As ecommerce is winking, profit margin is shrinking! …and how to deal with it!
I don’t want to overstate the case; it may be surprising, but the facts are clear. It’s not going to get any easier to be profitable in e-commerce. Without a doubt, Amazon is one of the world’s top e-commerce stores. However, Amazon profits from AWS rather than ecommerce, and without AWS, Amazon’s results would have been negative. Other Retailers/CPG don’t have this extra income, so they have to keep a close eye on how to cut costs and boost profits…
In a report from Alvarez and Marsal, “the true cost of online” of six major European economies, the results are disillusioning. According to the figures, retail pre-tax profit margins decreased from 6.4 percent to 4.5 percent as a result of online shopping, indicating that as e-commerce penetration increases, profit margins decrease. During and after the epidemic, customers’ purchasing habits will become increasingly digital, making it harder for operational models that rely heavily on physical channels to rebalance costs. I haven’t found anything comparable in North America, but I doubt things are any different in other parts of the world. (Also, it’s important to note how different the margins are in different European markets. Germany is the most competitive and hard to profit from.)
This phenomenon can be attributed to a variety of factors, but the challenge and opportunity are particularly high among hybrid Retailers/CPG who operate both online and offline. Order fulfillment and return processing are both expensive. Omnichannel Retailers must strike a balance between online and offline sales while consumers expect fast, free shipping, putting retailers under significant financial pressure.
- Returns amplify the costs, and they happen far too frequently. According to the National Retail Federation, returns in retail will account for $761 billion in the United States in 2021, or 16.6% of total retail sales. This compares to a 10.6 (!) percent return rate the previous year. E-commerce returns are increasing and will account for 20.8 percent of all e-commerce sales in 2021. The return rate in store sales is significantly lower before this is reduced in any way. While e-commerce requires 50% or more returns, store sales only generate 10% to 15% returns! Apparel, as shown also in a recent Coresight study, has the highest return rate for obvious reasons. All of this is impressive, as is the significant margin erosion! Return costs include shipping, customer service, inspecting and sorting goods, sometimes repackaging and repairing them, storage, and sometimes liquidation. Due to costly returns, e-commerce has been exceptionally hard in terms of cost. Pure-play e-tailers earn only 77 cents on every dollar spent. When customers return online purchases to stores, however, the margin improves because they pick up additional items on the way back, resulting in a basket size of 107 percent of the original purchase. Although this graph is from an older study, the points it makes are still relevant today (see below).
- Commerce orders are frequently fulfilled from a designated warehouse, and this has been the case for a long time. Those days, however, are long gone, and the options have multiplied. Pick up in store, ship from store, and drop ship are now available, complicating the process. Kathy Thomas’ graph below shows how margins erode depending on how they are fulfilled. It should be noted that traditional store sales continue to be the most profitable. Because store delivery is less efficient, it’s only natural that “ship from store” is also the most expensive method in terms of process costs.
- Everyone is talking about direct to consumer in Consumer packaged goods (CPG). Ecommerce creates new opportunities, and it is understandably appealing to take advantage of these opportunities. Of course, the margin varies depending on the category sold, but we can already see a trend. Ecommerce/Amazon costs are driven by digital advertising and logistics. Overall as stated in the McKinsey article I read, brick-and-mortar stores continue to be the most profitable channel. Online shipping and warehousing costs are higher for a variety of reasons. CPG companies don’t have to lose money on their ecommerce efforts. It is critical for CPG companies to shift their mindset, whether it is direct to consumer, in-store, or in the marketplace; they must incorporate margin-focused thinking into their long-term strategy and daily operations. Failures must be abandoned expeditiously, and successes must be expanded.
After going over three different aspects of e-commerce margin analysis, it’s time to wrap things up. While the “traditional” store is clearly the winner in terms of margin in all three areas. For retailers and the consumer goods industry, margins alone can explain why they’ve held tight to their traditional relationships and distribution channels for so long. However, this is not yet a strategy. The fact that they’ve finally gotten in on the action means that they must now find a way to strike a good balance between online and offline, partners, marketplaces, and so on. The challenge is the existing complexity, on the one hand, and the uncertainty about how the future might look, on the other. Not only is the online expanding, but it will become increasingly important to integrate it into offline operations and make dynamic decisions that intelligently consider both margin and customer satisfaction.
SAP is moving forward with solutions that are both flexible, future proof and easy to install. Order management will be critical in the future, as it will integrate the numerous front-end activities as well as the growing number of back-end fulfillment options. Any player in the consumer business arena will need assistance in making the right decision about whether to split, ship from store, or delay a delivery. The idea is also to provide as much assistance as possible, such as choosing a relatively expensive option, such as shipping from the store, to avoid e.g. discounting! While we see this from a margin standpoint, it also has a significant impact on sustainability. Returns that are directed to a store, bundled in a location, sent to a supplier, and so on will be required in the future to have a positive impact on emission reduction. Let’s work together to get it done; every penny counts:-)
SAP Intelligent Returns Management: Provide a frictionless, transparent product return process through the use of AI-assisted routing, dispositioning, and analytics, all while increasing return margins and lowering carbon emissions.
SAP Order Management Foundation: An SAP cloud solution for the manufacturing industry that makes it easy to connect your sales channels to your fulfillment systems and locations so that you can easily make and ship orders.
SAP S/4HANA Retail for merchandise management: Intelligent ERP for the retail industry transforms core processes. You can use real-time information to improve in-store operations, drive customer-centered merchandising, and improve your supply chain.
SAP Commerce Cloud: Create digital storefronts that work on any device and use artificial intelligence to deliver hyper-personalized e-commerce experiences, recommendations, and promotions that boost conversions, which means more sales.