eCommerce and its Profitability Issue. Why its So Hard to Make Money
eCommerce is expensive. When you shift activities consumers used to complete on their own to a retailer, someone has to pay for it. Think about the last time you made a purchase online, say for groceries from Walmart. Walmart picked, packed and delivered that order to you all while you sat patiently or not so patiently and waited for your order to arrive. Even if you paid a delivery fee it is often not enough to cover those expenses. A study by the Capgemini Institute found that on average retailers charge their customers just 80% of the cost of delivering goods. 97% of those surveyed in the same study said that grocery delivery models are “unsustainable” without finding other avenues to eliminate costs.
The irony of online shopping is that the most economical model for a retailer is when customers are not purely online shopping at all. As Bloomberg reported: “if retailers can continue to convert a meaningful portion of that demand into pickup versus delivery, it will provide an offset to the inherently higher supply-chain operating costs of a digital model.”
If getting the order to you is expensive what about returns? Raise your hand if you have ordered multiple versions of the same outfit in different sizes because you don’t know what your size is at a particular retailer. This process of ordering and returning goods is very expensive. Take mattress retailer Casper. In 2018 Casper spent $80.7 million on “refunds, returns, and discounts”. Since Casper launched in 2014 it has yet to make a profit. High marketing costs are one reason for Casper’s struggles but returns have also eaten into the brand’s profitability. It is estimated that the return rate for returns of online orders is three times that of orders made in store. For categories like clothing and shoes the return rate is between 30% to 40%. It is also believed that returns cost retailers 10% of revenue. That’s a lot of money for an industry often characterized by thin margins.
Even when eCommerce drove growth for many retailers at the height of the COVID-19 pandemic some retailers decided not to jump on the eCommerce bandwagon. Trader Joe’s does not offer online shopping and does not plan to. Trader Joe’s defends its decision by saying: "customers are asking if given current circumstances [the pandemic] we're planning on offering delivery or curbside pickup," says Tara Miller, Trader Joe's vice president of marketing, in an episode of the company's podcast, Inside Trader Joe's, "we understand the impulse, and we know that some other retailers are offering these services. We also know those offerings don't always translate into positive results." "While other retailers were cutting staff and adding things like self-checkout, curbside pickup, and outsourcing delivery options, we were hiring more crew and we continue to do that. We know that this period of distancing will end, and when it does, our crew will be in our stores to help you find our next great product just as they've always been."
Reflecting on the challenges of selling online, Simon Roberts, Sainsbury’s CEO said that the pandemic led to “moving sales out of our most profitable convenience channel and driving a huge step-up in online grocery participation, our least profitable channel.”
Echoing this sentiment Jill Standish, Accenture’s Global Head of Retail has said: “if you had done 15% of your business online and now all of a sudden you’re doing 50% of your business online, boy, that’s a cost of doing business that you didn’t plan for. You might see a lot of volume, but you’re not going to see a lot of profitability.” While Walmart has made impressive gains in its eCommerce business it is not immune to the challenges of selling online. In 2019 Walmart’s eCommerce business lost an estimated $2 billion.
While everyone is trying to be the next Amazon it’s important to realize Amazon struggles with profitability in its eCommerce business as well. In the past Morgan Stanley has estimated the average order value for a one day shipping order from Amazon is $8.32. But it costs $10.59 to fulfill and ship that order which means Amazon loses money on many orders. In 2009 Amazon’s shipping and fulfillment costs were 15.6% of sales. But by 2021 they were 32.3% of sales or $152 billion.
What’s most interesting about everyone’s quest to be the next Amazon is that Amazon isn’t just a retailer at all. At some point Amazon realized the challenges of having a profitable online business and began creating new and more profitable ventures.
In 2006, 12 years after Amazon went into business it launched Amazon Web Services (AWS). AWS is now the largest cloud infrastructure business in the world. It is also Amazon’s profitability engine responsible for 213.98% of Amazon’s operating income in the third quarter of 2022 despite only generating 16.2% of Amazon’s revenue. Amazon’s North American retail business had operating margins of -0.5% in the third quarter of 2022, while AWS’ operating margin was 26.3%. As a separate business it has been said that AWS could have a $500 billion dollar valuation. Not bad for a “retailer”.
Then there’s Prime. There are over 150 million Prime members which help to subsidize the cost of Amazon’s eCommerce business. Let’s not forget about advertising. Amazon’s advertising business generated $31 billion in 2021. Analysts estimate Amazon’s advertising business has margins as high as 75%. Having all of these businesses on top of a retail business makes it easier for Amazon to continue to grow and offer services like one day shipping.
Source: The Economist
While eCommerce continues to be popular, retailers have to come up with a business model with better margins. Iterating on a loss generating model isn’t going to work in the long run. If you look at the products and services Amazon has launched over the past two decades you will see how many experiments it has made to create a business model that supports and elevates its main retail business. "When [competitors are] in the shower in the morning, they're thinking about how they're going to get ahead of one of their top competitors. Here in the shower, we're thinking about how we are going to invent something on behalf of a customer." - Jeff Bezos
To do what Amazon has done seems impossible now. But at one point in time it was just a bookseller. What if Amazon thought that’s all it could be? The retailers that are fighting for their survival also need to expand their vision of who they are and what they can be or they are at risk of being left behind.
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Walmart has made a number of moves in recent years that show why it’s the number one retailer in the world. Its way forward is similar to Amazon’s in some respects. It is trying to grow its third-party marketplace. That’s the place where you can buy general merchandise items off its website. It’s a lucrative business because Walmart doesn’t have to incur costs to buy the merchandise but it takes a cut of sales. Walmart is also working on adding more advertising to its website, customers have likely noticed more ads are popping while they shop online with Walmart. It has also made a significant investment in grocery pick up with the service available at more than 3,500 Walmart stores.
Walmart also followed in Amazon’s footsteps when it launched Walmart+ which is largely a delivery subscription service. It’s no Amazon Prime but it will help to subsidize delivery costs. All of these initiatives have more promising economics. To win in eCommerce retailers can’t stick to their core business they have to develop more creative and profitable solutions to fund a business that is loved by consumers but is a drag on profits.