February 01, 2008

E-Commerce And Catalog Management Case Study: Managing Details

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Yesterday, we demonstrated how the little details make a big difference in the profitability of an e-commerce or catalog brand.

Unfortunately, few of us get to be a CEO, few of us get to learn this valuable lesson.

In our example, there are four metrics that require significant attention. Let's review each metric.

Merchandise Fulfillment Rate

This rate represents the percentage of merchandise a customer asked for that the merchant was able to deliver to a customer. Take a customer who orders over the telephone. She asks for three items, but only two are available, one item is sold out. The merchandise fulfillment rate is 2/3 = 67%.

The CEO uses this metric to understand how effective the inventory management team is at satisfying customer demand. If an item sells out, and the inventory manager is somehow able to procure additional merchandise, then everybody benefits.

There are problems with this metric. When business is bad, merchandise is always available. When business is great, merchandise is never available! So to some extent, the metric has an inverse relationship with brand success.

Online brands often fail to understand the importance of this metric. Customer advocates preach that online brands should "pull down" items that are sold out, so that the customer is not disappointed. It's great that a customer should not be disappointed, but it is terrible for next year's customer, because the inventory manager doesn't learn how much s/he "could have" sold.

Return Rate

Return rate measures how much merchandise is returned to the brand by the customer. This metric plays a disproportionate level of influence in the profitability of an e-commerce or catalog brand. A new CEO will look into different ways that return rates can be lowered. Are there indirect reasons why the rate increased, like merchandise preference skewing from low-returns items to high-returns items? Or are there direct reasons why the rate increased, like quality being lowered in order to improve gross margin?

Each brand has a return rate that is typical for the business model the brand manages. Within this range, brands can succeed or fail. The new CEO will try to eliminate the failures in returns, since every item that is not returned drives increased profit.

Gross Margin

Gross margin represents the difference between what a customer paid for an item, and the cost the brand paid for the item. Take a $100 item that the brand paid $40 to acquire. The gross margin is (100 - 40) / (100) = 60.0%. Now, take a $100 item that is on sale for $60. The gross margin is (60 - 40) / 60 = 33.0%.

Gross margin has a disproportionate influence on the profit and loss statement. When a business is failing, the CEO is required to liquidate or discount merchandise, in order to get rid of it. Consequently, gross margin will be low. When a business is succeeding, it can charge a premium for merchandise, driving up the gross margin.

Gross margin is also a reflection of the ability of the inventory management team to accurately forecast sales trends. When the inventory management team buys too much merchandise, regardless of business trends, merchandise must be liquidated, lowering the gross margin rate.

Pick / Pack / Ship Expense

This metric does not receive enough attention, yet is also important to the profitability of a brand.

This metric is defined as the cost to pick, pack and ship merchandise to a customer as a percentage of net sales. For instance, if a brand spends $10,000,000 delivering merchandise to your home, and generates $80,000,000 net sales, the rate is (10,000,000 / 80,000,000) = 12.5%.

Outstanding catalog and e-commerce brands drive this rate down relentlessly, via automation and efficiency. Other brands look for low-cost solutions, or look for shipping and handling revenue to offset delivery costs. Ultimately, automation and efficiency result in lower rates, and increased profit.

The new CEO will focus on these four metrics, seeking to drive all of these metrics toward historical best performance. The best leaders realize that as much as half the reason a catalog or e-commerce brand fails is due to mismanagement of these four simple metrics.