Drapers investigates the real costs of running an online operation for fashion retailers, and analyses what steps retailers can take to make the most of this fast-growing route to market.
Ecommerce has long been heralded as the saviour of UK fashion retail: a rapidly growing and cheaper alternative to the fixed costs of bricks-and-mortar stores that can weigh so heavily on retailers.
Almost every business Drapers speaks to reports that online is their fastest-growing channel, and this is backed up by the statistics. More than half (53%) of all retail sales will be made online in less than 10 years’ time, up from 19.2% currently, a report from Retail Economics predicted last month.
Stores may come with the burden of rents and rates, but a successful digital business can require equally heavy investment in customer acquisition, fulfilment and, of course, the perennial problem of returns.
Consumer appetite to discover and purchase fashion online is high and growing, resulting in the fashion category moving online at a very rapid rate
Anita Balchandani, McKinsey & Co
The UK is the biggest ecommerce market in Europe, research from investment bank JP Morgan shows, and it is expected to grow by 9% to €231.2bn (£208bn) by 2021. However, that growth is not as fast as it once was. Online retail sales registered their lowest-ever growth in the first half of 2019, up just 5.4% year on year, compared with a 16.9% rise in the first six months of 2018. As costs rise but growth slows, retailers are re-examining their digital strategies to ensure maximum profitability.
“The economics of online and the potential to make it profitable vary widely from sector to sector,” says Anita Balchandani, partner leading apparel and fashion at McKinsey & Co. “On the one hand, consumer appetite to discover and buy fashion online is high and growing, resulting in the category moving online at a very rapid rate. The conundrum is that it can be difficult to make money online in fashion.”
The CEO of a high street womenswear retailer tells Drapers: “When the ecommerce boom first happened, everyone thought it was a free channel. It is not a free channel. It should absolutely be profitable, and I would advise any retailer running a loss-making website to close it.” One UK department store is said to have told suppliers that any online order under the value of £30 is unprofitable.
Next estimates that every pound that moved from stores to online last year cost an additional 6p in overheads such as warehouse picking and delivery. In its 2018/19 results, the retailer said “the digital evolution has not been easy and nor is it without cost”.
Even the sector’s trailblazers can be knocked sideways by the cost of doing business online. Etail giant Asos was forced to issue its second profit warning in seven months in July after it was hit by £47m in costs from overhauling infrastructure and technology in its US and European warehouses.
“Brands and retailers are learning that building and maintaining a web store is expensive,” notes Erica Vilkauls, former CEO of premium retailer LK Bennett. “You need to fulfil orders and process returns, create a single view of stock, integrate your warehouse management systems, have an online marketing plan and use influencers effectively.”
Nevertheless, many retailers do make a profit online. Boohoo, for example, continues to enjoy soaring growth: revenue was up 39% to £254.3m for the three months to 31 May.. Pre-tax profits soared by 38% to £59.9m in the year to 28 February 2019.
Drapers counts up the hidden costs of online retail.
Returns: “the big profit killer”
Asos hit the headlines earlier this year when it changed its returns policy, and threatened to blacklist customers it suspects of consistently wearing and returning goods. Serial returners can be a thorn in retailers’ sides, but, as McKinsey & Co’s Balchandani stresses, most customers are returning products for entirely legitimate reasons.
Genuine or not, returns are one of the key costs when it comes to operating online.
“A very high percentage of fashion orders placed will be returned,” Balchandani says. “This varies by subcategories but, in a category like dresses, a retailer could have a returns rate of anywhere between 30% and 50%.
The fact is that it is convenient for customers to buy online and try at home, so they might buy two different sizes
Anita Balchandani, McKinsey & Co
“Yes, there are serial returners, but the fact is that it is convenient for customers to buy online and try at home, so they might buy two different sizes.”
She stresses that the answer is not to make the returns process for customers more difficult, because a competitive, speedy returns process is a “central component” of a modern fashion retailer. However, retailers should analyse data to proactively manage down returns rates, and use clear photography, product details and copy to help customers find products more likely to suit them.
Vilkauls tells Drapers: “Returns can be the big profit killer. Reducing returns is a surefire way to cut costs, but how do you do it? I’ve heard from several ecommerce directors that their returns rates are north of 70%. This alone kills any profit. Many customers buy with an explicit plan to immediately return some or all of their items. That isn’t going to change, so the returns process needs to be quick and slick, so retailers can get product back quickly and free up the stock to sell.”
Returns can be the big profit killer. Reducing returns is a surefire way to cut costs, but how do you do it?
Erica Vilkauls, former CEO of premium retailer LK Bennett
She adds that to cut down on returns, retailers need to elaborate on product descriptions, use as many product pictures as possible, and, ideally, add video to product pages. They should also provide good size guides, encourage product reviews and work with the best couriers to ensure an efficient delivery service for customers.
“Returns are part of the online model and there are a lot of things retailers can do – such as providing as much product information as possible – to reduce returns,” the high street CEO agrees. “Free returns are a given at the moment, but there have been some examples of retailers introducing a nominal return fee [last year, Next introduced a £1 returns fee when a courier is used to collect items], so it will be interesting to see how that trend develops.
“This is definitely an important space for optimisation, particularly as the popularity of “buy now, pay later” services, such as Klarna and Afterpay, are driving even higher returns, as customers don’t even have to pay when they order.”
The online boss of one high street supplier notes that one large retailer has scaled back on offering customers free returns and delivery. He predicts that retailers will become increasingly conscious about the costs of online retail in the future, adding that a more personalised, curated offer could help reduce returns.
“When you look at the high street, retailers are struggling to turn the sales they make online into profits,” he says. “The notion of editing is going to become more important. Part of the problem is that when customers go online, there’s just so much choice. That means returns rates are really high. Retailers need to become more edited and really curate their offer to their customers, which should result in few mistaken purchases that customers then choose to return.”
Delivery: “the biggest cost”
Online shoppers expect to go from clicking “order” to holding the product in their hands as quickly, conveniently and cheaply as possible.
“The biggest cost coming to retailers online is delivery,” observes Jeremy Wilson, chief commercial officer of ecommerce consultancy Practicology. “Technology costs are certainly there, marketing costs are escalating, but the real arms race across the whole customer proposition is around delivery. That has been led by Amazon, which has paved the way by offering free next-day delivery and even same-day delivery for Prime members.”
As consumers become more and more accustomed to buying online, they are making frequent but small orders that can eat into retailers’ margins.
“Fashion is a sector where customers often place very frequent orders for small values,” explains McKinsey’s Balchandani. “The cost of picking, packing and dispatching an order worth £20 or an order of £100 is the same. If everyone was spending £100 an order, the economics of ecommerce would be better, but that’s not how customers are behaving.”
Free shipping is a very costly model. We don’t offer free shipping unless it is over a certain order value threshold
High street retailer boss
To try to mitigate the cost of delivering to customers’ homes, retailers are doubling down on click-and-collect services. Many choose to offer free in-store click and collect but charge for home delivery, but even here there are costs. John Lewis introduced a £2 charge for click-and-collect orders under the value of £30 in 2015. At the time of writing, House of Fraser is offering customers who choose to collect their online order in store a £10 voucher.
“We’re seeing a big increase in click-and-collect incentives designed to get customers to pick up and return in store, because of the upselling and cross-selling opportunities,” adds Wilson.
To build a successful – and profitable – returns strategy, retailers need to assess what is important to their customer and what is driving their purchasing behaviour.
“Free shipping is a very costly model,” the boss of one high street retailer tells Drapers. “We don’t offer free shipping unless it is over a certain order value threshold and we have a subscription service where customers can pay for unlimited next-day delivery. Our approach is to work out what is a good deal for our customers that is also something we can afford to offer. That also allows us to offer free delivery promotions at key times of the year.”
Shifts in consumer behaviour could also change how much deliveries cost retailers. There is an increasing tension between the hefty carbon emissions created by delivery vans and lorries travelling up and down the country, and the pressure on the sector to become more sustainable. Retailers could kill two birds with one stone, helping the environment and cutting costs, by developing partnerships.
“Lots of retailers want to be more sustainable and do some good for the world, but the ecommerce model is about frequent buying and regular delivery, which is in conflict with the sustainable agenda,” explains Bhavesh Unadkat, principal consultant at professional services firm Capgemini. “Retailers could be proactive and educate customers about the environmental impact of smaller orders or take a peer-to-peer approach that would also cut costs. If retailers all have deliveries going to the same street, why not work together and pool resources rather than each send a van?”
The high street boss agrees: “I do think that some time in the next decade we’ll get off the consumption drug we’ve been on and question whether it is right that, for the sake of speed and wanting something tomorrow, we’re destroying the planet. It is only right that retailers respond to concerns about sustainability but that does come with a lack of convenience.”
Customer acquisition: the cost of key words
Without the visual presence of high street store fronts, retailers need to invest in drawing shoppers through their virtual doors. The costs of customer acquisition are on the rise and standing out from the crowd in an increasingly competitive market is not easy and can be a huge drain on retailers’ resources.
Next, for example, has ramped up investment in its website and marketing capabilities after admitting it had “fallen behind the best in the sector”. The retailer spent £36m on digital marketing this year and expects to splash out £46m in 2020, compared with £19m in 2018 and just £8m in 2016.
Battling to attract customers can also take a toll on a business’s bottom line. Fast fashion retailer Quiz blamed “increased costs associated with obtaining and servicing online customers” as one of the factors behind a 97% plunge in profits to £200,000 in the year to 31 March 2019.
The dominance of powerful platforms such as Facebook, Instagram and Google in the world of online advertising can lead to high customer-acquisition costs.
“Around 80% of our business comes from online, and most of our marketing budget goes on customer acquisition,” explains Joel Jeffery, CEO and co-founder of luxury pyjama brand Desmond & Dempsey. “Paid social, like Facebook and Instagram, drives our customer acquisition.”
Retailers can use paid search to ensure their website to appears when customers search for particular words or phrases on platforms such as Google.
“These are super-heavyweight platforms that a lot of retailers have to advertise through and as a result, there can be a full-scale bidding war on the key terms customers are searching for,” Capgemini’s Unadkat argues. “Ten years ago, the online terms retailers were bidding on might have cost 25p or 30p. Now, they might cost £6 or £7. Retailers need to scrutinise every penny of what they’re spending and be disciplined if key words or campaigns are not delivering return on investment.”
Quite often, retailers might be paying three times for the same customer
Jeremy Wilson, chief commercial officer of ecommerce consultancy Practicology
Vilkauls agrees: “Retailers need to ensure they understand which activity is driving what and the resultant profitability. Calculate the return on investment to ensure that it is not only revenue growth but margin growth that is being achieved. This will mean marketing is effective.”
Practicology’s Wilson stresses that retailers need to spend as much time, money and effort on customer retention as acquisition.
“When you look at the structure of a retailer’s P&L [profit and loss account], the costs of returns and delivery is high, and marketing costs are another big one. Retailers tend not to be as good at retention as they are acquisition. Quite often, retailers might be paying three times for the same customer: they might come to your website via a paid search query, through a voucher code website or a paid link. There’s a lot of focus on paid search and paid social, without the same focus on re-engaging those who have already purchased and are driving lifetime value. That’s something a lot of retailers could do better.”
As Capgemini’s Unadkat concludes: “Retailers need to able to use data and insights to truly measure the performance of their businesses. They need to scrutinise every penny and challenge every process.”
The Drapers Verdict
Online can be a valuable – but potentially costly – channel for fashion retailers. Convenience means this is increasingly many shoppers’ channel of choice and retailers need as many touchpoints with customers as possible to stay competitive in today’s landscape. A good digital offer needs investment to keep up with customer demand and stay ahead of the pack. Retailers need to keep tight control of what is being spent and where to maintain profitability. Using data can be a key tool in their arsenals.
Many retailers are able to make a profit online and it is a brave business that chooses to shun ecommerce altogether. The only high street giant not to have a transactional website is Primark, which eschews ecommerce because the cost of doing business online would eat into the profit margins of its low-cost product. However, for most, not having a digital offer is unthinkable.
Rising costs combined with slowing growth rate could pose a problem for the sector. To combat this, retailers need to be strict about how and where they are spending.