Over the past five years, billions have been spent on making investments into e-commerce — all in an effort to meet the needs of today’s digitally aware consumer and to keep up with online giant Amazon.com.
And the results have been startling: Since 2011, while total retail sales have grown 14 percent (or about 3 percent per year), according to data from the U.S. Department of Commerce, e-commerce sales have swelled 72 percent (or 14 percent per annum).
“But in that same period, Amazon’s North American sales’ growth has increased 139 percent,” said Antony Karabus, chief executive officer of HRC Advisory. “It has grown faster, and has taken more market share.”
Still, public retailers have been optimistic and continually tout the growth of their online efforts. But industry analysts have speculated for the past year or so that investments in e-commerce could be chipping away at brick-and-mortar sales.
Now there is evidence supporting that notion.
In his latest retail thought leadership study, titled “Retail’s Unspoken Issue: Online Shopping is Eroding Retailer Earnings,” Karabus analyzed financial data for 11 department stores and luxury chains with aggregate sales of $126 billion as well as 22 specialty apparel and beauty stores with $67 billion in total sales. He also included four off-price retailers with aggregate sales of $49 billion. Karabus, who describes himself as “passionate about retail” while also being a “facts guy,” also conducted live interviews with 15 retail executives.
Karabus’ conclusions were eye-popping: earnings before interest, tax, depreciation and amortization as a percent of sales have declined 25 percent or more for many retailers “as a direct result of the shift from in-store to online sales, combined with the high additional investments that have been made to enable e-commerce and omnichannel capabilities and the much higher variable cost of servicing, completing and fulfilling e-commerce transactions.”
Karabus noted that the aggregate, additional investments made in supply chain upgrades, digital marketing and IT, variable logistics costs and managing “the high level of returns for e-commerce” is generating incremental selling, general and administrative costs of 2 to 3 percentage points of sales. The cannibalization of sales at physical stores from online channels along with real estate and wage inflation “have been the primary drivers of the reduction in retailer EBITDA as a percent of sales,” Karabus added.
He also noted in the study that free shipping and returns are done as a “way for retailers to protect and even enhance market share against both other traditional retailers and the pure-play retailers such as Amazon, but have become an increasingly serious cost issue as retailers find that unwanted e-commerce orders are at times returned to stores late or in unsalable condition and often need to be returned to a fulfillment center for assessment, remediation/steaming prior to being made available for sale again potentially at a markdown.”
Earlier this year, in a separate report from EKN Research (working in partnership with Aptos Inc.), it was revealed that fulfillment costs alone garner 18 percent on each dollar of sales to “satisfy today’s customer expectations of buy-anywhere, pick-up anywhere.”
The analysts at EKN and Aptos applied the 18 percent metric to the $3.07 billion of estimated online sales from last year’s Cyber Monday and it showed that U.S. retailers “would have spent $540 million on that one single day to get their products into customers’ hands.”
That said, Karabus also strongly feels that retailers did the right thing by making early, massive investments into e-commerce — even if it seemed like it was hastily done. “They did not have a choice, they had to rush in and build their market share as Amazon continued to experience massive growth,” he said. And even now, retailers that are scaling back on cost structures and even experiencing reductions in workforce “are again doing the right thing because they are fine-tuning their strategies in order to right-size their economic models,” Karabus added.
And contrary to other analyst reports calling for widespread store closures to address declining sales, Karabus urges caution and for retailers to avoid “reactive actions,” and to be more thoughtful and strategic. Moreover, taking an omnichannel approach is likely the smartest thing retailers can do.
“While an increasing number of stores’ profitability has declined due to transfer of sales from stores to e-commerce, e-commerce volumes are not yet sufficient to justify store closures, especially when the candidate stores for closure have not reached lease expiration and the stores are likely still cash flow-positive,” Karabus explained in his report. “As many stores have significant lease termination obligations, the cost to close these stores is significant.”
It’s also important to consider that online sales were robust in the early years, but Karabus’ analysis shows a clear deceleration of growth. For the department stores tracked, for example, online sales growth went from 39.3 percent in 2012 to 18.6 percent in 2015. E-commerce growth was essentially flat for off-pricers, and it’s worth noting that this segment has made little investments in e-commerce (and, in turn, also have a low online-to-total sales ratios).
For the specialty segment, online sales growth went from 17.5 percent in 2012 to 9 percent last year. And for all the sectors studied, online sales growth dropped to 10.4 percent in 2015 from 16.3 percent in 2012.
Karabus praised omnichannel-enabled retailers who are meeting the heightened expectations of today’s “digitally savvy consumer.” An omnichannel approach allows shoppers to engage with retailers “across channels when, where and how they wish to” while the retailer provides the “varied fulfillment models to meet and exceed customer needs,” which garners additional sales, and cuts the “level of stranded and aged inventory,” he said.
“The new capability of providing complete visibility of chain-wide inventory availability to fulfill customer demand whether online or in a store can potentially be lucrative in reducing markdowns and improving inventory performance,” Karabus said.
Karabus also included several recommendations in his report to help “mitigate and hopefully offset the negative impact of e-commerce on [retailers’] operating earnings and return to their historically higher profit performance from brick-and-mortar stores.”
This includes: becoming more efficient omnichannel operators; re-examining cost structures of physical stores; reconsidering and introducing more nuances into free shipping and return policies to staunch the losses from extremely high variable fulfillment costs; maximizing inventory controls and efficiencies; and re-examining their support infrastructure.
“The omnichannel approach will be key because it provides the ability to rescue stranded inventory,” Karabus said. “The growth of e-commerce has changed everything. Retail was once largely a fixed cost business. Now with online sales, which rely on very high cost-fulfillment expenses and high return rates…[retail is evolving] into a variable-cost model. And that requires new approaches to how the retailer’s economic business model should be reimagined in an effort to return to historic profitability levels.”
Karabus said omnichannel retailing has the potential “to make strong retailers even stronger, while they increase market share from the weaker performers that have filed for Chapter 7 and/or 11, or have downsized and are facing difficulties.”
“While omnichannel is very costly if it is largely shifting sales between channels, it can be very rewarding if it is garnering incremental sales that would have previously gone to other retailers,” he said. “We live in exciting times, which are not for the faint of heart.”
Online Sales to Total Sales %
Segment: 2011: 2015:
Department Stores 8% 15.5%
Off-Price 0.6% 0.7%
Specialty Apparel 11.8% 17%
All Sectors 7.8% 12.9%