American Eagle is pitching a 'frenemy network' of vertical logistics to its retail peers — and it's paying off

American Eagle wants to be more like Amazon.

Not to get in the business of selling everything from shoes to pet food to toilet paper. But to master a business function that became critical for retailers during the Covid-19 pandemic: the supply chain.

That's where Shekar Natarajan, American Eagle Outfitter's chief supply chain officer, comes into the picture. Since he joined the apparel retailer roughly three-and-a-half years ago, the company has acquired two supply chain businesses for hundreds of millions of dollars and began swiftly building out a logistics platform that others companies — even its rivals in the apparel industry — can utilize, too.

It's a bet that American Eagle can lead the industry into a new territory of vertical logistics and dilute costs. Its peers will either emulate the model and play catchup, or lean on American Eagle long term.

American Eagle's goal, according to Natarajan, is to "Uber-ize" the global supply chain, thereby making it a shared service for retailers. His belief is that brands that compete for shoppers in clothing, makeup or home goods shouldn't also be competing over things like quicker delivery windows and cardboard boxes.

Instead, if enough businesses work together and pool resources, a conglomerate of retailers could be shipping out just as many packages daily as Seattle-based e-commerce behemoth Amazon, and hopefully at a profit, Natarajan explained in a recent sit-down interview.

He calls American Eagle's communal supply chain platform the ultimate "frenemy network."

"The only way that you could actually have Amazon-like scale, Amazon-like costs and Amazon-like capabilities — you have to share," said Natarajan. "Collectively, we can have the same [package] volume as Walmart. ... And that way, companies are only competing on what they do best, which is the product, marketing and customer experience."

The coronavirus pandemic accelerated an existing opportunity for American Eagle, which reported record revenue of $5 billion in fiscal 2021, up 33% from the prior year. As sales ballooned, so did e-commerce revenue. American Eagle's digital sales represented 36% of total transactions by the end of 2021, compared with 29% two years earlier.

That means shipping more packages to customers, handing them fewer shopping bags at the cash register, and shifting inventories around to meet newfound demand on the internet.

At the same time, backlogs and shortages have snarled the global supply chain due to labor constraints, temporary factory shutdowns and skyrocketing costs to manufacture and transport goods — to name just a few obstacles.

American Eagle isn't immune to these challenges. As a result, under Chief Executive Jay Schottenstein, the company fast-tracked its vision to create a streamlined model that can offer retail partners help on everything from ensuring orders with multiple items are packaged together, to speeding up home deliveries.

"This strategy was laid out pre-pandemic," Natarajan said. "We just accelerated the entire journey by almost four years."

In May of 2021, American Eagle acquired AirTerra, a Seattle-based parcel shipping start-up, for an undisclosed amount.

Six months later, it announced it would be paying $350 million to purchase Quiet Logistics, which operates a handful of distribution centers around the United States to help fulfill shipments for brands including menswear retailer Mack Weldon, athletic apparel start-up Outdoor Voices and bedding maker Boll & Branch.

Those companies, along with a handful of others, remain clients of the Quiet Platform, now the internal logistics branch of American Eagle. The division is run by Natarajan and a small-but-growing team that stays at arm's length from the core retail division. It recently added Saks Off Fifth, the off-price department store, to its roster of customers.

According to Natarajan, retailers sign multi-year deals to be part of the Quiet Platform. He declined to comment on the financial arrangements.

CEO Schottenstein said on an American Eagle earnings conference call in early March that the company's two acquisitions were already translating into cost savings, cementing a new "growth platform" for American Eagle.

The efforts aren't going unnoticed on Wall Street, either.

"For the many retailers that are investing in their supply chain, acquiring upstream like this is not that common," said Corey Tarlowe, an equity analyst at Jefferies. "This is truly unique."

Tarlowe said the investments should help American Eagle over time to improve its inventory management, mitigate risk for markdowns and ultimately boost profit margins. The greater economics of scale the company can achieve, the better, he said.

To be sure, investors are waiting to see more proof points, and it shows in the stock's performance in recent months, which is lagging the broader industry.

American Eagle shares are down roughly 60% since news of its AirTerra deal first surfaced in late August. Year to date, the retailer's stock is down about 33%, compared with the S&P 500 Retail ETF's loss of about 16% in the same period.

Prior to joining American Eagle, Natarajan had stints at major consumer-facing businesses including PepsiCo, the Walt Disney Co., Walmart and Target — oftentimes within the supply chain division.

Those experiences offered him clearer perspective on the competitive advantages that some of the biggest retailers in the industry have, he said, but also the disadvantages for so-called midsized retailers that do less than $40 billion or so in sales each year. At $5 billion in annual sales, American Eagle fits the bill.

"I was always worried about what was going to happen to retailers in the middle," he said. "Because it's not a level playing field."

And so rather than creating a network solely for American Eagle's benefit, he worked with Schottenstein to create a business that, should it grow big enough, could stack up against Amazon's logistics arm, or at least offer brands another option.

"The reality is none of us own our supply chain," Natarajan said. "We manufacture goods in factories that are shared right across retail. We move them in ships that are shared across businesses.

"But shared capabilities — whether they're technology capabilities, fulfillment capabilities or transportation capabilities — are the future of this industry."

American Eagle's Chief Operating Officer Michael Rempell said the apparel retailer — including its intimates- and swim-centric Aerie business — is already more effectively managing inventories and labor, thanks to its Quiet logistics business.

"Not only are we shipping less packages and it's costing us less ... but [orders] are getting to customers 30% faster than they were before," he said in an interview. "We see it as a tremendous business opportunity," for both American Eagle and for the Quiet Platform as a standalone business, Rempell added.

Bryan Eshelman, a managing director in the retail practice at global consulting firm AlixPartners, said he can see the logic behind American Eagle's unique approach.

Retailers that attempted to build out supply chain capabilities on their own in the thick of the Covid pandemic saw those efforts "come back to bite them," he said, in large part because it's so costly to go it alone: "There needs to be a better solution."

American Eagle clearly made investments that were "bigger than its own needs," Eshelman said. But that will likely put the retailer in a stronger position in the future, particularly as supply chain disruptions persist, he said.

American Eagle won't be vying with other retailers over space for its goods on trucks and planes. It'll be pitching its own operations to its rivals.

American Eagle has projected its logistics business to contribute around 5 to 6 points to the mid-teens revenue growth rate it's calling for in fiscal 2022. It also expects its supply chain business to break even on profitability this year.

In the coming months, Natarajan is focused on onboarding more businesses. The Quiet Platform counts about 50 customers today but Natarajan hopes to grow that base closer to 250, he said.

"I'm essentially trying to create Amazon-like capabilities and cost advantages, without being Amazon," he said.