Everyone agrees that the retail industry is going through a huge turmoil of changes. From digitalization to disruptive business models to sustainability challenges, most of the retailer’s business-as-usual is being turned upside down. But few seems to agree on the most critical issue: what role will physical stores play in the future of the retail value chain?

Some experts believe that physical stores will eventually disappear, pointing to the evidence that stores and retail chains are closing every day. Others tell stories about the revival of stores and why the end of stores is not near.

In trying to find some answers and insights about this critical issue, let’s start by looking at one of the most crucial success factor and cost driver of today’s retail, order fulfilment.

How can we compare stores and e-commerce in terms of fulfilment costs? What are the main drivers and dissimilarities? What insights can we get from such a comparison?

Of course, omnichannel is about making these two channels partner seamlessly and complement each other. However, for retailers to understand how to address their current and future challenges given their unique business logic, there is great value in being able to compare their cost efficiency.

The fulfilment value chains of stores and e-commerce are very different, and their costs are driven by very different parameters:

- Store cost efficiency is driven by parameters on store level such as Rent and Running Costs/m² or Sales Personal

- E-commerce costs are driven by parameters related to each customer order, such as Pick/Pack cost in outbound logistics, Transport costs and Customer care costs.

In order to compare them, we can analyse how much revenue each channel delivers versus the costs they drive. We call it the “Revenue vs Costs efficiency”. In the case of stores, costs will be compared to Sales/m² and Sales/FTE (Full-Time Equivalent). In the case of e-commerce, costs will be compared to the value of the customer order.

- Looking at the two tables below you see a high-level summary of our analyses, where we have estimated the Revenue vs Cost efficiency of the two channels, considering the main cost drivers and the main sales efficiency parameter. Keep in mind that we have applied this model to the Swedish market. Same exercise could obviously be done for any retail market.

*FTE: Full-Time-Equivalent. Revenue by FTE estimated from 500 000 SEK/FTE for low efficiency stores to 7 000 000 SEK/FTE for best-in-class stores. Revenue by m2 estimated from 5 000 SEK/m2 for low efficiency stores to 110 000 SEK/me for the best-in-class stores

*Customer pays 20 SEK in delivery costs. ** Customer pays 40 SEK in delivery costs. Returns are estimated to 25% of additional costs and Customer service to 5% of total costs

From this “revenue vs cost” analysis we see that even the best stores (and there are not so many) can earn a max of 10 SEK per 1 SEK of cost. We note also that even inefficient stores will earn up to 6 SEK per 1 SEK of fulfilment costs if they are in cheap C-locations. On the other hand, e-commerce “revenue vs cost efficiency” is mainly driven by order value. The higher the order value and the more efficient the e-commerce fulfilment, the more likely e-commerce will beat stores in terms of fulfilment:

What insights can we get from this analysis?

There are many key insights that can be gathered from this analysis, and even more so when you dig into more specific numbers. But let’s start with the most obvious:

When it comes to small order value, stores always win

No e-commerce can survive an average order values of 100 SEK, or even of 200 SEK, when compared to stores. That explains why companies like Primark, Flying Tiger or Normal do not have any e-commerce shops: these companies know physical stores will always win in their business model of frequent-buys/small-basket/low-cost products. What that means for most retailers with more variable customer baskets is that you must accept unprofitable transactions when selling through e-commerce. This is often very hard to admit for a traditional retailer, but this is one of the reasons for Amazon’s success: accept unprofitable transactions but make sure they are offset by profitable ones

Showrooms will not be enough

Sales inefficient stores will not survive. Turning them into showrooms will not save them (except for a few branding/flagship stores). To survive, stores will have to consistently work on and increase their “halo effect” which means making sure that customers visiting the store will increase the retailer’s revenue, even if not during the actual store visit. The IKEA kitchen store is a perfect example of a showroom store with great “halo effect”. There are many ways of maximizing the store visit of the customer, but this will require several strategic shifts for brick & mortar retailers:

Having stores as show room means retailers must deliver on the stores’ “halo effect”, otherwise they will be too costly.

E-tailers must work even more strategically toward higher e-commerce order values

Driving customer towards higher order value is a clear and common strategy in the e-commerce business models, but currently it is mainly driven by “free shipping” offerings and through simple cross-selling algorithms. However, as e-commerce is much more cost efficient with high value orders, this should be one of the strategic focus of any e-commerce business, and definitively a critical innovation area. There is huge potential in creating more customer value through intelligent cross-selling and up-selling AND in introducing other drivers to the customers than free shipping in order to increase order value. Sustainability could and should be one of the silver bullets here!

Inefficient stores selling high value products will have a very hard time against e-commerce

When looking at the “sales vs cost efficiency” tables above, we see that stores with low sales efficiency will easily lose versus e-commerce when average order value is 800 SEK or more. This shows that inefficient stores (with a low revenue by m² by FTE) are no competition to e-commerce when selling high-value products, which are much more suitable for an efficient and profitable e-commerce. There are several examples of such store closing, with several cases within the consumer electronics, like RadioShack, Circuit City and hhgregg. These kind of inefficient stores could be replaced by showroom stores with high “halo effect”, but retailers need to act swiftly and disruptively if they want to succeed with this. To get inspiration, have a look at the success of Best Buy in renewing their stores and their big-box model.

A final thought

Our analysis presented here is generic but aims to simplify a complex issue. And it clearly shows one thing: it is essential for all retailers and e-tailers to have full understanding and visibility of their fulfilment costs. Understanding what drives costs and what strategy should be applied to minimize and optimize them is a crucial capability and it is a critical success factor for all retailers. All too often we meet retailers that only have an average and rough understanding of these costs and of what drives them.

Most retailers also need to remodel their old KPIs. Here are some examples:

- When stores are becoming stock point, back storage areas need to be included in the store’s Sales/m²
- Stores Like-for-like growth must become a number one KPIs and must include the store’s “halo effect”in order to make sure this becomes a strategic focus
- Return costs must be included in the overall cost and profitability calculation, and built into the fulfilment processes already from the start
All this requires a full understanding and mastering of the fulfilment value chain’s cost structure and cost drivers

So, who do I think will win eventually?

Taking a step back and looking at the overall picture, one must admit that the advantage in the long-run will probably go to e-commerce. The fulfilment costs of e-commerce will decrease as volume increases and improvements in its efficiency has only just begun, with the huge potential of automation. Compare this to the structure-heavy, costs-heavy, already-mostly-optimized store business. Even focusing on stores “halo effect” will shift the balance of power towards e-commerce.

Will e-commerce win in the long run? Most probably. But only at one condition: e-commerce businesses must build their growth on sustainable solutions, in all and every aspect of their model. Customers will not fully shift towards e-commerce if this is not the case. Implementing sustainable solutions in an e-commerce business will make the success of the future leaders in the retail business

Hoping that these overall insights have inspired you, do not hesitate to contact us if you want to discuss the details of this analysis or how it can apply to your business.

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