Nordstrom (JWN -1.71%) reported first-quarter results on May 25 that disappointed investors. Shares are down roughly 10% since the retailer announced earnings. The main reason markets were less than impressed seems to be because Nordstrom didn't raise estimates for 2021.
Rival Macy's (M -7.72%) announced earnings a couple of weeks before Nordstrom and had raised expectations for the rest of the year. So Nordstrom was heading into the release with a high bar to scale, which it failed to do. With all this focus on fiscal year guidance, you probably missed this one important number from Nordstrom's first-quarter earnings release.
Increasing options for customers
That number is the increase in choice count. In other words, the amount of selection a customer sees when visiting Nordstrom online. The company added 20% more choice count as of the end of the first quarter, compared to the same quarter pre-pandemic (2019). Impressively, it did this while decreasing inventory investment by 2%. How can a company add choice for customers while decreasing inventory investment?
By bringing on third-party sellers to its website. The outside vendors invest in the inventory and list their products on Nordstrom's site, then ship the product directly to the customer when an item sells. Although not exactly the model Amazon (AMZN -0.22%) employs on its platform, it is similar.
Nordstrom earns a percentage of the sales revenue and gains the pleasure of its customers who appreciate the increase in selection. Here's what President and Chief Brand Officer Peter Nordstrom said on the company's first-quarter conference call:
I think the main thing here is the dropship model, in particular, allows us to expand choice count in a way that creates a lot of leverage for us in terms of all the work that goes with bringing inventory in. If it was in a traditional wholesale model, that's -- obviously, there's a lot of manual effort that goes with that. So it's a great way for us to expand the choice count.
What this could mean for investors
The increase in selection could have the effect of driving more sales and customer visits online. Certainly, if there are more products available, it increases the odds of making a sale. For example, folks may visit Nordstrom.com to buy a shirt and notice a pair of pants provided by a third-party seller that matches that shirt, and add those pants to the purchase -- an addition that may not have happened without the third-party seller.
And if you ignore the disruption caused by the pandemic after 2020, you can see inventories decreasing even as revenue was trending upward (see chart).
However, this model does come with risks. If customers start to experience a lower quality of products, it could hurt Nordstrom's brand image. Further, these sales could come with lower profit margin and cannibalize sales of higher-margin items from Nordstrom's owned inventory.
Overall, however, it should be a net positive in the long run. It will allow Nordstrom to scale up choices to its customers without making a multi-billion dollar capital investment. And it should reduce merchandising risk for Nordstrom. Consider that Nordstrom purchases inventory for its stores months in advance. There is always the risk that when the inventory arrives, customers don't buy it -- leaving Nordstrom owning unwanted inventory it then has to discount. That's one fewer risk investors have to worry about.