So what should be more profitable for a retailer, selling from physical stores or selling over the web? That’s the question that a recent Wall Street Journal article considers (How the Web Drags on Some Retailers, Dec 1). At first glance, the answer seems straightforward. Web sellers don’t need to rent stores or have staff cooling their heels waiting for customers. However, the reality isn’t necessarily so clear,
While conventional wisdom holds that online sales should be more profitable, because websites don’t need the pricey real estate and labor necessary to maintain a store network, many retailers actually earn less or even lose money online after factoring in the cost of shipping, handling and higher rates of returns.
For retailers that outsource their Web and fulfillment operations, costs can run as high as 25% of sales, industry analysts said.
Kohl’s Corp. says its profitability online is less than half what it reaps in its store. Wal-Mart Stores Inc. says it expects to lose money online at least through early 2016 as it invests to build its technology, infrastructure and fulfillment networks. Target Corp. says its margins will shrink as its online sales grow. Best Buy Co. said faster growth on its website will weigh on its profitability at the end of the year.
Click here for a video of the reporter discussing her findings.
So what is behind the fall in margins as sales shift to the web? Pricing would certainly be one concern. On-line shopping lowers consumer search costs and provides greater price transparency. That could certainly impact a firm like Best Buy that carries the same cameras and game consoles as Lord-knows-how-many-other firms.
But that’s not the whole story. One of the firms discussed in the article is Lululemon, which doesn’t face the same level of competition as a multi-brand retailer. (Aside: We now get into a question of just how to measure margins. Lululemon actually breaks out their web-business from everything else and reports higher margins on web-sales. However, they have some discretion in allocating costs in their reporting. The article notes that their overall margins have fallen as web sales have increased.)
One thing the article notes is that moving sales from the store to the web basically shifts costs from being fixed to being variable.
Another factor weighing on e-commerce margins is that online sales have a higher degree of variable costs. A brick-and-mortar retailer incurs roughly the same costs whether 10 or 50 people purchase a pair of pants from a store. The lights are already on, the rent is paid and the employees are in place. That means when sales go up, profit goes up faster.
But online, there are costs associated with each additional order. Employees must locate those pants in a warehouse, pack and ship them, and then deal with return shipping and restocking when goods come back, often at two or three times the rate at which store-bought goods are returned.
That seems a fairly compelling story. There are certainly benefits in managing inventory centrally but those can be of a much smaller order of magnitude than shipping and handling costs — particularly if returns are high.
While this is certainly bad news for retailers who feel they have little choice but to move to the web to keep up with customers (this is essentially the argument Kohl’s CEO makes in the article), I am not sure that it is an overall bad thing for retailing as a whole. This is essentially a question of trading fixed costs for variable costs. The expense of building out a national network of stores is immense and would generally limit the growth of new entrants. An innovative seller would need a long time to reach the scale of Kohl’s or Best Buy. On-line selling, however, offers instant reach to anyone. A start up can grow more quickly. There is certainly some benefit to both retailers and customers for that possibility to exist.