December 29, 2014

2014 Year In Review: How Omnichannel Will Impact Retail Markets

This question came to me from one of our loyal followers:

Question: How will omnichannel be bad for a retail market? We are creating new markets (e-commerce, mobile, social), and that will yield more customers. Omnichannel will result in sales growth, not in a sales decline. How can you miss this simple fact?

In order to understand how omnichannel will play out, we have to understand how profit impacts Executive decisions. In order to do this, we need to look at a retail market over time, and we need to understand what happens to a retail market when a store closes.


Ok, let's evaluate a retail market ... let's pretend that you have two stores in Des Moines, Iowa. Let's compare the market in 1995, and then in 2015.

In 1995, we observed the following:

  • Store #1 = $1,600,000 sales.
  • Store #2 = $1,200,000 sales.
  • Total Sales = $2,800,000.
  • Gross Margin = 35%.
  • Contribution = $980,000.
  • SG&A = 25% of sales, or $700,000.
  • Earnings Before Taxes = $280,000 ... 10% of net sales.
Now, in 2015, marketing conditions changed, obviously. This market now generates 20% of sales via e-commerce. Retail comps are up about 10% over the past twenty years, but skewed to Store #1 ... Store #2 is in a retail location that is not as "upscale", so-to-speak.

  • Store #1 = $2,080,000 sales.
  • Store #2 = $1,000,000 sales.
  • Total Sales = $3,080,000.
  • Gross Margin = 35%.
  • Contribution = $1,078,000.
  • SG&A = 25% of sales, or $770,000.
  • Earnings Before Taxes = $308,000 ... 10% of net sales.
  • E-Commerce = $616,000.
  • Gross Margin = 35%.
  • Contribution = $215,600.
  • SG&A = 20% of sales (less than in retail), or $123,200.
  • Earnings Before Taxes = $92,400.
  • Total Market Sales = $3,696,000.
  • Total Market Profit = $400,400 ... 10.8% of net sales.
On the surface, it looks like everything is better. The market had a 32% sales gain over 20 years, profit dollars increased, and profit percentage increased.

However, somebody in the Finance department is looking at individual store profitability. They don't like Store #2, and for good reason. That store generates $350,000 of gross margin dollars, but has an SG&A of $335,000. Store #2 is essentially at break-even. And if trends continue, this store will be unprofitable.

So as the business becomes increasingly "omnichannel", the lowest performing stores are exposed as being unprofitable. These stores will be closed.

It's been my experience that when a store closes in a multi-store retail market, between 60% and 70% of the sales at that store disappear. They're gone. In a single store market, between 70% and 85% of the sales at that store disappear.

In our case, let's assume that 70% of the sales in Des Moines Store #2 disappear, if the store is closed. 30% of the sales will remain ... 15% will transfer online, 15% will transfer to store #1. Now let's evaluate what the market looks like:
  • Store #1 = $2,080,000 + $1,000,000*0.15 = $2,230,000 sales.
  • Store #2 = $0 sales (store is closed).
  • Total Sales = $2,230,000.
  • Gross Margin = 35%.
  • Contribution = $780,500.
  • SG&A = $450,000 (some of the expenses in Store 2 move to Store 1, not much).
  • Earnings Before Taxes = $330,500 ... 14.8% of net sales.
  • E-Commerce = $616,000 + $1,000,000*0.15 = $766,000 sales.
  • Gross Margin = 35%.
  • Contribution = $268,100.
  • SG&A = 20% of sales (less than in retail), or $153,200.
  • Earnings Before Taxes = $114,900.
  • Total Market Sales = $2,996,000.
  • Total Market Profit = $445,400 ... 14.9% of net sales.

Do you see what #omnichannel does to the Des Moines market?
  • Omnichannel resulted in market growth from $2.8 million to $3.7 million.
  • However, omnichannel rendered the weak store unprofitable. Once the unprofitable store is closed, sales drop from $3.7 million to $3.0 million.
  • The store closure improves profitability from $400,400 (10.8% of sales) to $445,400 (14.9% of sales).
On the surface, omnichannel will result (has resulted) in sales increases. Folks love this.

But omnichannel exposes unprofitable store locations. Sales are shifting from low-performing stores to high-performing stores. Sales are shifting from commodity items in stores to commodity items in e-commerce.

When low-performing stores are rendered unprofitable by omnichannel, they will be closed. When these stores are closed, only a fraction of the sales are recouped. However, company profit will increase.

Over time, omnichannel will expose low-performing stores, forcing them to close, causing an actual sales drop coupled with a profit improvement.

What omnichannel is doing, then, is exposing the fraction of your retail sales that are truly generating break-even or worse performance. Omnichannel will then, ruthlessly, cause low-performing stores to close. At that time, e-commerce will not make up the difference, causing a sales decline and a profit increase.

Omnichannel's logical outcome is the ruthless elimination of unproductive and underproductive and unprofitable retail sales.