-Gall: Is one of the big areas of growth understanding behavior, consumer behavior, customer behavior in terms of—in some ways, we feel we understand it already versus where we were when things were essentially done, someone bought something, but you got no feedback. You didn’t understand the purpose, you didn’t understand why they went to that place, you didn’t understand what they were searching for.

So, in some senses you could argue there’s quite a lot that’s understood, but I wonder back to my question; in 5 years’ time, 10 years’ time, understanding intent, desires, predictive—are we still quite early on that journey? Does that tie back what you were saying about the GDP of the internet? The GDP of the internet still might be quite early, almost in its infancy because there’s a lot that we don’t understand in terms of what ultimately any producer, any seller would like to know versus what they do know. That’s still quite a big gap.

Jay Kannan: That’s right, Hugo. A good way to think about this might be to think about the evolution of the advertising business model and how that has transitioned as it relates to either improving the way one could measure the intent of the targeted audience and then relay that back to the top of funnel. Make advertising even more targeted, even better as a result of that.

Back in the day, we had offline ads at its most basic form. Think of a billboard that you and I drive by every day. We see the same billboard all the time. Think of that as level one. Level two was then online, where it was more contextual. If you went to a sports website, you saw an ad related to sport. If you went to an e-commerce website, you likely saw an ad related to apparel or some sort of shopping-related intent, so a little more contextual.

We then came into search, which I define as probably level three, where depending on what you searched for, you found an ad which was a little more targeted but couldn’t really capture ultimate intent. You often didn’t transact at that level. We’re now moving into level four or level five, which I would argue on an absolute basis is still very early, where either merchants or ecosystems can track a consumer’s journey.

They see some of your past behavior in terms of either transactions, intent, what you may be looking for, and then there’s predictive analytics on that, of course well within the bounds of what can be allowed in a privacy-controlled and sensitive environment. That helps enhance the customer experience. It also enhances intent for the consumer when it comes to what they might be wanting to do.

I would say that’s where we are today. Where can we go from here? Well, we can do a lot more with intent. We can have business models where essentially companies are paid based on the return on investment you get for the marketing spend, so cost per converted customer as opposed to cost per either impression or cost per showing an ad. That’s one example of where we might be going forward. We can do a lot more for that.

Also, when it comes to merchants, which is the other stakeholder here in the ecosystem, you can have just-in-time inventory management and a lot more in terms of predictive behavior of a customer. Think about grocery online purchases when it came to the current environment. A lot of retailers were quickly able to bring that up to speed in their inventory systems because grocery behavior, for the most part, is repeatable, predictable. It’s likely that you’ll order the same amount of milk every week if the number of folks in the household remain constant.

That’s one example of how this can help transform inventory management and other logistics infrastructure for the merchant as well.

Hugo Scott-Gall: While you were talking there, I began framing my next question, which wasn’t my next question. I changed my mind. Really, as a technology analyst the business of forecasting growth, where there’s going to be growth is really central because it’s such a dynamic, fast-growing area. How do you approach that task? How do you approach the task of where to find growth across the broader tech spectrum?

Jay Kannan: I humbly submit that this is probably one of the most exciting parts of what we do on a daily basis but at the same time challenging as well. This can go in so many different directions, so as much as we’d like to explore, we sometimes have to bring it back to either growing revenue pools and then investible, exploitable opportunity sets within them. As a team, we often try to think about first principles. We try and understand where growth is overall, so we think about the overall revenue pie and how this may either be growing in different aspects of the economy or shifting in many cases as a result of what is going on in our case here in technology.

Either advances or innovation, technological changes; this could be more of the same. This could be revolutionary or disruptive in many cases. We often look at that as a starting point. Now, of course alongside that there are quite a few bread crumbs that we find along the way as we research. Now, this can be thinking about or reviewing funding activities. We often look at what the smartest venture capitalists do or private equity investors not necessarily as something we want to do, but essentially as a guide for what might be happening in changes in the economy.

Finally, I’d say we enjoy learning. We try and either speak with or learn from who we believe are the cleverest minds and use some of the best in the industry, whether they be academics or scientists or other industry entrepreneurs in innovative companies are saying, doing, and seeing. We’ll use some of that as a mosaic to identify patterns and start from there on.

Hugo Scott-Gall: So, it’s the identifying of patterns. I guess one of the things I’ve always found interesting and a fascinating concept is this idea of recombinant innovation. When you take two things and put them together, they produce something that you wouldn’t necessarily predict or know about. An obvious example is all the platform apps that you can have on your phone are only really made able by communication technology, 4G and now 5G. How do you think about this equation of problem to solve, new technology, often a communication technology, and what that might lead to?

It wouldn’t necessarily always get you to a music streaming app or even something like a TikTok, or even when the whole Pokémon craze or virtual reality, so it’s hard to know specifically what’s going to happen. How do you weigh the odds of a problem getting solved because the odds are now in favor of the problem being solved because of a non-related technology, this sort of idea that when you put these things together precisely unknowable things happen but directionally knowable things happen?

Jay Kannan: I remember first thinking about this a few years ago because I think that the phrase recombinant innovation comes from The Second Machine Age, which was a book whose author taught school when I happened to be there, at graduate school. That’s when I first heard about not just combining and creating an innovative product by combining either components or systems that for the most part, already existed.

Of course, we’ve seen plenty of examples of that as you rightly pointed out where these components are, very often like you said, communication technology or some advances thereof. We had to look back 5 or 10 years at a key starting point or a leading indicator of where we see recombinant innovation. Much of that has been accessed to communication technology, so either becoming faster, more accessible, or cheaper for the most part.

Waves of that continue to happen. Now, that can be with next-generation communications technology, but that can also be with inherent problems that exist in the world today which are yet to be solved. Let’s think about it from the consumer’s perspective. When we think about leisure time in the world over the past 10 years, it’s largely remained flat or time devoted to leisure, but the share of that time has largely moved online. A large percentage of that has increasingly, for the most part in various aspects of the world moved towards either gaming or in its broadest bucket, entertainment, which can be some combination of gaming, watching content, consuming content either video or audio.

What am I getting at with all of this? Inherently, the consumer’s desire to either want or do something digitally today remains the same. Then, when we put that together with a lot of these other elements, you bring in commerce from one direction, so we all will continue to shop. Think about gaming. Many of us would like to entertain ourselves on a daily basis, gaming being one avenue for that. Then, you bring yourselves either aspects of entertainment. That can be music streaming, video consumption, and so on and so forth.

Put all of that together, and then very often now you have one platform that uses communications technology but essentially is innovative because it solves different problems. It takes up a fair amount of your leisure time, allows for entertainment, allows for commerce or shopping, and then uses some form of underlying payments technology to enable all of that.

Hugo Scott-Gall: This is a tough question, maybe not even a fair one, but when you put together all of the growth themes that sit within your coverage, within the broader tech sector, where do you think it is underestimated?

Jay Kannan: Let’s start with the first part of that question, which is very broadly if we had to classify or think about where growth could be as it relates to the technology sector, I’d probably bucket those into five categories. Not necessarily exhaustive, but where we feel very excited; one, I’d say is ubiquitous connectivity, so more number of devices, more connections in the world. The second I’d say is Digital Enterprise 2.0, so more enterprises adopting digital infrastructure, cloud infrastructure for the most part, subscription-type software services, platforms, and infrastructure.

The third would probably be next-generation computing, so the increase in both our capacity as well as the need to consume more processing power in the world today. That’s likely going to increase with the increased amount of data that is both created on a regular basis but also consumed, researched, tracked, so on and so forth.

The next we’d say is just the digital lifestyle. Think about the digitization of the consumer, more of regular, daily services, whether they be classifieds or food delivery or practically anything else, consumption of entertainment, moving to the online world and technology enabling that. Lastly, we’d say is a fair bit of de-globalization. We’ve seen that for both geopolitical reasons but also as a result of disruption in supply chains over the past year or so, increasing supply resilience with different parts of world, increasing localized or accessible supply to technology-related infrastructure as a result of what is going on in the world today.

Having said that and set the framework for where we think growth might be, we’d say that one aspect—many of these are exciting, many of these have smaller elements where we believe growth is likely underestimated—but one of them is the one we’re currently researching. It’s the digitalization of the consumer and how that’s happening in different parts of the world but in smaller, atomic business models that could be geography-specific as it relates to countries that are late on the adoption curve or consumers where behavioral shifts haven’t taken place to the extent that they have in certain other parts of the world.

Hugo Scott-Gall: I’ll ask you two more questions, and then we’ll wrap. The first one is how lessons are learned. Particularly, going back to connected commerce, what do you think are the learnings from an area that has been, as a generalization, overall consistently underestimated rather than overestimated?

We can observe that from the performance of many stocks and share prices of many companies who are linked to this theme but also in the forecast for their revenue, which have generally been upgraded rather than downgraded. So, there was an underestimation here, so why do you think that was? What are the lessons you’re taking away from that?

Jay Kannan: Perhaps at the first instance, Hugo thinking about lessons learned we maybe will use what you’ve just mentioned two questions ago, which is recombinant innovation. We say often innovation or technology is incremental for the most part until there’s a step function change at some point, and then it becomes radical. What does that mean? What’s the case study here?

We think about wider smartphone penetration, cheap access to and ubiquitous connectivity, so data access, especially in emerging markets. As investors, or a wide part of the investment community underestimating not the first-level impact of that, so number of people in these countries who buy a smartphone or get connected. We have lots of data on that, but the second and tertiary impacts of wider smartphone adoption; that is likely one area or aspect that has been underestimated, especially in connected commerce-related business models in the emerging world.

We’ve often seen that either in South Asia, Southeast Asia, Latin America more recently, and perhaps the new, unexplored investible opportunity is parts of Africa, where connectivity is still in its first few stages. That’s probably underestimated at the first instance.

The second aspect of what could we see from here or lessons we could have learned is that change in consumer behavior as a result of this, so the ability to engage online, the ability to overcome either digital or vernacular language, illiteracy, innovation around payment systems, osmosis of technology, and then finally innovation of localized solutions for localized problems in many of these markets. It’s often easy to paint a single brush suggesting that one global technology would likely penetrate and be adopted in its shape and form around the world, but we often see that as not being the case.

We underestimate the ability of local, innovative companies to produce solutions that cater to their local markets and the durability of their competitive advantage sustaining over many, many years.

Hugo Scott-Gall: That brings me to my final question, which is a tough one because it’s a tough one in the sense that it’s hard to know. It’s an easy one to answer because it’s hard to prove you wrong, but give me some sort of moon shots. Give me some low-probability but high-impact things that could radically change the economy, the way we live, certainly change your area of technology more broadly. What are the kind of things that are maybe not visible today but are being worked on that could have an outsized impact if they come to fruition?

Jay Kannan: Let’s perhaps start with the more obvious ones. Then, we can go to less obvious ones as we think along here. At the first instance, I’d say a faster rollout of 5G, which is the newest communication technology, perhaps can lead to new business models that don’t necessarily exist today. For the most part, we think this would be faster than the current infrastructure, better experience, but similar to what we saw with 4G and ride hailing or food delivery, there could be new use cases here in terms of smart cities, fixed wireless, so social use cases of reaching parts of the population who don’t have access to high-speed, broadband internet today.

And then, areas like connected vehicles, so autonomous vehicles, connected cars speaking with each other, and perhaps that leading to better safety outcomes or better efficiency outcomes, so that’s maybe one area that we could crystal-ball on.

When we think of less obvious ones, let’s think about broadly what’s happened over the past year. As a result of the current environment, we’ve had a higher degree of personalization of one’s self or increased personalization of technology within one’s self. Here, we can think about either wearable devices, we can think about smart dust or even smart fabric for that matter, which may not be so much of a moon shot five years from now, especially if we have faster, cheaper, more ubiquitous connectivity.

We could have, many of us constantly connected not just with one another but with ourselves as well and that data being used to either predict health outcomes or do other things that may lead us to eating healthier, exercising more, speaking with one another, connecting with those or predicting mental health issues, things like that.

Then, I’d say perhaps the other aspect of this which we can also think about is the commercialization of either drones, which isn’t a moon shot anymore but certainly has many challenges between what is done today in a more secure manner, and what can be done where delivery packages arrive on a drone as opposed to being delivered by someone. Those are three or four examples of where we could see outsized impact to revenue pool creation or shifts in the future.

Hugo Scott-Gall: I thought you were going to talk about space and maybe also companion robots, which would have made lockdown a lot easier for some people.

Jay Kannan: There’s always your closest video streaming service to learn more about those two at this point in time.

Hugo Scott-Gall: True, very true. Jay, I want to say thank you very much for coming on the show. It was a delight to have you. We covered a lot of stuff, and so thank you again.

Jay Kannan: Thank you.

Meet Our Moderator

Hugo Scott-Gall, Partner
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