March 11, 2007

Under Pressure

Profit is being squeezed out of our multichannel businesses, especially in the online and catalog channels.

This is an example of what a reasonably healthy online/catalog profit and loss statement might look like today.

Demand $50,000,000
Merchandise Fulfilled $45,000,000
Returns $11,250,000
Net Sales $33,750,000
Gross Margin $16,875,000
Less Catalog Marketing $4,000,000
Less Online Marketing $2,000,000
Less Pick/Pack/Ship $4,050,000
Variable Operating Profit $6,825,000
Less Fixed Costs $4,050,000
Earnings Before Taxes $2,775,000
EBT As A % Of Net Sales 8.2%


This business generates $2.8 million profit on $33.4 million net sales, yielding a healthy EBT of 8.2%.

Then, the USPS elects to make mailing catalogs more expensive. If you simply absorb the cost of this increase, your profit and loss statement might look like this:

Demand $50,000,000
Merchandise Fulfilled $45,000,000
Returns $11,250,000
Net Sales $33,750,000
Gross Margin $16,875,000
Less Catalog Marketing $4,360,000
Less Online Marketing $2,000,000
Less Pick/Pack/Ship $4,050,000
Variable Operating Profit $6,465,000
Less Fixed Costs $4,050,000
Earnings Before Taxes $2,415,000
EBT As A % Of Net Sales 7.2%


The USPS increase takes a full percent of your Earnings Before Taxes.

Even more interesting, however, is the looming trend toward free shipping and free returns. Long-term, I don't think we can escape this trend. The customer will demand we provide this service for free. A customer will gladly pay $3.00 for a $0.60 cup of coffee at Starbucks, but she won't pay to have a dress shipped from Columbus, OH to her home in Portland, OR.

Free shipping and free returns will put a lot of pressure on the profit and loss statement. If free shipping and free returns drove enough top-line sales to offset the expense, every multichannel retailer would already be offering free shipping and free returns. Let's take a look at the future p&l, after absorbing the expense of free shipping and free returns.

Demand $55,000,000
Merchandise Fulfilled $49,500,000
Returns $14,850,000
Net Sales $34,650,000
Gross Margin $17,325,000
Less Catalog Marketing $4,360,000
Less Online Marketing $2,000,000
Less Pick/Pack/Ship $5,890,500
Variable Operating Profit $5,074,500
Less Fixed Costs $4,050,000
Earnings Before Taxes $1,024,500
EBT As A % Of Net Sales 3.0%


Ooops.

Free shipping and free returns are likely to increase the overall return rate, and reduce shipping and handling income, costing our business another $1.4 million of Earnings Before Taxes.

Remember, our business was generating $2.8 million in profit before the USPS increases, $2.4 million after, and maybe $1.0 million after having to move to free shipping and free returns.

Business leaders will be put in a difficult situation. Expenses will have to be cut, in order to maintain a healthy level of profit. I see two areas where this is likely to happen.

First, catalog circulation will be dramatically cut, mostly in low-productivity areas like prospecting. This is why you see our vendor community so up in arms.

The second area will impact the customer. Items with high return rates will not be featured in advertising, and may not even be offered at all, in an effort to lower the overall return rate. Free shipping and free returns will encourage customers to take more risks, but it will encourage businesses to take fewer risks to make the p&l work. Ultimately, the customer is going to lose the breadth of merchandise assortment she has grown used to.

Multichannel CEOs and CMOs: Start planning today for the pending pressure our profit and loss statements will face in the future. This is a good time to test free shipping and free returns (for an extended period of time, not just a few weeks in December), and project the financial impact this will have.

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