Fortnightly Thoughts May 21 v2 - MicroCapClubmicrocapclub.com/wp-content/uploads/2015/05/GS-Convenience.pdf · 16 What’s next for retail: Carl Hazeley on online disruption and what

The Goldman Sachs Group, Inc. Goldman Sachs Global Investment Research

At your convenience Convenience is an important competitive weapon to shift share or upturn industry revenue pools (think Netflix vs. Blockbuster). Why it matters more now is because tech is changing the rule book by rapidly shrinking the marginal cost of providing convenience and in turn shifting user expectations; the on-demand economy for everything - driven by apps, data, artificial intelligence or logistics - is the democratisation of convenience.

With well-funded start-ups targeting customer pain points, risks are mounting for incumbents that thrive on complexity and friction costs. And in sectors like media and retail, the need to marry differentiated content with convenience has become crucial. We identify companies that are consistently good at making life easier for their users, enablers of convenience as well as content providers also focused on the ease of use.

What’s inside

Interview with…Benedict Evans: Partner at Andreessen Horowitz

6

Convenience – Apple’s core: Bill Shope on Apple’s focus on simplicity and ease of use

8

Sky embracing connectivity: Vighnesh Padiachy on joining content with convenience

9

Tuning into convenience: Drew Borst on the lessons video has learnt from music

11

Convenience pays: Our US Payments analysts on new and faster ways to pay

14

At your doorstep: Our retail analysts write that the CVS sector is set to sweep across Asia

16

What’s next for retail: Carl Hazeley on online disruption and what comes after

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The pain points Top industries (ex-telcos) by the number of complaints received by the BBB in the US, 2014

Source: Better Business Bureau; www.bbb.org

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Sumana Manohar, CFA [email protected] +44 (20) 7051 9677 Goldman Sachs International

Hugo Scott-Gall [email protected] +1 (212) 902 0159 Goldman, Sachs & Co.

Megha Chaturvedi [email protected] +44 (20) 7552 3305 Goldman Sachs International

0 5000 10000 15000 20000 25000 30000

Electric Companies

Satellite Equipment

Airlines

Travel Agencies

Movers

Internet Services

Credit Cards & Plans

Apartments

Property Management

Department Stores

Insurance Companies

Auto Repair & Service

Banks

Furniture - Retail

Internet Shopping

Auto Dealers - Used Cars

Collection Agencies

Auto Dealers - New Cars

Television

Fortnightly Thoughts May 21, 2015 Issue 89

Goldman Sachs does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. For Reg AC certification and other important disclosures, see the Disclosure Appendix, or go to www.gs.com/research/hedge.html. Analysts employed by non-US affiliates are not registered/qualified as research analysts with FINRA in the U.S.

Goldman Sachs Global Investment Research 2

Fortnightly Thoughts Issue 89

When big market share shifts occur, the investment opportunity is large. The cause of a large market share shift (and sometimes extinction) is a shift in a product’s attractiveness in terms of one or more of the following factors: cost, capability and convenience. All three are sources of competitive advantage, but in our view convenience receives insufficient attention, primarily because it is hard to measure (not everything that counts can be counted). But this is wrong, as convenience matters, and often a great deal. Netflix put Blockbuster out of business because a large part of the shift in the relative attractiveness of their products was down to convenience. Why does this matter now? Because technology is massively increasing the potential for improved convenience and expectations, especially from younger consumers who not only demand it, but take it for granted. Well-funded start-ups are taking aim at inconvenience (high friction costs or complexity) and are seeking to turn industries upside down as they launch products that are better on at least one, if not more, of the three Cs. Consider Uber and Instacart or many of the other so-called unicorns; cost and convenience are core to their offering. With the marginal cost of providing convenience in areas like media, payments and retail are falling so rapidly, unless an incumbent is protected by regulation, complexity and friction will leave it vulnerable to market share loss. In this essay, we explore where inconvenience has been shattered (and the investment consequences), where it is being addressed now, and where we see pain points waiting resolution (and who is at risk from that).

Re-writing rules

The classic marketing textbooks state that sellers can essentially aim for one or more of these selling propositions: form utility (making the product available in the format that suits the customer best; e.g. IKEA’s flat packs, ready-to-eat packaged food), time utility (ensuring product availability when the customer requires it; e.g. late-night pharmacies), place utility (ensuring product availability where the customer requires it; e.g. ATMs, convenience stores, batteries) and possession utility (allowing consumers to do as they please with the product once they have bought it). However, the online-driven on-demand economy has redefined most of these rules; the ability to pause the TV show on your tablet to finish ordering groceries at 11 pm for next-day door delivery ticks so many convenience boxes. It’s similarly hard to put many of the new-age convenience competitors in just one of these utility baskets.

Cheque mate Number of transactions by cheques and cards in billions, G7 countries

Note: Does not include Japan’s card transactions in 2013 owing to lack of data. Source: BIS.

Uber convenientShare of total paid car rides for business users, US

Source: Certify SpendSmart Report 1Q15

Uber is a solution to uncertainty around the availability of transport, both in terms of time and location. It also provides a much more convenient alternative to owning a car. It tips the scale towards access and away from ownership. And these attributes are fuelling the proliferation of the Uber-business model across various new apps for all sorts of chores and tasks, including cleaning, shopping, laundry and other household chores (think handy.com, instacart or hassle.com). This is the democratisation of convenience. Then there are attempts to reduce the time spent on the act of purchasing itself: Amazon’s one-click purchase options or even its (still beta) Dash button, NFC-based payments (and ApplePay) and mobile ordering apps for Starbucks or Domino’s are all successful examples of eliminating those few seconds of hassle that might put a customer off, even after he or she has made the purchasing decision. Underestimating how even the most marginal improvement to the buying process can influence consumer spending and brand perception can be a mistake that is hard to recover from. There’s a subtle message here: only when the new product arrives did you realise that the old one was inconvenient.

Another way of saving consumer’s time and hassle is by aiding decision making, providing all the necessary information and options in one place. By this, we are referring to aggregators and marketplaces (eBay and Amazon etc.), review sites (like Yelp.com and Tripadvisor.com), marketplace/platforms (like JustEat and Etsy) and comparison sites (like Skyscanner and Priceline); they are all attempting to simplify and reduce the effort needed to search, sift and choose. These companies all have one thing in common - they have taken share from the previous way of purchasing, with high street retail’s woes being the obvious consequence. We have written previously about the stealthy, but meaningful shift taking place from reactive to pre-emptive online recommendations and services; i.e. the difference between having to search out what the weather’s doing and devices now advising users proactively to take an umbrella to their next appointment. As devices become smarter and get access to larger and more diverse datasets, it is easy to imagine them answering more complex queries before we ask them, or making simple decisions for us. Artificial intelligence is a big shift in capability, but it is also shifting convenience – it could scan all of your data and communications and enhance your productivity and decision making at minimal cost.

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At your convenience



Simplifying complexity can be very disruptive to intermediaries that thrive on information asymmetry, i.e. those with hard to replicate expertise or knowledge that gain from friction costs coming from often artificially erected barriers to entry. Where is this happening? Asset management for a start. Start-ups like Nutmeg, WealthFront and Betterment are offering not only a cheaper alternative to traditional asset managers - transparency and convenience are at the core of their pitch (e.g. it takes 10 minutes to open a trading account). The same could happen in fields such as real estate, healthcare, taxation and recruiting. The unravelling of information asymmetry is a topic that we will come back to in the near future, but our point here is that friction costs for consumers often form the revenue pool for an industry, and simplification (and information provision) can put that at risk by increasing convenience in terms of time and effort, as well as reducing cost.

No longer stuck in the middle with you

We’re not heralding the end of intermediaries. But we are arguing that the shift towards convenience requires a different set of enablers and middlemen. For instance, logistics (and last-mile logistics in particular) is the backbone of the on-demand economy. It’s not the basics of being able to deliver, but having the ability to deliver to a specific location at a specific time (and handle returns), which is increasingly becoming the basis of competitiveness for retailers and other consumer service providers. And we need look no further than Amazon to understand the economics of providing convenience and the drive to constantly improve customer service; Amazon’s capex rose from 1% of Wal-Mart’s outlays in 2004 to 40% in 2015. Our point is that competing on convenience, whether via logistics, investment in technology (software and equipment like new point-of-sale terminals) or a rewiring of the supply chain (especially if customisation and speed is part of the offering), can be expensive, and something not every incumbent can afford, especially if it is encumbered by legacy fixed assets.

Delivering convenience to your door step Number of commercial vans registered in the UK

Source: Society of Motor Manufacturers and Traders

Inconvenient truths

So the question to ask is, where is convenience-led competition coming next? We believe it will be where products/services are difficult to access, inconvenient or plain unpopular. In our recent piece on artificial intelligence, we looked at autonomous cars and how they could solve some of the costs and inconveniences of car ownership (being stuck in traffic, parking and driving itself). Wireless charging could be a respite for the average

urban consumer who owns multiple smart devices. And smartwatches are being pitched as an alternative to digging a smartphone out of a bag or pocket. Where else do we see pain points? Applying for visas, opening (and closing) a bank account, completing tax returns. On a broader level however, the three big areas where we think there is scope for easier and more convenient access and services include healthcare, education and financial services, provided regulation allows some existing problems to be solved (or better, if regulators promote greater convenience, e.g. current account portability in the UK). Parts of financial services are already seeing the rise of disruptors (digital payments, peer-to-peer lending, decentralisation via blockchain technology, wealth management, crowdfunding), but education and healthcare have been relatively immune, and this is reflected in the fact that they are the only two components of the DM CPI basket that have consistently become more expensive over time.

Stuck on the roadEstimates of average annual hours wasted in congested traffic

Source: CEBR report, INRIX

Convenience vs. cost vs. content

This also brings up the relationship between convenience and costs, because they tend to go hand in hand; disintermediation or removal of friction naturally brings down costs. However, the convenience aspect is often overlooked, as it is harder to quantify. But it’s not always about costs. Consumers are often willing to pay for that extra bit of convenience; consider no-frills airlines and extra charges for allocated seating.

An extra servingAncillary revenues as a percentage of total for Ryanair

Source: Company data.

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Similar unbundling of pricing could become more conventional in the world of media and entertainment. The optionality to pay for individual channels rather than packages also reveals a lot about viewer choices and preferences. As Benedict Evans of Andreesen Horowitz says on page 6, taking this further would mean providing viewers with the option to pay only for particular TV shows or specific games, repeating a shift similar to that which we saw in the world of music, which unbundled from albums to individual songs.

Change the channel Number of channels receivable and tuned per household in the US

Source: Nielsen.

Marrying differentiated content with convenience (for a reasonable cost) is key for consumer acquisition and retention; Netflix and Amazon Prime’s rising investments in exclusive content, should be taken parallel to moves from the likes of HBO and Dish this year to begin offering over-the-top streaming services to attract viewers that were moving away from cable (especially millennial cord-cutters) or those that never intended to pay for a cable connection. Content is still king, but convenience is queen. On page 11, Drew Borst writes about how the video industry has managed to learn from the music industry’s tale of woe.

See you later Proportion of time-shifted viewing (through TV catch-up services such as BBC iPlayer etc. or by storing on DVRs) of television by age, UK

Source: OFCOM, BARB, network, based on average daily minutes.

The cost of convenience

Convenience often comes at a cost to consumers. We mentioned the four-pronged utility model earlier, and the last of those is possession utility, which refers to providing consumers with the flexibility to use the product as they wish post purchase. Digitisation and portability allow consumers to use data generated or transfer goods purchased (like media), but only as long as they choose to stay in the ecosystem. Apple and Android are perhaps the most obvious examples here, but as technology elongates the reach of sellers beyond the point of sale, and if and when switching costs outweigh the benefits of being in an ecosystem, we think that rights of possession could become more contentious in terms of customer satisfaction (e.g. the inability to export data from one smart device to other platforms, the right to re-sell e-books or passing on songs on iTunes to dependants). Privacy is a related risk worth considering, as convenience for consumers often comes at the cost of giving up personal data such as location or contacts or buying behaviour. A regulatory backlash that limits the use of private data could raise hurdles for many of the new convenience-based business models. Where else have shifts in consumer behaviour turned against convenience? Food consumption is one area where this may be happening; the decline in the demand for canned food, ready meals and breakfast cereals in the US should signify a shift away from convenience towards content.

Consumers are ready to cook Yoy change in per capita sales of canned food and ready meals, US

Source: Euromonitor.

At your convenience

Seeing how the relative attractiveness of products shifts, owing to cost, capability and convenience, is critical to understanding future market share dynamics. The most obvious cause for worry is a company extracting high rents from an inconvenient product. If its protection is regulation, that can change, as can consumer expectations. If its protection lies in industry structure, then it is increasingly possible that a new entrant could arrive from an unexpected quarter with a product that is cheaper, more capable or more convenient. In short, invest in an enabler of convenience (e.g. logistics, aggregators), ecosystem providers (e.g. Apple, Amazon), content providers that also focus on convenience (the likes of Sky, TWC and Disney) and watch carefully for industries where the core offering is yet to be significantly challenged by technology-powered new alternatives (e.g. financial services, healthcare).

In an age of increasing transparency, tolerance of inconvenience will almost certainly diminish, and in an age of abundant capital, it becomes an easy target. And on the next page is how we’ve thought about investing in this.

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Canned/Preserved Food Ready Meals



How to invest in this

Source: Datastream, Goldman Sachs Global Investment Research. * On the relevant regional Conviction List. Prices as of May 19, 2015. All target price horizons are 12 months except Ocado and Zalando at 2 years.

CompanyCountry/

SectorRating

Market Cap

($mn)

Last

Price

Target

PriceUpside Rationale

Ease of purchase/ delivery

AmazonUS

InternetBuy* 196,537 $422 $510 21%

Pioneer of one day deliveries; new offerings like Echo (voice driven device that can

add products to cart, control smart devices) and Dash (a simple button that reorders

products when pressed) simplify buying process

OcadoUK

RetailBuy* 3,409 380p 700p 84%

Making grocery shopping more convenient with deliveries at suitable times; online

grocery is still nascent (5% of total in the UK), but Ocado has grown sales at 5x the

listed 3 supermarkets during '08‐14

Zillow

Group

US

InternetBuy 6,154 $97 $127 31% US real estate aggregator with 100mn+ properties registered on its platform

Ease of product use

AppleUS

HardwareBuy 749,499 $130 $163 25%

Relentless focus on simplicity is at the core of its platforms and offerings are designed

to work together seamlessly. Apple Pay also gaining traction and brings ease of use

and increased security features

StarbucksUS

RestaurantsBuy* 78,487 $51 $57 11%

Mobile ordering app fast gaining traction, allows people to save time by bypassing

the line and have the food/drink ready; (3% of total observed transactions came

through the app in just one month of launch)

MedtronicUS

MedTechBuy 115,764 $78 $90 15%

Its insulin pump automatically adjusts insulin delivery based on constantly monitored

glucose readings and reduces the need for multiple injections

Location‐based convenience

Seven & I

Holdings

Japan

RetailBuy 38,816 ¥5244 ¥5500 5% Operates 7‐Eleven, the world’s largest chain of convenience stores

CP ALLAsia

RetailBuy* 12,562 Bt47 Bt50.75 9%

Benefits from the structural growth of convenience stores in Thailand, offers superior

returns being the market leader

Oki ElectricJapan

ElectronicsBuy 1,864 ¥259 ¥300 16%

Makes ATMs; benefits from greater installation of foreign‐card compatible ATMs and

cash recyclers (both accept deposits and dispense cash, thus simplify cash handling

for stores) in Japan

Content marries convenience

NetflixUS

InternetBuy 38,608 $616 $620 0.6%

Benefits from a strong momentum behind its original and exclusive content (House of

Cards, Unbreakable Kimmy Schmidt, The Fall etc.) and expansion of the distribution

system across connected devices and networks

SkyUK

MediaNeutral 29,605 1090p 1200p 10%

Unique content (premier league, HBO partnership) on multiple platforms (apps to

allow viewing on the go, catch up services and downloading) is improving customer

satisfaction and reducing churn

ZalandoEurope

InternetBuy* 7,897 €29 €40 38%

Early mover in offering convenience of online shopping to German customers; now

focussing on content and personalisation (launching curated shopping to drive higher

customer engagement) to sustain leadership



Benedict Evans is a partner at Andreessen Horowitz. As a long-time mobile analyst, Benedict has been working in the media and technology industries for 15 years. He first entered the industry as a sell-side equity analyst for investment banks before moving on to strategy and business development roles at Orange, Channel 4 and NBC Universal. Benedict writes about and discusses strategic and operating issues around consumer technology, ecosystems and mobile platform on his blog, and on Twitter @BenedictEvans.

The internet and smartphone revolution has made many things much easier and more accessible for consumers. How do you see this evolving?

One of the fundamental changes we are witnessing as a result of smartphones is a move from one device per household to one device per person, while at the same time we are moving away from being confined to a particular location (say your living room)

to having the device with you everywhere you go. And as we move from the relatively simple interaction model of desktops, to the much more sophisticated environment of smartphones, the possibilities around customer engagement are changing too. There is also a multiplier effect as people do a lot more things much more frequently on a smartphone than those who are online only on the web. And this in turn creates a broader set of digital content. Companies such as Google and Facebook for instance can know exactly where you are, whether you are walking or standing still, who your friends are, when your next meeting is etc., and they can target their offerings based on all of that information.

Of course the locational advantage of smartphones offers convenience to customers as well. The only thing that people could do in bed earlier was watch TV or read a physical book before going to sleep, but by making it possible to read or watch anything anywhere, tablets and smartphones have changed the nature of competition for most media-focused business.

Many of these start-ups that start off trying to solve a relatively small problem, end up creating a completely new product or service and eventually end up fundamentally transforming the way industries operate, instead of just taking some share away from incumbents

The other thing that grows as we move content to the digital world is the scope for greater unbundling. And this in turn changes the selection behaviour that people exhibit while buying products and services. This is evident in music; the ability to buy standalone tracks has changed the industry. I believe that the impact of unbundling will soon become evident in the TV domain as well. And this will prove to be a much more interesting phase of unbundling because it’s not just going to be about unbundling channels from cable boxes, but also unbundling individual TV shows as independent brands. Once that happens, each show will have to compete on its own merits and brand value.

This also relates to the distribution channel, which hugely influences consumer decisions; take what has happened in apparel for example. The amount of stock retailers can hold and the way they display it significantly affects the implicit and explicit choices consumers make. And so, the decision criteria and buying behaviour of people is completely different on the web and even more so on smartphones, given that they make it even more convenient for people to see the product, add it to a list, find out more about it, and buy it anywhere, anytime. Books, I think, are a great example here; books that are bought online tend to be very different from books that are bought at bookshops.

Many of these solutions to inconveniences are driven by new entrants. At your firm, do you see this often when entrepreneurs come to pitch their ideas?

This is a common element to a lot of successful start-ups. Pretty much everyone who comes to us with a good idea is usually trying to solve a problem or attack a pain point for consumers.

The other strand here is that many successful start-ups emerge to tackle local inconveniences and then realise that the solutions can be generalised globally. For example, the lack of good taxi services in San Francisco was one of the main reasons for Uber to emerge here and I think it is unlikely that we would have seen someone in New York or London come up with a service like Uber, simply because there wasn’t a similarly big enough need for it.

And it doesn’t stop there. Many of these start-ups that start off trying to solve a relatively small problem, end up creating a completely new product or service and eventually end up fundamentally transforming the way industries operate, instead of just taking some share away from incumbents. If we look at Uber again, it is not only taking share from traditional taxi businesses, but it is also challenging the entire concept of owning a car. Airbnb similarly is threatening the hotel industry, without actually owning any hotels.

And that is where the market opportunity lies. Many legacy business, whether taxis or hotels, exist to due to some historical logistical issue. When these industries were born they were trying to solve other types of problems. But if we shift these services to an entirely new digital platform, then the underlying problems might change and the solutions need to change too. If you look at the magazine industry for example, recommendation was one of the key leverage points for their business, and they thought it was unlikely that independent blogs and new entities on the internet could seriously threaten that strength. But the incumbents were running their businesses like a manufacturing company, in terms of how they priced and sold their product. On those same terms, internet-based companies could run their businesses like light manufacturing businesses (lower cost, greater flexibility) and that caused them most damage.

Interview with...Benedict Evans



What about new products like smartwatches? Does the Apple Watch actually address a genuine pain point and so will it be widely used in the future?

With respect to the Apple Watch in particular, I think it is positioned more as a pleasure product that gives people a new experience rather than something that necessarily targets a specific problem. But the deeper point to be kept in mind here is that when a consumer product or device is in its early stages of development, most people often underestimate the problems it can address or how it can make life easier in the future, especially as it evolves into a better product and becomes more economical. When cars didn’t exist, it didn’t seem like people needed them.

Back in 1980, when a not so powerful, black and white computer sold for US$5,000, a lot of people had doubts if (a) it would ever get better and cheaper, and (b) even assuming it did, if would anyone want to use it. The same is true for mobile phones 20 years back. No one really thought then that heavy US$1,000 devices would some day be this cheap and shrink to the size of playing cards. When trying to find the total addressable market for phones back then, many analysts would have looked at demographics, number of business travellers and similar factors. Even the most optimistic analysts would have arrived at a market size estimate that is much lower than what it is today. Even if they believed that phones would become extremely cheap, it would have required a huge mental leap for someone to conclude that everyone in the world would eventually own a phone some day. But that’s exactly where we seem to be headed. The tablet and PC market is similarly set to top a billion units in sales. Now obviously, not every new tech product will find that big a market. I don’t think everyone will have a smartwatch in future, even if they became really cheap, but the point I’m trying to make is that it is still very hard for people to realise how widely accepted new tech products can be in the future.

Do you think there is a risk that added convenience comes at the expense of privacy, and that at some point we may see some backlash against it?

There are a few things about privacy that are important to understand. Firstly, the attitude towards privacy risks varies a lot by countries. Germans on average care about personal data and privacy much more than Americans, and this stems from the country’s culture and political history. And Americans in turn care about privacy more than the British.

Secondly, concerns around privacy also differ by the value proposition of products and the core promise of the brand in consideration. Banks for example inherently know the financial status of their customers and phone companies know about their location. This has always been true and acceptable in the physical world, but consumers at times get more sceptical about online privacy. Not all of those concerns are entirely rational. And that really hurts brand image. Once consumers are angry about their privacy being violated, they don’t go back. And that is why, I think, people use multiple social networks and messaging platforms. Facebook has positioned itself as a medium where nothing can be guaranteed to be private and that positioning has meant that many users don’t use it for private messages.

Also, while the subset of people who feel that privacy should be a big concern for everyone is an extremely vocal one, a much larger

proportion of people are actually more or less indifferent to online privacy of personal data, or have already adjusted their behaviour based on data privacy concerns. Of course, there is another subset of people who don’t know the risks at all. But in general, most users now realise that Google knows what they search for and are more or less ok with it. The continuously rising amount of content that people are sharing on Facebook is another tangible metric that shows that the level of concern that people hold for their data privacy online is often exaggerated. Many surveys around the topic further exaggerate the perception of data privacy concerns, but in reality, those survey results are often significantly influenced by the way questions were framed.

When a consumer product or device is in its early stages of development, most people often underestimate the problems it can address or how it can make life easier in the future, especially as it evolves into a better product and becomes more economical

Which companies do you think are consistently good at coming up with convenient offerings for their customers?

A facile answer to give here would be Silicon Valley, because as an ecosystem it consistently comes up with more and more convenient offerings. But if we need to identify companies, I’d say that Apple, Google, Facebook and Amazon are the four companies that have built exceptional platforms that allow them to deliver their services in a consistent way to users, and it is extremely tough to constantly come up with a flow of innovative, delightful products like they have. But, while all of them are extremely good at their core businesses, they are not so good when it comes to things outside their core competencies.

In essence, Amazon is the world’s biggest warehouse with a very good search engine, but a customer doesn’t necessarily discover anything new on Amazon if he or she didn’t know what to look for. Similarly, Google is excellent at things that fit into its data engine, but the company hasn’t been very successful at areas that don’t fit into its model, and this is evident in most of the challenges that Google has faced. Facebook similarly has been very good at surfing user behaviour, but not that good at shaping it.

And we have seen that happen repeatedly – Facebook has tried many times to get subscribers to use the social network in a certain way, but it has rarely worked in the first attempt. But, then again, Facebook has been very good at tracking and recognising what people didn’t like and adapting accordingly. And finally, Apple is extremely good at creating hardware that delights people, but it isn’t very good at, say artificial intelligence and other services. We could argue that this is a deliberate choice that Apple has made, given that it can use something like Google for expertise in areas like AI. But the broader point remains that all these four companies are have all struggled to replicate their success in their core businesses anywhere else.

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Bill Shope, our IT Hardware analyst, on how Apple’s focus on simplicity and ease of use has driven the company’s financial success

We have long argued that one cannot simply attribute Apple’s financial success to its seemingly uncanny ability to produce a sustained string of hit products. More accurately, we believe that knowledge of the company’s platform model is the key to understanding its story and the economics behind its success. One of the critical components of Apple’s platform differentiation has been its relentless focus on simplicity and “ease of use.” While the technology behind Apple’s products is far from simple, the company relentlessly pares down unnecessary bells and whistles so that users aren’t overburdened with the complexity that so often accompanies “feature creep” in consumer electronics. In addition, the company leverages sophisticated software to ensure that its devices can all seamlessly work together. All of this tends to make it very convenient to integrate Apple devices into a consumer’s daily life, and over time, it can be remarkably inconvenient to abandon the Apple platform.

On the one hand, some would argue that “ease of use” robs users of the ability to deeply customise their user experience, and Apple’s competitors often boast of offering customers a broader feature set. However, we believe that Apple’s focus on fine-tuning its hardware and software into a system that the casual user can master without an instruction manual has endeared it to the average consumer and allowed its premium-priced products to penetrate the mass market at a surprisingly rapid pace. Apple’s design theory is hinged on concision: the company spends quite a bit of time deciding what features and components are absolutely necessary, and then eliminates all others. From a hardware standpoint, Apple packs a remarkable amount of technology into its compactly-sized devices (perhaps the new 13.1mm-thick MacBook best exemplifies this). Nevertheless, software is responsible for the true ease-of-use within Apple’s product portfolio: from the most granular elements of iOS (an increasingly simplified and standardized UI) to the broadest (iCloud and Apple ID), software allows Apple’s entire product portfolio to work together in an inimitably unified manner. When an Apple user purchases a new iPhone, for example, everything—from contacts to media to preferences and more—seamlessly transitions from the prior device with little effort.

As Apple’s product portfolio expands, with Macs, the iPod, the iPhone, the iPad, and now the Watch, the company continues to focus on ensuring a convenient user experience. With iOS 8, launched in October, Apple introduced “Continuity,” a service that allows a user’s iPhone, iPad and Mac to work together in new ways; one example of this would be that a user can start writing an email on an iPad and then quickly resume this activity on a Mac. On the Apple Watch, “Glances”, one of Apple design chief Jony Ive’s favorite features, is a service that delivers real-time information like weather, stock quotes and upcoming calendar events, without requiring the user to open an app or take out an iPhone. At our Technology and Internet Conference in February, Tim Cook noted that one of the advantages of the Watch is that users can check sports scores or read text messages without needing to take out their phones at the dinner table.

The “convenience factor” of Apple’s products is not only key to helping it attract new users, but it is also a key driver of the user loyalty behind its powerful platform model: Apple’s devices and services work together seamlessly and the addition of non-Apple products to this ecosystem can dramatically raise complexity, effectively raising switching costs for iOS users. Indeed, we tested this theory two years ago when we switched a real iPhone user to a Samsung S4 Galaxy (see our Switching from the iPhone to Android: how hard can it be? dated June 19, 2013), and, in brief, we found the switch to be painfully inconvenient. Indeed, after painstakingly transferring apps, calendars and multimedia content, it was still necessary to keep an active iTunes account and Apple-supported consumption device (iPad, Apple TV, Mac, etc.) in order to access our purchased TV shows, movies, and even some DRM-protected songs. We believe that these switching costs remain the key reason behind iOS loyalty, and this dynamic is what differentiates Apple from traditional IT hardware companies, who often struggle with the forces of commoditisation.

That’s been one of my mantras — focus and simplicity. Simple can be harder than complex: You have to work hard to get your thinking clean to make it simple. But it’s worth it in the end because once you get there, you can move mountains – Steve Jobs

Moreover, we have conducted consumer surveys to understand the sources of platform differentiation for smartphones and tablets, and the data generally favoured our argument that Apple’s ease-of-use drives platform stickiness. In a late 2012 survey of over 1,000 smartphone users, we found that once a smartphone manufacturer gains a subscriber, the likelihood of retaining that user is high given the lock-in through familiarity and the inconvenience and cost of switching devices and/or platforms. To illustrate this point, we gave respondents the opportunity to indicate that their phone’s ecosystem did not matter to them, and only 14% did so. Key reasons why users wanted to stick to their existing smartphone manufacturer included: (1) familiarity with how the device works; (2) an unwillingness to repurchase apps; and (3) a lack of desire to move photos, music, videos, or e-books (see Clash of the Titans dated December 7, 2012 for more detail).

Without question, the obvious negative to Apple’s ease-of-use is that iOS users can become heavily dependent on and locked into its platform. Nonetheless, we believe the benefits of Apple’s simplicity far outweigh the costs, and Apple’s continued installed base growth appears to support this contention.

Bill Shope, CFA

IT Hardware analyst

email: [email protected] Goldman, Sachs & CoTel: 1-212-902-6834

Convenience: Apple’s core



Vighnesh Padiachy, our European Media analyst, delves into Sky’s initiatives

Sky embracing connectivity - a win/win scenario

There are areas in media in which strong content, aligned with improving customer functionality, can lead to benefits for both the consumer and for corporates. In the UK triple-play market, Sky is beginning to reap the benefits of offering its customers a wide range of content on multiple platforms. It now has over seven million connected set top boxes, and an array of apps which allow consumers to watch linear television, use a PVR, access catch up services, download movies or box sets and watch content on the go (either by streaming or by downloading). Since it has embraced connectivity, churn has reduced to levels last seen in 2005, while customer satisfaction levels have improved and TV additions have been at their highest since 2006.

Sky has seen strong connected box growth… Internet connected Sky + HD homes (fiscal quarters; ‘000)


A high level of content differentiation is key

Sky's ownership of unique content is a strategic differentiator against the backdrop of a converging market in the UK. It has a strong position in sports, with its Premier League rights renewed until mid-2019. It has also built a competitive advantage in Entertainment (exclusive HBO partner until 2020/ output deals with all six major studios) and through original content production (c.£600 mn spend per annum).

While Sky Sports 1&2 are obligated to be wholesaled (in standard definition), and movies are available ubiquitously, Sky Atlantic is only available on Sky products. The Sky Atlantic channel features HBO content such as Game of Thrones and Sky's own commissions such as Fortitude. In this area, Sky has a high level of content differentiation and it has seen the biggest drop in churn by package over the last few quarters.

Content and convenience driving down churn and improving customer satisfaction

Sky is allowing its customers to access this content through multiple distribution forms. Some seven million customers (60% of the base) are now connected, leading to higher loyalty and increased consumption. In 2Q 2015 churn at 9.2% was the lowest in a decade. Growth in pay TV additions was the highest in nine years, helped by the growth of Now TV, a cheaper online product which competes with Netflix in the UK.

Sky's strong grip on premium content and its connected base provides it with a feedback loop to:

take price where content is most in demand; create the content which consumers download the most; target those customers most at risk of churning; and segment its customer base more effectively.

… and now has the largest installed base Three-year connected box growth for Sky, VM and BT (mn)


Driving incremental revenue streams

The connected box is allowing Sky to drive new revenue streams such as Sky Store Rental, Buy and Keep and box sets:

Box Sets: An entirely new product developed for On Demand and Sky Go. It is available to over five million customers and Sky has 50% more content than its nearest rivals. In FY 2014 box sets added 450k new customers and helped to lower Family Bundle churn by 500 bp yoy. With strong usage and improved customer satisfaction, Sky intends to increase prices from this June for box sets by £1 per month.

Contributing to a 30-fold increase in downloads Sky+ weekly downloads of content (mn)


The next step is to move box sets to a premium service and Sky is likely to invest in quality titles and new features.

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Movies on demand is rejuvenating the movie service with over 1,000 movies offered on demand. Some three quarters of the movie base is now connected and this is leading to increased consumption. In September 2014, Sky added 50p to movie prices, the first price rise for movies in three years.

In addition Sky Store offers movies to buy and rent. Sky has c.1,600 movies to buy and rent and has plans to increase this total to c.4,500.

Connected boxes have allowed Sky to launch a buy and keep movie service. Consumers can buy a movie in digital form and received a physical copy in the post. This opens up the £1.4 bn movie purchase market to Sky. The physical rental market is worth another c.£180 mn in the UK (as of 2014).

In 1H 2015, Sky Store revenues were up 90% from a low base with 2.7 mn customers transacting. Some 24% of buy and keep customers had not purchased a movie in the last 12 months. Decipher analysis also shows that Sky regularly ranks as the number one or two digital retailer for new releases.

In 2015/16 Sky intends to extend the buy and keep service to a variety of other connected boxes. Box sets and TV shows will also be added to the service.

Sky Go is increasing customer engagement. Registered households are now at 5.8 mn (54% of the base). On demand views have increased threefold since December 2011. Sky Go Extra allows over 1.5 mn customers to download products and watch portably (on up to four devices) at an additional cost of £5 per month.

SkyGo registered households are up 142% in three yearsRegistered households (mn)


While we are at a relatively early point in this innovation, we believe that this strategy is likely to succeed. It is an example of an incumbent leveraging technology to benefit both its users and itself. It also highlights the ever increasing demand for high-quality video content.

Fewer leaving SkySky churn (quarterly annualised, 1993-2015E)

Source: Company data, Goldman Sachs Global Investment Research.

We believe that there are three factors required to implement such a strategy:

1. Exclusive and differentiated content;

2. A connected customer base. It may well be that a connected and converged set top box has greater functionality and use before TV services move directly onto the cloud; and,

3. An innovative mindset. Sky's connected strategy is giving it a valuable feedback loop. There was a risk that NOW TV, which competes with Netflix UK, could have cannibalised Sky's traditional pay service. Instead It has helped Sky segment the market and create new revenue streams - for example in the last three quarters some one million sports passes were purchased - a revenue stream which comes at a high incremental margin.

Vighnesh Padiachy

European Media analyst

email: [email protected] Goldman Sachs InternationalTel: 44-20-7774-1857

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Drew Borst, our US Media & Entertainment analyst, argues that the internet has reshaped the landscape of the industry

Content and convenience

Internet connectivity combined with modern devices (e.g., smartphones, tablets, smart TVs) that feature once unimaginable processing power, form-factor and connectivity, have ushered in an unprecedented era of access and convenience for consumers. Many of these advanced devices are now meaningfully scaled, including smartphones with 75% penetration, DVRs at 49% and tablets at 48% (see exhibit).

Smarter households US household penetration

Note: smartphone penetration is a function of total mobile phone subs. Source: Nielsen.

For the media and entertainment industry, the internet and connected devices have reshaped the landscape. For starters, the barriers to entry have been dramatically reduced, by eliminating the chokepoints that existed when entertainment production and distribution was controlled by a handful of corporate gatekeepers and (yes) media moguls. The migration of media from a packaged, physical format to a digital one has made entertainment more

readily and easily accessible to consumers. Of course, lower barriers to entry have predictably translated into new entrants and increased competition.

This increased competition has supercharged the fragmentation of audiences, pressuring advertising business models. At the same time, subscription business models have been more difficult to establish online, thanks, in some measure, to online piracy and the difficulty of competing against free. Another factor, albeit less direct, is the seemingly limitless pool of capital available to fund disruptive start-ups, based on valuations derived from metrics nowhere to be found on standard-issue financial statements (e.g., unique visitors, total addressable market). But, this is a topic entirely unto itself. The simple fact of the matter is that the availability of entertainment content has exploded online. From US$300 mn professionally produced films to 10-second clips of burping babies, and everything in between, consumers have never had so much entertainment content, literally, at their fingertips.

The consumption data demonstrates that consumers have thoroughly embraced this brave new entertainment world. The challenge for incumbent entertainment and media companies, in addition to fending off these new competitors, is to harness this consumption in a manner that is at once profitable and additive to existing profits. On this point, the music industry serves as the ultimate cautionary tale for the broader entertainment industry.

Music Industry: The reluctant digital pioneer

The music industry was the first entertainment business to confront the digital transition, although it was not exactly a willing pioneer. Rather, it was thrust into this role as a matter of survival, as it grappled with the rapid rise of online piracy in the early 2000s.

The music industry was incredibly slow to respond to the digital transition. Napster, the original music piracy site, burst onto the scene in 1999, but it wasn’t until 2004 when Apple iTunes debuted that consumers grew more and more primed to free music.

This was a serious error and haunted the music industry for years thereafter, costing the industry multi-billions in annual sales. The rest of the entertainment industry has taken note and, as a result, all other entertainment sectors, including video, have been comparatively quick to embrace digital distribution.

The ‘90s scene… US music sales (US$ mn)

…doesn’t exist anymore US music – songs sold (in million)

Source: MPAA. Source: MPAA.

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Tuning into convenience



The music industry, rather than focusing on a legal digital download service, initially focused all its effort on shutting down Napster by way of a copyright infringement lawsuit. Ultimately, the industry prevailed and the courts shut down Napster in mid-2001; however, this was a pyrrhic victory. By the time Napster was shut down, the pirates had moved on to the next new thing: decentralized peer-to-peer file sharing, led by Gnutella. Unlike Napster, these piracy sites were virtually impossible to shut down because there was no central server storing the files. Shutting down Gnutella would have been tantamount to shutting down the entire internet.

In addition to the failure to launch a legal alternative to the pirate sites, the music industry was, understandably, paralysed by its fear of album unbundling. Piracy had given consumers a taste for singles and there was no going back to albums.

Against this backdrop of piracy and absent a legal digital alternative, music sales plummeted. From a peak of nearly US$15 bn in 1999, US music sales declined cumulatively by 15% to US$12 bn in 2003 (previous exhibit). The decline in song units (assuming 10 songs per album) was even more dramatic, declining by 29% cumulatively to 7.7 bn over the same time. Little did the industry know that this was only the beginning of the decline. By 2004, the music industry was in dire straits. Physical sales were in free fall and its own efforts to launch a digital download service were failing. Apple, with the dominant digital music player and superior software engineering skills, was a perfect partner (nay, savior) for the music industry, with Steve Jobs Achieving a very consumer-friendly retail price of US$0.99 per song and a wholesale price of US$0.70. This wholesale price was, in effect, a 30% price reduction from the implicit price per song on a physical album (i.e., US$10 album wholesale price, 10 songs per album).

After a small bump in sales in 2004 from the launch of iTunes, the declines resumed as the double whammy of album unbundling and a 30% wholesale price cut took its toll. From 2004 to 2014, US music unit and dollar sales declined cumulatively by another 50%, erasing US$5 bn in annual sales.

There is no rest for the weary, and the music industry is already confronting another digital transition, call it digital transition 2.0, in the form of online streaming. Song sales stabilised from 2010 to 2012, but have since resumed declining as music demand is now shifting from digital downloads (ownership) to online streaming (rentals), such as Pandora.

Home entertainment: Benefiting from music’s misfortune

The digital transition for the home video market, which was once dominated by thousands of Blockbuster video stores dotted across the country, has been comparatively smooth, although far from painless. The US home video market totalled nearly US$18 bn in retail sales in 2014. While this is 18% below the 2004 peak of US$22 bn, this is mild in comparison to the music industry.

Over the past 15 years the US home entertainment market has actually gone through two distinct transitions. First was the transition from physical rentals to physical ownership, starting in the late 1990s. In 1999, rentals totalled US$13 bn in retail sales, and accounted for 91% of the US home video market. Then, DVDs took over, benefiting from: (1) a step function improvement in technology over VHS (i.e., picture resolution, durability, and form factor); (2) attractive retail pricing for ownership; and (3) a favourable US economic backdrop. By 2006, rental sales accounted for only 20% of the market, with US$4 bn in annual sales, while DVD purchases, in less than eight years, had skyrocketed to nearly US$17 bn annually, accounting for 77% of the market.

What are they spending on?US home entertainment spend, Bn USD

Source: Digital Entertainment Group, SNL Kagan.

The second home video transition was actually two transitions wrapped into one; home video moved from physical to digital and transitioned back to rentals from ownership. At the DVD peak in 2006, digital sales totalled US$1 bn or 5% of the market but by 2014 totalled US$7.6 bn or 42% of the market. Included in digital is subscription video on-demand (SVOD), such as Netflix, which totals US$4.8 bn. Meanwhile, DVD sales plummeted by nearly 60% to US$7 bn in 2014 and, for the first time ever, were eclipsed by digital sales. Looking at the market through an alternate lens, the proportion of sales from ownership declined from 77% in 2006 to 48% in 2014 as SVOD consumption displaced DVD purchases.

As rental prices are generally lower than purchase, retail sales understate the significance of this shift. Since 2008, US home video unit demand has contracted cumulatively by 35% to 2.3 bn in 2014 as ownership and rentals have each declined by more than 30% (exhibit below). However, this data excludes SVOD, which has limited disclosure on unit consumption. However, based on what we know about Netflix consumption, the rise in Netflix streaming easily explains the unit decline in home entertainment.

Fewer trips to the DVD storeHome video units (in millions)


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Netflix disclosed that in 1Q15 cumulative global streaming on its service was 10 bn hours, which equates to average viewing per subscriber of nearly two hours per day. This figure has doubled since 2011, as the content library has continued expanding, and now includes multiple original series. Assuming that US subscriber consumption is consistent with this global average, this stat implies annualised consumption among US subscribers of nearly 27 bn hours. If we convert this consumption into home video units by crudely assuming 1.5 hours of content per for home video unit, it would equate to 18 bn units. In other words, the 1.2 bn decline in home video units from 2008 to 2014 equates to only 7% of current Netflix streaming consumption.

Of course, this is an “apple-and-orange” comparison, but it does illustrate that the underlying consumer demand for home video demand has expanded rather meaningfully, despite the top-line decline in home video sales, thanks to digital technology. That said, this notion of demand up meaningfully and sales down, reinforces the earlier point about the challenges for the incumbent entertainment companies of growing, or at least defending, profit streams.

Television: Embracing digital to drive consumption

Home video is clearly not the only entertainment sector impacted by SVOD. Television is another sector that appears vulnerable to share loss to Netflix. Sure enough, average daily consumption of traditional (live) TV is down 5%, or 14 minutes per day, since 2011 (Exhibit below). Nearly half of this decline is attributable to consumption shifting to DVRs. The other half is a shift to multimedia devices, such as Apple TV and Roku, where Netflix is undoubtedly one of the most popular apps. Even among this shifting consumption, the total pie of video consumption has still increased by 2% or five minutes per day per user.

Times are changing Average daily consumption (in minutes)


The most active consumers of online video are among the most active consumers of all forms of video. Some of this is due to the expansion in connected devices that enable video watching at times and in places where, in bygone days, it was not even possible. According to Nielsen, the top quintile of online video streamers averages 23 minutes of online video viewing per day, 63 minutes surfing the internet and 262 minutes watching television. What is fascinating about this statistic is that the average daily TV consumption among this very top quintile of online streamers is actually 3% higher than the TV viewing for non-streamers and 4% higher than the TV viewing for the overall population (exhibit below). The biggest online video streamers not only watch more video online than everyone else, but they also watch more TV than everyone else. They are true super video consumers.

Binge watchingAverage daily consumption (in minutes)

Source: Nielsen.

The video industry has clearly learned from the music industry’s tale of woe

By embracing digital distribution, the video industry has avoided some (though not all) of the pitfalls that plagued the music industry more than a decade ago. The good news for the video industry, writ large, is that consumer demand for its products has never been higher and that is always, no matter the business, a mandatory prerequisite for profit growth. Some pundits think the video industry is too eager and its digital strategies are undermining long-standing business models and profit pools. For instance, how does licensing content to the likes of Netflix impact cable TV subscriptions? This critique, however, seems based on the false premise that the world is static, that technology is not constantly evolving and empowering consumers. Digging in your heels, sticking to the past practices and ignoring the evolving market is not really a business strategy. Just ask the music industry.

Drew Borst

Media & Entertainment analyst

email: [email protected] Goldman, Sachs & Co.Tel: 1-212-902-7906

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TV Online Video Internet



James Schneider and SK Prasad Borra discuss the way we will pay in the future

Convenience drives customer adoption and disruption in payments

In developed markets such as the United States and Western Europe, there has been a substantial shift away from cash and cheques toward electronic payments over the past 20 years. Greater convenience, along with rewards programmes and consumer protection regulations, have stimulated growth in electronic payments globally. In parallel, a number of innovative and disruptive payment vendors have emerged over the past five years, and user adoption has grown dramatically over that period.

Consumer convenience was the driving force behind the growth of payment networks

The need for a system where banks can easily communicate and process credit card transactions gave rise to credit card networks including Visa and MasterCard, which began as bank-owned associations facilitating transaction authorisation, clearing, and settlement among member banks. The card network associations established a number of rules which bind merchants who accept credit cards, in order to ensure universal acceptance of credit cards as a form of payment, as well as the equitable treatment of all banks which are part of the network. Ultimately, these rules were key to the early expansion of credit card acceptance in the United States given the convenience of using electronic payments and the lack of additional charges for doing so (for consumers), the incremental sales (and higher ticket rate per transaction) generated (for merchants), and fees and interest generated from greater consumer credit balances (for issuing banks).

In the US, this system has resulted in a dramatic increase in electronic forms of payment over the past 20 years.

Disruptors promise convenience, lower costs and faster payments

We believe that there is real demand among merchants for many of the services offered by innovators, and think new technologies

being explored by disruptors could lower the cost of payment acceptance. These disruptors seek to lower the cost of payment acceptance for merchants by replacing the existing credit/debit card networks operated by Visa, MasterCard, and AmEx with either existing payment infrastructure (such as ACH) or distributed network technology (such as Bitcoin). Although we think these alternatives have a chance of succeeding, they will have to overcome several disadvantages including less consumer protection, as well as a lack of loyalty and rewards programmes compared with traditional credit/debit card networks.

Banks and payment networks have built a powerful market position, reinforced by tangible benefits for consumers. Importantly, incumbent payment networks are innovating. From enabling mobile payment systems like Apple Pay, Google Wallet, and Samsung Pay to developing merchant analytics platforms like MasterCard Advisors and Visa Transaction Advisors, payment networks are evolving their offerings to make them more competitive with emerging players.

We see the payment networks’ strong market position continuing for the foreseeable future, so long as they remain nimble and innovative. However, we see the opportunity for emerging players to make inroads, particularly outside the US and in emerging markets, where regulatory and cultural dynamics differ.

C2C payments: A fast-moving market with significant disruption potential

Few areas of payment technology are changing as rapidly as consumer-to-consumer transactions, also known as C2C. C2C payments involve consumers directly transacting with each other using technology infrastructure provided mainly by banks. Technology and demographics are shaping C2C payments, with new technologies like “Instant ACH” allowing for real-time transfers between consumer bank accounts, and mobile apps like Venmo and Square Cash being adopted by tech-savvy Millennials for everyday transactions between friends.

We believe C2C payments are most likely to see significant disruption over the next 10 years for several reasons:

Developed markets have high adoption of electronic payments Transactions by payment format

Source: Eurostat.

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Convenience pays



(1) convenience and ease of use; (2) lack of “entrenched” counterparties such as businesses, which are typically much slower to adopt new business processes; (3) lack of “stickiness” for incumbent service providers such as offers and rewards.

Consumers under 35 display a significantly greater willingness to provide personal data in exchange for rewards

Source: Alix Partners.

Today, consumer-to-consumer (C2C) payments represent an estimated US$30 bn in fee revenue, mainly driven by international money remittance. Few, if any, domestic C2C services charge explicit fees (they are embedded in standard consumer banking fees) and thus there is no profit pool to disrupt. However, there is a significant profit pool in international C2C payments and crossborder remittance. New online approaches (like Xoom) plus new technology approaches (like Bitcoin, TransferWise, and Ripple Labs) have the opportunity to disrupt traditional in-person money transfer services provided by Western Union and many large banks. Although Bitcoin and other cryptocurrencies are still in the early stages of development, they could gain traction once clear use cases become more established.

C2C FX vendors reduce transaction costs using a currency marketplace Total cost of sending £1,000 from UK to Germany

Source: TransferWise (survey conducted by Charterhouse Research).

Apple Pay: The convenience of one-touch payments

In September 2014, Apple introduced Apple Pay, its mobile payments service. Apple Pay allows iPhone and Apple Watch users to make one-touch payments for goods and services with their Apple devices at retail locations with NFC enabled terminals. The

solution works with payment and technology incumbents (including networks and banks) to bring ease-of-use and increased security features to consumers, issuers, and merchants. Three months after launch, Apple Pay accounted for more than 65% of contactless payment dollar volume across all payments networks in the US. Over 90% of US credit card issuers, the payment networks, and several merchants have already signed up to support Apple Pay, which we believe signals the early impact Apple Pay is having on the industry. In addition we believe Apple Pay will serve as a slight catalyst for merchant NFC adoption, with many large merchants already accepting Apple Pay payments. We see point of sale (POS) vendor Verifone as the key beneficiary of EMV and NFC adoption in US.

Convenience and distribution strength is creating new payment models in emerging markets

Access to a bank account is one of the most basic needs in DMs such as the US and Western Europe. However, the World Bank estimates that more than 50% of the global population (over the age of 15) does not have access to basic financial services. Non-financial institutions with distribution strength are tapping into the unbanked and under-banked population. Historically, wireless telecom carriers have had a negligible role in payments, but the emergence of mobile as the primary growth channel for payments is creating interesting new opportunities for telcos. Ventures like M-Pesa show the opportunity related to unbanked customers in emerging markets given high mobile penetration rates and its ease of use for consumers. M-Pesa (JV between Vodafone, Safaricom) has over 12.8 million active customers. According to the GSMA, there are 150 live mobile money deployments, and an additional 110 deployments are being planned.

Significant gap between mobile and banking penetration creates attractive opportunities Mobile penetration (%), access to financial services (%)

Source: GSMA Mobile Money Tracker.

James Schneider, Ph.D

Payments and IT Services analyst

email: [email protected] Goldman, Sachs & Co.Tel: 1-917-343-3149

S.K.Prasad Borra

Payments and IT Services analyst

email: [email protected] Goldman, Sachs & Co. Tel: 1-917-343-7293

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Our Japan and Korea Consumer analysts examine how convenience stores are suited to serving Asia’s urban millions

Looking for a way to capitalize on Asia’s growing urban millions? We think convenience stores are an attractive vehicle to take advantage of the theme, with Asia’s convenience store sector entering a dynamic stage of its development – a burgeoning urban population, greater wealth, changing spending consumer habits and a maturing business model are all acting as tailwinds.

Not just your corner shop

In Tokyo, you could happily live without going further afield than your local convenience store. Not only can you buy the usual fare: a drink, chewing gum or cigarettes; you can also get freshly cooked hot food with a cup of fresh-brewed coffee, a new pair of socks, or ready-to-cook vegetables. You can get cash from an ATM, pick up a parcel, pay your bills, buy a movie ticket or make photocopies, 24 hours a day. Convenience stores are veritable treasure troves, 100 square metre stores selling 3,000 odd items to 1,000 people per store per day. There are more than 50,000 convenience stores in Japan, dominated by 7-Eleven, serving 100 mn urbanites, with sales of US$100 bn a year and accounting for a surprisingly high 10% of all retail sales.

Did you know that...? CVS are one of the most resilient retail formats to e-commerce.

Some 70% of items sold at CVS either cannot be bought online or are not online-friendly such as fast food, tobacco and alcohol. As most CVS products have low ASP and offer gross profits below

US$10, they are generally unsuited to online sales.

Lifestyle, climate and development factors to spur growth

Although Japan clearly leads the way, convenience stores have gained popularity in Thailand, Taiwan, and South Korea; and have begun to take root in China. As of 2014, convenience stores’ weighting as percentage of the retail industry is highest in Japan and Thailand at 10%, followed by Taiwan (8%) and Korea (5%). This is generally much higher than in the US (1%) or Europe and we attribute this to:

(1) population density and concentration in urban areas,

(2) relatively high smoking rates making a substantial boost to store footfall, and

(3) local culture and consumer habits, including commuting method (on foot, by bicycle or public transport) and frequency of purchases (i.e. Asian consumers tend to buy small amounts of food and daily essentials rather than the less frequent, larger basket sizes of their European/US counterparts).

That said, this affinity for the CVS format, coupled with increasing wealth, leads us to expect the convenience store format to continue to penetrate the retail sector in Asia.

As shown in the following exhibit, we believe that Thailand, Taiwan and Korea are in the second stage of their CVS development, with prices on a gradual rise, convenience store awareness rising and customer footfall at reasonable levels.

Thailand, Korea and Taiwan CVS entering the second stage of growth… Convenience store development stages

Source: Goldman Sachs Global Investment Research.

Five underlying tailwinds to the industry in Asia to drive US$63 bn in sales by 2020E…

We expect convenience stores in Asia’s cities to almost double their sales, to US$63 bn by 2020, from US$37 bn in 2013. We identify five key secular drivers:

1) Asia’s urban population to grow by 900 mn to 2.8 bn by 2030 (with 350 mn in China, Taiwan, Korea and Thailand).

2) Asian city life is a tailwind with most people still getting around by foot, bicycle, train, bus, train or motorcycle. Convenience stores afford easy access and generally do not require parking lots.

3) Asians set to spend more on “having fun”, and hence more on “eating out”.

4) Resilience to the e-commerce threat with c.70% of items sold in CVS unsuitable for e-commerce. Convenience stores’ average ticket is below US$10, making it difficult for e-commerce providers to cover the cost of delivery (around ¥1,000).

5) Demographic tailwinds include ageing population (i.e. consumers aged 50 and over drove growth in the second half of the 1990s for Japanese convenience stores) and smaller household sizes, with approximately half of households in Japan/Korea/Taiwan and Thailand being one/two person.

Where’s the upside?

There is a wide gap between average daily sales at convenience stores in Japan and those in other Asian markets as illustrated in the following exhibit.

1) Differences in food prices: partly a function of Japan’s relative wealth in GDP per capita so will take more time for other regions to catch up. Another key driver is;

2) Japan’s meaningfully higher fast food and private-brand contribution to sales – 44% in Japan versus 17% in Korea, 25% in Taiwan and 27% in Thailand. We view fast food and private label expansion as crucial to future of CVS growth in these regions, which will require…

3) …major changes to distribution and manufacturing channels. If the CVS can overcome these hurdles, we expect daily sales to increase, convenience stores to play a greater role in the social infrastructure, and the format to establish a solid footing in the overall retail industry.

At your doorstep



Japanese daily sales stand out; showing the way Average daily sales of major CVS chains by market (US$, FY2013)

Note: PSD = Daily sales per store. Source: Company data, Goldman Sachs Global Investment Research.

Mind the gap: Raising the weighting of fast food and private brand sales is the key

In the initial stage of convenience store development in Japan, Seven Eleven’s fast food/private brand ratio (although it had no private brand then) was just 12%, so in the last three decades it has increased the ratio by more than 30 pp. Other Asian convenience store operators are already focusing on this gap and have begun taking steps to increase fast food/private brand sales. We estimate that the fast food/private brand ratio in each of these three markets will rise by around 1 pp annually (in line with Japan’s history). How do we think Korea, Taiwan and Thailand will compare to Japan’s example?

Korea: We believe that Korea’s CVS logistics infrastructure is roughly on a par with Japan’s, but see ample room from for fast food/private brand penetration as the current 17% is one of the lowest in the region. For instance, fresh brewed coffee and desserts/delicatessen is a big, lucrative white space category (vs. 7-11 Japan/Taiwan among the top coffee retailers), which should have positive implications not only for ticket growth and profitability, but also for expanding the CVS consumer base to female and younger customers, hence boosting store traffic.

Taiwan: Logistics remains mostly a three-step process of factory to center to store, but efforts are underway to shift to a two-step process with integrated factory/logistics sites delivering straight to stores. We believe that this will enable operators to reduce delivery times and introduce a three-delivery-a-day system, which should help boost the fast food/private brand ratio.

Thailand: Daily deliveries are possible only to a limited number of stores in the central city, with other stores receiving deliveries only about three times a week, indicating substantial room for improvement. Thailand 7-11 is also rolling out fresh brewed coffee and a private brand delicatessen in 2015, which should help boost the fast food category.

Fast food and private brands are the key to higher ticket and profitability… Average combined fast food/private brand ratio at CVS in Asia (FY2013)

Source: Company data, Korea CVS Association, Goldman Sachs Global Investment Research.

Make sure you plug into the top CVS ideas in the region: Seven & I (Japan), BGF Retail (Korea) and CP All (Thailand)

We cover eight CVS stocks in Asia with three Buy ideas (BGF Retail, CP All and Seven & I).

CP All (CL-Buy; Bt45.5): We believe CP All offers three attractive propositions in one: exposure to the structural growth of convenience stores in Thailand, superior returns as the market leader, and an earnings turnaround story.

BGF Retail (Buy; W135,000): BGF is our preferred convenience store vehicle in Korea given top-quartile returns and double-digit earnings growth out to 2017E.

Seven & I (Buy; Y5,271): Continues to strengthen same-store sales and provide support for franchise stores as it fends off lower-ranked chains. Its position in the sector remains extremely strong in our view, and we expect it to benefit from any industry shakeout in Japan.

Taiwan FamilyMart (Neutral; NT$241): TW FM is catching up with 7-Eleven on higher SSSG and margin expansion thanks to operating leverage and product mix upgrades. We expect it to deliver stronger earnings growth than 7-Eleven in Taiwan. However, Neutral on valuation grounds despite liking its longer-term prospects.

Sho Kawano

Japan Retail & Restaurants analyst

email: [email protected] Goldman Sachs Japan Co., Ltd.Tel: 81-3-6437-9905

Christine Cho

Asia-Pacific Consumer & Retail analyst

email: [email protected] Goldman Sachs (Asia) L.L.C, Seoul Branch.Tel: +82 (2) 3788 1773

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Our European retail & internet analyst Carl Hazeley on how some companies are catching up in online convenience and some first movers are extending their lead

For as long as there have been retailers, they have catered to various consumer needs beyond simply offering merchandise in order to get them shopping. Be it Sears at the turn of the last century, which offered all manner of products in a single place, to luxury brands that offered customers the opportunity to make a statement about their lifestyle or personality. In this context, the shift driven by e-commerce at the turn of this century has been no major surprise. Online businesses, in the first instance, put convenience at the heart of their customer proposition: the ease of shopping at home, more choice, price transparency and home delivery were all important in attracting customers at the expense of offline players. In UK grocery, this has been a source of competitive advantage for Ocado as we discuss later.

In other end-markets, brand, personalised service and product quality remain areas of focus of the customer proposition. Established players have been able to use their heritage (e.g. Hermes in luxury) and brand momentum (e.g. Michael Kors in speciality apparel and accessories) to sustain pricing power even as online has made it easier for new brands to reach customers at scale. In some of the most commoditised sectors, we have seen bifurcation of the incumbents’ performance. For instance, in consumer electronics RadioShack filed for bankruptcy while Dixons faced headwinds leading to its merger with Carphone Warehouse. Conversely in apparel, Next has made significant strides in the online channel; it represents 37% of brand sales. Meanwhile a number of successful first movers online are at the next frontier, using content, aggregation and scale to generate network effect, which could make it tougher for incumbents to catch up, which we will explore

Ocado used convenience to grow faster than offline supermarketsOcado UK grocery revenue growth vs. ‘listed 3’ supermarkets UK growth CY2008-14


Where is just being online enough? Convenience a key factor in UK grocery

Through most of the 19th century, customers would visit their local butcher, baker and other small shops to buy their groceries. The advent of the supermarket in the late 1800s and then the self-service supermarket in the 1950s meant that customers could more conveniently visit a single location for the majority of their grocery

needs. Using the internet, Ocado took this one step further by offering the added convenience of being able to shop home at any time of day, and added service of having your groceries delivered right to your door at a time that suits. The preceding exhibit shows that Ocado has grown revenues by c.5x the rate of the ‘listed 3’ supermarkets through 2008-14, leveraging convenience, price, choice, and service. UK supermarkets were forced to respond, and have developed their own online offerings but online represented only c.5% of UK grocery sales in 2014 illustrating how nascent the shift to online is in the category. By comparison, 2014 online penetration in UK apparel was c.18%.

Where are incumbents responding online? Incumbents catching up as convenience becomes commoditised

While initially slow to adapt to and eventually adopt e-commerce channels than their disruptive, oft leaner, and nimbler online competitors, offline incumbents have in many cases been able to replicate convenience and service through their own online offerings. In some cases, the offline component has in fact been a key contributor improving the customer proposition. For example, Inditex believes Zara has a lower returns rate for online orders than online-only competitors as customers simply return or exchange products in store.

Within apparel, the rise of offline players in online retail has been more pronounced for more commoditised, lower-value goods. For example, Debenhams (60% apparel and accessories) has been relatively successful in developing an online offering, with 19% of UK retail sales online in 2014. For Next, the transition to online was easier because it was able to migrate a captive catalogue / mail order customer base online, giving its e-commerce efforts a scale advantage from inception. Indeed, Next’s online sales were 37% of brand revenues in 2014 and the segment represented 46% of 2014 brand EBIT.

Offline incumbents are catching up with online in apparel Next, Debenhams UK, and Next online sales as a percentage of total retail sales (fiscal years)


Moving up the price ladder, brands such as Ted Baker have been slower to migrate online than their apparel peers mentioned above. Ted’s e-commerce sales were 9% of retail revenues in 2014 from just 1% in 2010. In luxury, online penetration is still mid-single-digit on a global basis. For Burberry, a digital leader in luxury, we estimate online penetration is only c.10%.

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What’s next for retail?



How are incumbents responding offline? Brands using personalisation and content

For brands, e-commerce can expand consumer and category reach, transforming their margin structure, pricing power and significance. One way in which potential brands of the future are well positioned for the new landscape is through a focus on personalisation by leveraging faster supply chains, which may allow for higher price premiums. Made to order and measure products such as Nike ID in sportswear may become more prevalent as brands seek to empower customers with greater control, selection and a bespoke experience. Customised products should mean greater price premiums and faster, more efficient supply chains should lower the cost of production leading to higher profitability.

Personalised product can drive pricing power for brands Price premiums for personalised products


An interesting dynamic has developed in the music industry as it evolves from primarily ownership of content to on-demand access which more convenient, putting pressure on industry revenues.

Falling commoditised music revenues increasing focus on live music? Sales of CDs, cassettes, LP/Eps, subscription & streaming and legal downloads

Source: RIAA, Goldman Sachs Global Investment Research.

One way in which the industry is partially offsetting this is through focusing on live content (concert tours) where the experience on offer is much tougher to disintermediate via online. Compared to the marked decline in music sales shown in the preceding exhibit, through 2007-12 US concert revenues grew 2.4% (global concert revenues grew 0.7%). In 2012 concert tour ticket sales represented 54% of global industry revenues.

How are online players responding? What’s next for online? Content and more convenience…staying ahead through curation, aggregation and network effects

Some online companies have found innovative ways to stay ahead of the competition as the initial attraction of convenience becomes more abundant. For instance, Trunk Club, Enclothed, Lyst and Farfetch are examples of companies which have put product and content curation at the heart of their customer proposition. Customers of Trunk Club and Enclothed input their clothing style and budget preferences and are sent a box of clothes curated by stylists. Here, the convenience element has evolved as customers are offered free returns on whichever items do not suit. Lyst and Farefetch use content curation to differentiate themselves from other online apparel/luxury distributors. Lyst pools roughly 11,500 online stores and designers, while Farfetch gathers approximately 300 luxury fashion boutiques and 1,000 labels.

Aggregation has thus far proven to be a larger barrier to success for new entrants to overcome, partly due to the first mover advantage enjoyed by online players, leading to scale, or due to self-reinforcing network effects which can trump the simple convenience of the online channel on its own. For example, Rightmove has roughly twenty thousand UK real estate agents on its platform vs. Zoopla’s eight thousand, partly owing to the former benefiting from first mover advantage. As a result, Rightmove commanded around four times the page views and around two times the average revenue per advertiser in 2013. By comparison, new entrant On The Market has averaged c.1/16th of Zoopla’s weekly traffic in the 12 weeks since its launch.

JUST EAT has leveraged its aggregation of c.25k takeaway / delivery food restaurants in the UK to generate high organic and direct traffic (61% of orders are on mobile), leading to c.46 mn UK orders in 2014. While the key customer proposition remains centred on convenience (a single hub for multiple restaurants, wide choice, card payment, reviews), the scale of the content (by comparison, the UK #2 player has only c.10k restaurants on its platform) and the network effect it generates has created an ever-growing moat which new entrants and existing competitors will find it increasingly hard to overcome.

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Nike Nike Air Zoom pegasus can cost up to US$135 personalised vs. $100 standard

Adidas running shoes can cost $150 personalised vs. $130 standard

Return to Tiffany charm bracelet with engraving can cost $315 vs. $285 standard

Jaeger LeCoultre Reverso personalised costs $5,300 vs. $4,800 standard

Pandora charm bracelet with engraved charm costs $61vs. $56 standard

Cartier Love ring with engraving costs from $1,175 vs. $1,100 standard

Michael Kors monogrammed tote costs $278 for both personalised and standard

Ralph Lauren Polo shirt costs $85 for both personalised and standard

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Scale drives content, content drives scale Overview of JUST EAT’s network effect in the UK, 2011-20E


Turning first mover advantage into sustainable leadership

Apparel retailer Zalando initially benefitted from first mover advantage by offering convenience to German customers under-served online by incumbent mail order / catalogue businesses. Despite being only seven years old, the company is taking steps to develop a platform for long-term leadership bringing together content and personalisation to drive positive network effects. This should lead to a sustainable competitive barrier against new market entrants and incumbents developing their respective online offerings.

Leveraging network effects to drive sustainable leadership Overview of Zalando’s platform network effect


On personalisation, Zalando is launching curated shopping which will be similar to Trunk Club and Enclothed. This should drive higher customer engagement with the platform and help shift away from a conversion-focused, convenience-led model which can be more easily replicated by peers. One way in which Zalando will leverage content is by developing flagship online stores for its brand partners within the Zalando website. Brands will have full control of their sites, giving them a direct route to engage with customers. For customers, more, specialised content should further increase engagement. For the c.1,500 brands currently on Zalando, extending their relationships should lead to higher attachment to the platform and strengthen Zalando’s position between suppliers and customers for the long-term.

Preference for sustainable leaders: Buy Ocado, Zalando, ASOS

Across our internet coverage, we have a preference for companies that are able to able to cement leadership positions by using brand, content, curation and personalisation to drive an attractive customer proposition. We also see companies with significant scale owing to aggregation and network effects as well placed to sustain long-term leadership. We are Buy rated on Ocado (Conviction List; 379.8p), Zalando (Conviction List; €28.9), and ASOS (3,785p).

Carl Hazeley

Retail, Digital Consumer analyst

email: [email protected] Goldman Sachs InternationalTel: 44-20-7552-3139

Customers

IntermediariesBrands

Traditional online retailBrand solutions

Curated shopping

Advertising services



In our six of the best section, we pull together a pot pourri of charts that we hope you will find interesting. They will be different in each edition but hopefully always of note.

Hit it and quit Ratio of quits to layoffs in the US, 3-month moving average

The Art of selling Global art transactions

Source: BLS. Source: TEFAF Art Market Report.

Go east, young man Amazon and Apple job postings, top 10 countries ex-US

Health drives Google Ventures investments (new investments only)

Note: The US has most openings for both Source: Company website. Source: Google Ventures.

Emptying the bat cave Comic book sales on ebay (US$)

Still a big chunk Dividends paid by Oil & Gas companies as a percentage of total

Note: DC's superheroes in black, Marvel's in blue. Data gathered over 180-day period ending March 29, 2015 from ebay US.

Note: Based on companies that give data for all years in Datastream universe

Source: Terapeak. Source: Datastream.

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Six of the best – our favourite charts



Disclosure Appendix

Reg AC

We, Sumana Manohar, Hugo Scott-Gall, Megha Chaturvedi, Bill Shope, Vighnesh Padiachy, Drew Borst, S.K. Prassad Borra, James Schneider, Christine Cho, Sho Kawano and Carl Hazely hereby certify that all of the views expressed in this report accurately reflect our personal views about the subject company or companies and its or their securities. We also certify that no part of our compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this report.

Unless otherwise stated, the individuals listed on the cover page of this report are analysts in Goldman Sachs' Global Investment Research division.

Investment Profile

The Goldman Sachs Investment Profile provides investment context for a security by comparing key attributes of that security to its peer group and market. The four key attributes depicted are: growth, returns, multiple and volatility. Growth, returns and multiple are indexed based on composites of several methodologies to determine the stocks percentile ranking within the region's coverage universe.

The precise calculation of each metric may vary depending on the fiscal year, industry and region but the standard approach is as follows:

Growth is a composite of next year's estimate over current year's estimate, e.g. EPS, EBITDA, Revenue. Return is a year one prospective aggregate of various return on capital measures, e.g. CROCI, ROACE, and ROE. Multiple is a composite of one-year forward valuation ratios, e.g. P/E, dividend yield, EV/FCF, EV/EBITDA, EV/DACF, Price/Book. Volatility is measured as trailing twelve-month volatility adjusted for dividends.

Quantum

Quantum is Goldman Sachs' proprietary database providing access to detailed financial statement histories, forecasts and ratios. It can be used for in-depth analysis of a single company, or to make comparisons between companies in different sectors and markets.

GS SUSTAIN

GS SUSTAIN is a global investment strategy aimed at long-term, long-only performance with a low turnover of ideas. The GS SUSTAIN focus list includes leaders our analysis shows to be well positioned to deliver long term outperformance through sustained competitive advantage and superior returns on capital relative to their global industry peers. Leaders are identified based on quantifiable analysis of three aspects of corporate performance: cash return on cash invested, industry positioning and management quality (the effectiveness of companies' management of the environmental, social and governance issues facing their industry).

Disclosure Appendix

Coverage group(s) of stocks by primary analyst(s)

There are no coverage groups associated with the analyst(s).

Company-specific regulatory disclosures

The following disclosures relate to relationships between The Goldman Sachs Group, Inc. (with its affiliates, "Goldman Sachs") and companies covered by the Global Investment Research Division of Goldman Sachs and referred to in this research.

Compendium report: please see disclosures at http://www.gs.com/research/hedge.html. Disclosures applicable to the companies included in this compendium can be found in the latest relevant published research.

Distribution of ratings/investment banking relationships

Goldman Sachs Investment Research global coverage universe

Rating distribution Investment Banking Relationships

Buy Hold Sell Buy Hold Sell

Global 32% 54% 14% 46% 37% 32%

As of April 1, 2015, Goldman Sachs Global Investment Research had investment ratings on 3,356 equity securities. Goldman Sachs assigns stocks as Buys and Sells on various regional Investment Lists; stocks not so assigned are deemed Neutral. Such assignments equate to Buy, Hold and Sell for the purposes of the above disclosure required by NASD/NYSE rules. See 'Ratings, Coverage groups and views and related definitions' below.



Price target and rating history chart(s)

Compendium report: please see disclosures at http://www.gs.com/research/hedge.html. Disclosures applicable to the companies included in this compendium can be found in the latest relevant published research.

Regulatory disclosures

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See company-specific regulatory disclosures above for any of the following disclosures required as to companies referred to in this report: manager or co-manager in a pending transaction; 1% or other ownership; compensation for certain services; types of client relationships; managed/co-managed public offerings in prior periods; directorships; for equity securities, market making and/or specialist role. Goldman Sachs usually makes a market in fixed income securities of issuers discussed in this report and usually deals as a principal in these securities.

The following are additional required disclosures: Ownership and material conflicts of interest: Goldman Sachs policy prohibits its analysts, professionals reporting to analysts and members of their households from owning securities of any company in the analyst's area of coverage. Analyst compensation: Analysts are paid in part based on the profitability of Goldman Sachs, which includes investment banking revenues. Analyst as officer or director: Goldman Sachs policy prohibits its analysts, persons reporting to analysts or members of their households from serving as an officer, director, advisory board member or employee of any company in the analyst's area of coverage. Non-U.S. Analysts: Non-U.S. analysts may not be associated persons of Goldman, Sachs & Co. and therefore may not be subject to NASD Rule 2711/NYSE Rules 472 restrictions on communications with subject company, public appearances and trading securities held by the analysts.

Distribution of ratings: See the distribution of ratings disclosure above. Price chart: See the price chart, with changes of ratings and price targets in prior periods, above, or, if electronic format or if with respect to multiple companies which are the subject of this report, on the Goldman Sachs website at http://www.gs.com/research/hedge.html.

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The following disclosures are those required by the jurisdiction indicated, except to the extent already made above pursuant to United States laws and regulations. Australia: Goldman Sachs Australia Pty Ltd and its affiliates are not authorised deposit-taking institutions (as that term is defined in the Banking Act 1959 (Cth)) in Australia and do not provide banking services, nor carry on a banking business, in Australia. This research, and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act, unless otherwise agreed by Goldman Sachs. In producing research reports, members of the Global Investment Research Division of Goldman Sachs Australia may attend site visits and other meetings hosted by the issuers the subject of its research reports. In some instances the costs of such site visits or meetings may be met in part or in whole by the issuers concerned if Goldman Sachs Australia considers it is appropriate and reasonable in the specific circumstances relating to the site visit or meeting. Brazil: Disclosure information in relation to CVM Instruction 483 is available at http://www.gs.com/worldwide/brazil/area/gir/index.html. Where applicable, the Brazil-registered analyst primarily responsible for the content of this research report, as defined in Article 16 of CVM Instruction 483, is the first author named at the beginning of this report, unless indicated otherwise at the end of the text. Canada: Goldman Sachs Canada Inc. is an affiliate of The Goldman Sachs Group Inc. and therefore is included in the company specific disclosures relating to Goldman Sachs (as defined above). Goldman Sachs Canada Inc. has approved of, and agreed to take responsibility for, this research report in Canada if and to the extent that Goldman Sachs Canada Inc. disseminates this research report to its clients. Hong Kong: Further information on the securities of covered companies referred to in this research may be obtained on request from Goldman Sachs (Asia) L.L.C. India: Further information on the subject company or companies referred to in this research may be obtained from Goldman Sachs (India) Securities Private Limited. Japan: See below. Korea: Further information on the subject company or companies referred to in this research may be obtained from Goldman Sachs (Asia) L.L.C., Seoul Branch. New Zealand: Goldman Sachs New Zealand Limited and its affiliates are neither "registered banks" nor "deposit takers" (as defined in the Reserve Bank of New Zealand Act 1989) in New Zealand. This research, and any access to it, is intended for "wholesale clients" (as defined in the Financial Advisers Act 2008) unless otherwise agreed by Goldman Sachs. Russia: Research reports distributed in the Russian Federation are not advertising as defined in the Russian legislation, but are information and analysis not having product promotion as their main purpose and do not provide appraisal within the meaning of the Russian legislation on appraisal activity. Singapore: Further information on the covered companies referred to in this research may be obtained from Goldman Sachs (Singapore) Pte. (Company Number: 198602165W). Taiwan: This material is for reference only and must not be reprinted without permission. Investors should carefully consider their own investment risk. Investment results are the responsibility of the individual investor. United Kingdom: Persons who would be categorized as retail clients in the United Kingdom, as such term is defined in the rules of the Financial Conduct Authority, should read this research in conjunction with prior Goldman Sachs research on the covered companies referred to herein and should refer to the risk warnings that have been sent to them by Goldman Sachs International. A copy of these risks warnings, and a glossary of certain financial terms used in this report, are available from Goldman Sachs International on request.

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Ratings, coverage groups and views and related definitions

Buy (B), Neutral (N), Sell (S) -Analysts recommend stocks as Buys or Sells for inclusion on various regional Investment Lists. Being assigned a Buy or Sell on an Investment List is determined by a stock's return potential relative to its coverage group as described below. Any stock not assigned as a Buy or a Sell on an Investment List is deemed Neutral. Each regional Investment Review Committee manages various regional Investment Lists to a global guideline of 25%-35% of stocks as Buy and 10%-15% of stocks as Sell; however, the distribution of Buys and Sells in any particular coverage group may vary as determined by the regional Investment Review Committee. Regional Conviction Buy and Sell lists represent investment recommendations focused on either the size of the potential return or the likelihood of the realization of the return.

Return potential represents the price differential between the current share price and the price target expected during the time horizon associated with the price target. Price targets are required for all covered stocks. The return potential, price target and associated time horizon are stated in each report adding or reiterating an Investment List membership.

Coverage groups and views: A list of all stocks in each coverage group is available by primary analyst, stock and coverage group at http://www.gs.com/research/hedge.html. The analyst assigns one of the following coverage views which represents the analyst's investment outlook on the coverage group relative to the group's historical fundamentals and/or valuation. Attractive (A). The investment outlook over the following 12 months is favorable relative to the coverage group's historical fundamentals and/or valuation. Neutral (N). The investment outlook over the following 12 months is neutral relative to the coverage group's historical fundamentals and/or valuation. Cautious (C). The investment outlook over the following 12 months is unfavorable relative to the coverage group's historical fundamentals and/or valuation.

Not Rated (NR). The investment rating and target price have been removed pursuant to Goldman Sachs policy when Goldman Sachs is acting in an advisory capacity in a merger or strategic transaction involving this company and in certain other circumstances. Rating Suspended (RS). Goldman Sachs Research has suspended the investment rating and price target for this stock, because there is not a sufficient fundamental basis for determining, or there are legal, regulatory or policy constraints around publishing, an investment rating or target. The previous investment rating and price target, if any, are no longer in effect for this stock and should not be relied upon. Coverage Suspended (CS). Goldman Sachs has suspended coverage of this company. Not Covered (NC). Goldman Sachs does not cover this company. Not Available or Not Applicable (NA). The information is not available for display or is not applicable. Not Meaningful (NM). The information is not meaningful and is therefore excluded.

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General disclosures

This research is for our clients only. Other than disclosures relating to Goldman Sachs, this research is based on current public information that we consider reliable, but we do not represent it is accurate or complete, and it should not be relied on as such. We seek to update our research as appropriate, but various regulations may prevent us from doing so. Other than certain industry reports published on a periodic basis, the large majority of reports are published at irregular intervals as appropriate in the analyst's judgment.

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Our salespeople, traders, and other professionals may provide oral or written market commentary or trading strategies to our clients and our proprietary trading desks that reflect opinions that are contrary to the opinions expressed in this research. Our asset management area, our proprietary trading desks and investing businesses may make investment decisions that are inconsistent with the recommendations or views expressed in this research.

The analysts named in this report may have from time to time discussed with our clients, including Goldman Sachs salespersons and traders, or may discuss in this report, trading strategies that reference catalysts or events that may have a near-term impact on the market price of the equity securities discussed in this report, which impact may be directionally counter to the analysts' published price target



expectations for such stocks. Any such trading strategies are distinct from and do not affect the analysts' fundamental equity rating for such stocks, which rating reflects a stock's return potential relative to its coverage group as described herein.

We and our affiliates, officers, directors, and employees, excluding equity and credit analysts, will from time to time have long or short positions in, act as principal in, and buy or sell, the securities or derivatives, if any, referred to in this research.

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Any third party referenced herein, including any salespeople, traders and other professionals or members of their household, may have positions in the products mentioned that are inconsistent with the views expressed by analysts named in this report.

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