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.

4 comments:

  1. Anonymous3:13 AM

    Kevin, as usual you do a nice job of laying out the general dynamics of the issues you are discussing and I agree that many retailers are talking the general approach you cite. But I don't quite agree that omnichannel's logical outcome is as you state.

    First, the right way to do the analysis is to focus on customer segments and whether they are profitable or not. This doesn't totally eliminate the need to look at store level economics, but it will give a different take on whether closing a store is accretive to the company or not.

    Second, as I've pointed out in my blog post "The future of omni-channel will not be evenly distributed"--and more broadly in my speaking and such-- "omni-channel" is a huge step forward in customer-centricity and for that reason it gives great potential advantage to some brands in some situations. I bristle more than a bit when you seem to be relentlessly negative about omni-channel. Moreover, it's sort of beside the point. Making a brand available anytime, anywhere, anyway is happening. Resistance is futile. Being mindful of how it will impact different customer segments and categories and choosing how to best respond is what matters.

    ReplyDelete
  2. I always freely admit that my point of view may be wrong.

    But I have mined billions of transactions, at a customer level (not at a segment level), measuring customer-level profitability, leading me to this conclusion.

    You can use your generous smarts to move the industry away from this outcome. It doesn't have to turn out this way. That's why I share this outcome - to kick-start people toward creating a profitable future. Go use actual purchase transactions (do the work) and measured individual customer profitability and create the outcome you want to see.

    Go do it!!!

    Read what publicly traded retail businesses are saying in their financial documents. Pier 1 has publicly stated that 60% of their leases are coming due, and that "omnichannel efficiences created by changing customer behavior and e-commerce growth gives them the flexibility to close locations in poorly performing locations". That's the very reason I write this stuff. Why criticize me when retailers publicly outline the very math I shared in this blog post?

    I realize that people have a financial incentive to argue against the data I analyze. I'm not negative about omnichannel. I'm negative about the unanticipated outcomes that omnichannel (and the former multichannel buzz word) strategy leads to. Having lived through this with catalogers, it was unnecessarily painful. Now the same thing is happening to my retail clients (read what publicly traded retailers are saying about closing store locations because of omnichannel efficiencies).

    ReplyDelete
  3. What am I missing - omnichannel delivered more profit for the business (although some people lost their jobs)... thats a good thing right? Or are we worried about poorer performances in the future / loss of economies of scale?

    ReplyDelete
  4. The omnichannel thesis repeatedly states that because you have more channels, your sales will grow, unfettered. Across my client base, that's not what is happening. My clients are finding that as online sales increase, retail traffic decreases, causing underperforming stores to perform worse, causing those locations to increasingly be closed when their leases are up. When those locations close, profit does increase, which is good, but sales as a result decline (opposite of the omnichannel thesis).

    If you are a fan of optimizing business performance, you'll love this.

    If you are constantly telling my clients that their business will grow because of omnichannel strategies, that is increasingly going to be a problem.

    ReplyDelete

Note: Only a member of this blog may post a comment.