An inconvenient truth about e-commerce: It’s largely unprofitable

The disruptive nature of e-commerce is undeniable. Entirely new business models are revolutionizing the way we buy. The transformative transparency created by all things digital has revolutionized product access, redefined convenience and lowered prices across a wide spectrum of merchandise and service categories. The radical shift of spending from brick & mortar stores to online shopping is causing a massive upheaval in retailers’ physical footprint, which looks to continue unabated.

But the inconvenient (and oft overlooked) truth is that much of e-commerce remains unprofitable–in many cases wildly so–and many corporate and venture capital investments have no prospect of earning a risk-adjusted ROI.

While it was once thought that the economics of selling online were vastly superior to operating physical stores, most brands–start-ups and established retailers alike–are learning that the cost of building a new brand, acquiring customers and fulfilling orders (particularly if product returns are high) make a huge percentage of e-commerce transactions fundamentally profit proof. Slowly but surely the bloom is coming off the rose.

Despite the hype–and a whole lot of VC funding–it’s increasingly clear that most of pure-play retail is dying, as L2’s Scott Galloway lays out better than I can. We have already seen the implosion of the flash-sales sector and the collapsing valuations of once high-flying brands like Trunk Club and One King’s Lane. Just the other day Walmart announced it was acquiring ModCloth, reportedly for less than the cumulative VC investment. A broader correction appears to be on the horizon and I suspect we will see a number of high-profile, digitally native brands get bought out at similarly discounted prices. And, ironically, we will continue to witness a doubling down of efforts by many of these same brands to expand their physical footprints, some of which is certain to end badly.

The challenges for traditional retailers and their “omni-channel” efforts are even more vexing. Walmart, Pier 1, H&M and Michaels are among the many retailers that have been criticized for their slowness to embrace digital shopping. Yet I suspect their seemingly lackadaisical approach owes more to their understanding of e-commerce’s pesky little profitability problem than corporate malfeasance. Alas, more and more retailers are increasing their investment in online shopping and cross-channel integration only to experience a migration of sales from the store channel to e-commerce, frequently at lower profit margins. Moreover, this shift away from brick & mortar sales is causing these same retailers to shutter stores, with no prospect of picking up that volume online. The risk of a downward spiral cannot be ignored.

Given the trajectory we are on it’s inevitable that more rational behavior will creep back into the market. But with Amazon’s willingness to lose money to grow share and investor pressure on traditional retailers to “rationalize” their store fleets, I fear it will take several years for the dust to truly settle.

In the meantime, e-commerce continues to be a boon for consumers and a decidedly mixed bag for investors.

A version of this story appeared at Forbes, where I am a retail contributor. You can check out more of my posts here.

 

The fault in our stores

Last week Target became the latest retailer to report weak earnings and shrinking physical store sales. They certainly won’t be the last.

As more retail brands disappoint on both the top and bottom lines–and announce scores of store closings–many may conclude that brick-and-mortar retail is going they way of the horse-drawn carriage. Unfortunately this ignores the fact that roughly 90% of all retail is still done in actual stores. It doesn’t recognize that many retailers–from upstarts like Warby Parker and Bonobos, to established brands such as TJMaxx and Dollar General–are opening hundreds of new locations. It also fails to acknowledge the many important benefits of in-store shopping and that study after study shows that most consumers still prefer shopping in a store (including millennials!)

Brick-and-mortar retail is very different, but not dead. Still, most retailers will, regardless of any actions they take, continue to cede share to digital channels, whether it’s their own or those of disruptive competitors. To make the best of a challenging situation, retailers need a laser-like focus on increasing their piece of a shrinking pie, while optimizing their remaining investment in physical locations. And here we must deal with the reality that aside from the inevitable forces shaping retail’s future, there are many addressable faults in retailers’ stores. Here are a few of the most pervasive issues.

The Sea Of Sameness

Traditionalists often opine that it all about product, but that’s just silly. Experiences and overall solutions often trump simply offering the best sweater or coffee maker. Nevertheless, too many stores are drowning in a sea of sameness–in product, presentation and experience. The redundancy in assortments is readily apparent from any stroll through most malls. The racks, tables and signage employed by most retailers are largely indistinguishable from each other. And when was the last time there was anything memorable about the service you received from a sales associate at any of these struggling retailers?

One Brand, Many Channels

Too many stores still operate as independent entities, rather than an integral piece of a one brand, many channels customer strategy. Most customer journeys that result in a physical store visit start online. Many customers research in store only to consummate the transaction in a digital channel. The lines between digital and physical channels are increasingly blurred, often distinctions without a difference. Silos belong on farms.

Speed Bumps On The Way To Purchase

How often is the product we wish to buy out of stock? How difficult is it to find a store associate when we are ready to checkout? Can I order online and pick up in a store? If a store doesn’t have my size or the color I want can I easily get it shipped to my home quick and for free? Most of the struggling retailers have obvious and long-standing friction points in their customer experience. When in doubt about where to prioritize operational efforts, smoothing out the speed bumps is usually a decent place to start.

Where’s The Wow?

As Amazon makes it easier and easier to buy just about anything from them, retailers must give their customers a tangible reason to traffic their stores and whip out their wallets once there. Good enough no longer is. Brands must dig deep to provide something truly scarce, relevant and remarkable. Much of the hype around in-store innovations is just that. For example, Neiman Marcus’ Memory Mirrors are cool, but any notion that they will transform traffic patterns, conversion rates or average ticket size on a grander scale is fantasy. Much of what is being tested is necessary, but hardly sufficient. The brands that are gaining share (and, by the way, opening stores) have transformed the entire customer experience, not merely taken a piecemeal approach to innovation.

Treat Different Customers Differently

In an era where there was relative scarcity of product, shopping channels and information, one-size-fits all strategies worked. But now the customer is clearly in charge, and he or she can often tailor their experience to their particular wants and needs. Retailers need to employ advanced analytical techniques and other technologies to make marketing and the overall customer experience much more personalized, and to allow for greater and greater customization. More and more art and intuition are giving way to science and precision.

Physical retail is losing share to e-commerce at the rate of about 110 basis points per year. While that is not terribly significant in the aggregate, this erosion will not be evenly distributed and the deleveraging of physical store economics will prove devastating to many slow to react retailers. This seemingly inexorable shift is causing many retailers to reflexively throw up their hands and choose to disinvest in physical retail. The result, as we’ve seen in spades, is that many stores are becoming boring warehouses of only the bestselling, most average product, presented in stale environments with nary a sales associate in sight.

The fault in our stores are legion. But adopting an attitude that stores are fundamentally problems to be tolerated–or eliminated–rather than assets to be leveraged and improved, makes the outcome inevitable and will, I fear, eventually seal the fate of many once great retailers.

PurpleCow

A version of this story appeared at Forbes, where I am a retail contributor. You can check out more of my posts here.

What if retail traffic declines last forever?

The results keep pouring in and they don’t bode well for brick & mortar retail. Across just about every sector and virtually every time period, traffic to physical stores continues to decline.

Of course, for the most part, we aren’t buying less, we are shopping differently. The obvious dominant trend is the explosion of e-commerce, and the one player accounting for the most growth is Amazon. Yet the real news for everyone else is how shoppers are diversifying the channels in which they research purchases and ultimately transact. This so-called “omni-channel” world is wreaking havoc with traditional retailers’ underlying economics and, like most things, the future will not be evenly distributed.

The vast majority of retailers have now likely entered a period where comparable store traffic will never increase again for any sustained period of time.

That’s profound. And more than a bit scary.

Drops in store traffic almost always dictate sales declines. Given that physical stores have relatively high fixed costs (rent, inventory, staffing, etc.) a material drop in revenue deleverages operating costs and profits fall disproportionately. This long-term (and increasingly widespread) trend is causing a great deleveraging across many retail segments and is the primary reason so many stores are being closed. It’s also causing brands to rethink the size and operating nature of the stores that remain or they plan to open. These shifts will prove seismic.

While there is a belief that e-commerce’s economics are superior to brick & mortar stores, that frequently is not the case, primarily owing to challenging supply chain costs, high product returns and compressed margins. As traditional retailers invest heavily in building their digital operations–and creating the much vaunted seamlessly integrated shopping experience–many are merely spending a lot of money to move sales from one channel to the other, often at lower profitability. Even brands such as Nordstrom, Neiman Marcus and, to a lesser degree, Macy’s, that are often touted as omni-channel pioneers and have industry leading online penetration, have seen profit growth stall despite massive investments.

Roughly 90% of all retail is still done in physical stores. Yet the growth of e-commerce will continue unabated and the resulting drop in store traffic is an undeniable and unrelenting force. With rare exception, there is little any retailer can do to stem this tide. One key focus must therefore be on right-sizing store counts and the remaining stores’ footprints and operating costs. But the far more important strategy is to create a remarkable customer experience across all channels that reflects how consumers shop today and the intersectionality of digital and physical channels. Ultimately the key is to maximize customer growth, loyalty and profitability irrespective of where the customer decides to transact.

The pain of store traffic declines is inevitable.

The degree of suffering from it remains optional.

 

This post originally appeared on Forbes where I recently became a contributor. You can check out more of my writing by going here.

Retail’s great deleveraging

Over the past several quarters an awful lot of retail brands have reported disappointing earnings. Expect that to continue.

Some of this is because of tepid overall consumer demand in certain categories. Apparel comes to mind. But it goes far beyond simple macro-economics.

We are going through the great deleveraging of retail. And for many brands this will end badly.

When retailers operate a fleet of strong brick & mortar locations with growing revenues, small increases in sales typically convert powerfully to greater profits and return on invested capital. Yet when revenues are headed in the other direction the converse is true. The high fixed cost nature of physical stores can quickly make a given location financially untenable when sales sag. This is the primary reason we are seeing a virtual tsunami of store closings.

But store closings typically cause deleveraging as well.  Many marketing, supply chain, administrative and other costs are relatively fixed. Pull volume out of the system through massive store closings and other types of deleveraging occur.

A lot of folks seem to think that aggressive investments in digital channels and omni-channel integration are the silver bullet answer. But that’s often not true. There is also a relatively fixed cost nature of fulfilling and shipping a direct-to-consumer order. Shift sales from a physical store where the marginal cost of filling an order is comparatively low to e-commerce, where the marginal cost is higher and, once again, the financial leverage gets worse, not better.

Most retailers are investing heavily in omni-channel integration capabilities. Many of these investments are necessary, but not sufficient. If all we are doing is adding a lot of cost to the system without gaining market share and becoming meaningfully more customer relevant, we are once again deleveraging our underlying economics.

Therefore, it should not surprise us that retailers experiencing relatively flat sales overall through a combination of minor declines in physical store sales, but strong increases online are seeing profits erode. Deleveraging is to blame.

Ultimately, the greatest long-term leverage comes from being more remarkable and more intensely customer relevant in ways that grow share of wallet and engender true loyalty, not by squeezing out operating costs and closing stores.

Show me a retailer that is all about cost-cutting and “rationalizing” its real estate and most often you’ve shown me a brand that is out of ideas. Far too often that merely confirms that the downward spiral has begun. Dead brand walking.

Does e-commerce suck?

Well it certainly isn’t bad for consumers. In fact, it’s been a bonanza.

The advent and enormous growth of e-commerce has dramatically expanded the availability of products, making nearly anything in the world readily accessible, 24/7. Product and pricing information that was previously scarce and unreliable is now easily obtainable. Prices are down, in many cases, dramatically. Digital tools and technologies have ushered in a new era of innovation making shopping far more convenient, easy and personalized.

For retail brands and investors the picture is much less clear and increasingly bleak. The fact is e-commerce is mostly unprofitable–and that’s not about to change anytime soon.

Amazon, which is both far bigger than any other retailer’s web business and growing faster than the overall channel, has amassed huge cumulative losses. The high cost of direct-to-consumer fulfillment and so-called omni-channel integration has made virtually every established retailer’s e-commerce business a major cash drain. And more and more, it’s becoming clear that most of the “disruptive” venture capital funded pure-plays are ticking time bombs. Quite a few major write-downs have already occurred (e.g. Trunk Club, Nasty Gal and just about every flash-sales business) and more are surely on the way (I’m looking at you Jet.com and Dollar Shave Club).

Investors have been throwing money at business models with no chance of ever making money for years. Analysts and pundits regularly excoriate traditional brands that are slow to “invest” tens of millions of dollars in all things digital and omni-channel while spewing nonsense about physical stores going away. Much of this is incredibly misguided.

It’s time for everyone to be more clearheaded and, dare I say, responsible.

Industry analysts and the retail press need to stop with the breathless pronouncements about the demise of physical stores. They need to back off the notion that retailers can cost cut their way to prosperity. They also need to quit labeling disruptive businesses as “successful” merely based upon revenues and rapid growth and take the time to really understand the economics of e-commerce and omni-channel (hint: it’s mostly about supply chain and customer acquisition costs).

More established retailers need to stop chasing all things omni-channel and prioritize investments based upon consumer relevance, long-term competitive advantage and ROI. They also need to realize that if they feel the urge to close a lot of stores or drastically cut expenses they are probably working on the wrong problem.

Venture capital investors need to start caring more about building a business based upon fundamentals, not just pricing everyone else out of the market and/or hoping that some idiot big corporation will come along and write a huge check. Also, have we forgotten that selling at a loss and making it up on volume has never been a viable strategy?

Of course, by far the single biggest thing that would restore an element of sanity to the overall market would be if Amazon were to decide to not treat most of their e-commerce business as a loss leader. Sadly, that doesn’t seem likely to happen anytime soon.

So if you are a consumer, enjoy the ride and the subsidies.

If you are retailer, yeah, that definitely sucks.

 

Easy to measure, not all that useful

For a long-time the retail industry has focused on same-store sales as the primary measure of a retailer’s success. This ignores the fact that a brand can drive a sales increase through excessive promotions and completely destroy profitability. It fails to recognize that we can teach consumers to become promiscuous shoppers and have them show up in droves during a given sales event while completely undermining true loyalty. It neglects the reality that total channel performance in a given trade area is a better metric because comp store sales don’t account for the role of a physical presence in creating a viable e-commerce model.

More recently, we’ve latched onto the growth of e-commerce as a key barometer for success, failing to acknowledge that virtually every pure-play brand has an unsustainable business model that is rapidly approaching its expiration date. We also seem to forget (or deny) that for most established omni-channel retailers the outsized increases are merely the result of existing customers shifting their sales away from a physical store to a channel with typically far worse economics (owing primarily to incredibly high fulfillment costs).

We work to optimize the ratio of digital ad spending to digital sales, even though we know that digital mostly drives physical channel volume. Worse yet, we make these sort of measures a part of an incentive scheme that reinforces the silo-ed behaviors that undermine customer-centricity.

We obsess over our e-commerce conversion rates even though they are highly imperfect measures of long-term consumer engagement and retention and we know that so much of our traffic is really part of the customer’s journey to a brick & mortar location anyway.

Attribution is messy. Economics is messy. Getting our organizations and constituencies to let go of metrics, processes and habits that are no longer relevant is messier still.

Yet just because we’ve always done it that way is a terrible reason to continue doing so.

Just because someone else expects us to do it doesn’t mean we have to.

Just because it’s easy to measure doesn’t make it useful.

And just because doing something is hard or imperfect doesn’t mean it isn’t worth trying.

 

h/t to Seth for inspiring this post.

Stop blaming Amazon for department store woes

Given Amazon’s staggering growth and willingness to lose money to grab market share it’s easy to blame them for everything that is ailing “traditional” retail overall–and the  department store sector in particular.

In fact, with announcements last week from Macy’s to Kohl’s and Sears to JC Penney that could only charitably be called “disappointing” many folks that get paid to understand this stuff reflexively jumped on the “it’s all Amazon’s fault” bandwagon. Too bad they are mostly wrong.

The fact is the department store sector has been losing consumer relevance and share for a long, long time–and certainly well before Amazon had even a detectable amount of competing product in core department store categories.

dept_store_sales_grwth_large

The fact is it’s just as logical to blame off-price and warehouse club retailer growth–which is almost entirely done in physical locations, by the way–for department stores’ problems.

dillards-2

The fact is that, despite other challenges along the way, Nordstrom, Saks and Neiman Marcus have maintained share by transitioning a huge amount of their brick & mortar business to their online channels and have closed only a handful of stores in the last few years. Nordstrom and Neiman Marcus now both derive some 25% of their total sales from e-commerce.

Don’t get me wrong, I’m not saying that Amazon isn’t stealing business from the major department store players. Clearly they are. And as Amazon continues to grow its apparel business they will grab more and more share.

But the underlying reason for department stores decades long struggle is the sector’s consistent inability to transform their customer experience, product assortments, marketing strategies and real estate to meet consumers’ evolving needs.

More recently, those brands that have been slow to embrace digital first retail are scrambling to play catch up. Those that still haven’t broken down the silos that create barriers to a frictionless shopping experience will continue to hemorrhage customers and cash.

Most importantly those that think they can out Amazon Amazon are engaged in a race to the bottom. And as Seth reminds us, the problem with a race to the bottom is that you might win.

seth-godin-quote-1-800x397