Profitability risk from retail media displacement

Our Head of U.S. Internet Research Brian Nowak joins U.S. Small and Mid-Cap Internet Analyst Nathan Feather to explain why the future of agentic commerce is closer than you think.

Read more insights from Morgan Stanley.

----- Transcript -----

Brian Nowak: Welcome to Thoughts on the Market. I'm Brian Nowak, Morgan Stanley's Head of U.S. Internet Research

Nathan Feather: And I'm Nathan Feather, U.S. Small and Mid-Cap Internet Analyst.

Brian Nowak: Today, how AI-powered shopping assistants are set to revolutionize the e-commerce experience.

It's Tuesday, February 17th at 8am in New York.

Nathan, let's talk a little bit about agentic commerce. When was the last time you reordered groceries? Or bought household packaged goods? Or compared prices for items you [b]ought online and said, ‘Boy, I wish there was an easier way to do this. I wish technology could solve this for me.’

Nathan Feather: Yeah. Yesterday, about 24 hours ago.

Brian Nowak: Well, our work on agentic commerce shows a lot of these capabilities could be [coming] sooner than a lot of people appreciate. We believe that agentic commerce could grow to be 10 to 20 percent of overall U.S. e-commerce by 2030, and potentially add 100 to 300 basis points of overall growth to e-commerce.

There are certain categories of spend we think are going to be particularly large unlocks for agentic commerce. I mentioned grocery, I mentioned household essentials. We think these are some of the items that agentic commerce is really going to drive a further digitization of over the next five years.

So maybe Nathan, let's start at the very top. Our work we did together shows that 40 to 50 percent of consumers in the U.S. already use different AI tools for product research, but only a mid single digit percentage of them are actually really starting their shopping journey or buying things today. What does that gap tell you about the agentic opportunity and some of the hurdles we have to overcome to close that gap from research to actual purchasing?

Nathan Feather: Well, I think what it shows is that clearly there is demand from consumers for these products. We think agentic opens up both evolutionary and revolutionary ways to shop online for consumers. But at the moment, the tools aren't fully developed and the consumer behavior isn't yet there. And so, we think it'll take time for these tools to develop. But once they do, it's clear that the consumer use case is there and you'll start to see adoption.

And building on that, Brian, on the large cap side, you've done a lot of work here on how the shopping funnel itself could evolve. Traditionally discovery has flowed through search, social or direct traffic. Now we're seeing agents begin to sit in the start of the funnel acting as the gatekeeper to the transaction. For the biggest platforms with massive reach, how meaningful is that shift?

Brian Nowak: It is very meaningful. And I think that this agentic shift in how people research products, price compare products, purchase products, is going to lead to even more advertis[ing] and value creation opportunity for the big social media platforms, for the big video platforms. Because essentially these big platforms that have large corpuses of users, spending a lot of time on them are going to be more important than ever for companies that want to launch new products. Companies that want to introduce their products to new customers.

People that want to start new businesses entirely, it's going to be harder to reach new potential customers in an agentic world. So, I think some of these leading social and reach based video platforms are going to go up in value and you'll see more spend on those for people to build awareness around new and existing products.

On this point of the products, you know, our work shows that grocery and consumer packaged goods are probably going to be one of the largest category unlocks. You know, we already know that over 50 percent of incremental e-commerce growth in the U.S. is going to come from grocery and CPG. And we think agentic is going to be a similar dynamic where grocery and CPG is going to drive a lot of agentic spend.

Why do you think that is? And sort of walk us through, what has to happen in your mind for people to really pivot and start using agents to shop for their weekly grocery basket?

Nathan Feather: I think one of the key things about the grocery category is it's a very high friction category online. You have to go through and select each individual ingredient you want [in] the order, ensure that you have the right brand, the right number of units, and ensure that the substitutions – when somebody actually gets to the store – are correct.

And so for a user, it just takes a substantial amount of time to build a basket for online grocery. We think agentic can change that by becoming your personal digital shopper. You can say something as simple as, ‘I want to make steak tacos for dinner.’ And it can add all of the ingredients you want to your order. Go from the grocery store you like. And hey, it'll know your preferences. It'll know you already like a certain brand of tortillas, and it'll add those to the cart. And so it just dramatically reduces the friction.

Now, that will take time to build the tools. The tools aren't there today, but we think that can come sooner than people expect. Even over the next one to two years that you start to get this revolutionary grocery experience.

And so, it's coming. And from your perspective, Brian, once agentic grocery shopping does start to work, how does that impact the broader e-commerce adoption curve? Does it pull forward agentic behavior in other categories as well?

Brian Nowak: I think it does. I think it does lead to more durable multi-year, overall e-commerce growth. And potentially in some of our more bull case scenarios, we've built out – even an acceleration in e-commerce growth, even though the numbers and the dollars added are getting larger. But there is some tension around profitability.

We are in a world where a lot of e-commerce companies, they generate an outsized percentage of their profit from advertising and retail media that is attached to current transactions. Agentic commerce and agents wedging themself between the consumer and these platforms potentially put some of these high-margin retail media ad dollars at risk.

So talk us through some of the math that we've run on that potential risk to any of the companies that are feeding into these agents for people to shop through.

Nathan Feather: Well, in our work for most e-commerce companies, a majority – or sometimes even all – of their e-commerce profitability comes from the advertising side. And so this is the key profit pool for e-commerce. To the extent that goes away, there is one potential offset here, which is the lower fee that agentic offers for companies that currently have high marketing spend. To the extent that agentic offers a lower take rate, that could be an offset.

But we think it's going to be very important for companies to monitor the retail media landscape and ensure they can try to keep direct traffic as best as possible. And things like onsite agents could be really important to making sure you're staying top of mind and owning that customer relationship.

Now, on the platform side, search today captures an implied take rates that are 5-10 times higher than what we're seeing in the early agentic transaction fees. If this model does shift from CPC – or cost per click – towards a more commission based model, Brian, how do you think search platforms respond?

Brian Nowak: I think the punchline is the percentage of traffic and transactions that retailers or brands or companies selling their items online that's paid is going to go up. You know, while search is a relatively more expensive channel on a per transaction basis, search works because there's a very large amount of unpaid and direct traffic that retailers benefit from post the first time they spend on search.

Just some math on this. We're still at a situation where 80 percent of retailers' online traffic is free. Or direct. And so if we do get into a situation where there's a transition from a higher monetizing per transaction search to a lower monetizing per transaction agent, I would expect the search platforms to react by essentially making it more challenging to get free and direct and unpaid traffic. And we'll have that transition from more transactions at a lower rate; as opposed to fewer transactions at a higher rate, which is what we have now,

Nathan, in our work, we also talked about a Five I’s framework. We talked about inventory, infrastructure, innovation, incrementality and income statement, sort of a retailer framework to assess positioning within the agentic transition. Maybe walk us through what your big takeaways were from the Five I’s framework and what it means that retailers need to be mindful of throughout this agentic transition.

Nathan Feather: Well, for retailers, I think it's going to be very important that you're winning by differentiation. Having unique, competitively priced inventory with infrastructure that can fulfill that quickly to the consumer and critically staying on the leading edge of innovation.

It's one thing to have the inventory. It's another thing to be able to be actively plugged into these agentic tools and make sure you're developing good experiences for your customers that actually are on this cutting edge. In addition, it's one thing to have all of that, but you want to make sure there's also incrementality opportunity.

So [the] ability to go out, expand the TAM and gain market share. And of course what we just talked about with the margin risk, I think all of those are going to be very important. And so on balance for retailers, we do see a lot of opportunity. That's balanced with a lot of risk. But this is one of those key transition moments that we think companies that really execute and perform well should be able to perform nicely.

Now finally, Brian, over the next five years, how do you think agent commerce reshapes competitive dynamics across the internet ecosystem?

Brian Nowak: I think over the next few years, we're going to realize that agentic commerce is no longer a fringe experiment or a concept. It's a reality. And we may get to the point where we don't even talk about agentic commerce or agentic shopping. We just say, “‘This cool thing I did through my browser.’ Or, ‘Look at what my search portal can do. Look at how my search portal found me this product. Look at how my groceries got delivered.’ And it'll become part of recurring life. It'll become normal.

So right now we say it's agentic, it's far off. It's going to take time to develop. But I would argue that every year that goes by, it's going to be becoming more part of normal life. And we'll just say, ‘This is how I shop online.’

Nathan, thanks for taking the time today

Nathan Feather: It was great speaking with you, Brian.

Brian Nowak: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen. And share the podcast with a friend or colleague today.