I recently read an article in the Wall Street Journal (WSJ) about Les Wexner and his belief in the physical store in retail. In the article Mr. Wexner asserts that people are social creatures and will continue to go to physical stores in part because they crave social interaction. In the same article he discussed that consumer’s fascination with smart phones was at a peak and would begin to fade.
I had the pleasure of working with Mr. Wexner and L Brands for nearly 5 years before I retired. He is highly intelligent, driven, thoughtful, curious, and more focused than perhaps anyone I have ever met. I learned a tremendous amount about specialty retail from Les Wexner and will always be grateful for that experience.
I agree with Mr. Wexner that people will continue to go to stores if the retailers can make the experience compelling, fun, and fruitful. Stores, especially for those products that are not commoditized, will continue to be the avenue many choose to discover, experience, and purchase products. As Mr. Wexner points out, people have gone to the markets for over 5,000 years and will continue to do so.
With all of that being said, what is the store’s role? Traditionally, a physical store is responsible for providing products the customer’s wanted for a specific geographic area or market. I don’t expect this traditional role to change. However, HOW the store provides the products will dramatically change in the coming years.
Yes, that is a bold proclamation and one that perhaps many would dispute. So before you stop reading this article, let me elaborate. Notice, nowhere in the traditional role of the store did we state how the store fulfilled demand. We naturally assume a customer walks into the store, selects the products they want, goes to the POS, pays, and leaves. That is one way. Now let’s explore some other possibilities.
Today, I live in small community of less than 20,000 people approximately 25 miles north of the major metropolitan area of Charlotte, NC. Yet, I can choose from over 1 million items on Amazon and get them the same day. As the number of items available for same day fulfillment grows, people who value convenience over experience find another reason to stay away from a physical store.
Often people will point to Amazon’s investment in approximately 150 distribution points throughout the US as the key to their delivery performance. Yes, that is a lot of distribution points. However, there are well over 100 retailers with more than 150 physical stores throughout the US. How many of those retailers use their store inventory to fulfill on-line orders from their local markets? How many handle the final mile of delivery to the customer’s house?
Inventory typically comprises a significant portion (as high as 50%) of current assets for most retailers. Inventory productivity is critical to improving revenues and gross margin performance. If you don’t have enough inventory to satisfy customer demand you lose sales. If you have too much inventory, you have to mark it down at the end of the season to move it and erode gross margins. The balancing act to maximize sales and minimize markdowns is conducted universally in retail every day. Yet, most retailers still look at inventories by channel (physical store, on-line). How many sales do retailers lose each year simply because the product a customer wants isn’t available at a given physical location (but exists at other places in the retailer’s chain).
Many retailers have a centralized hub of inventory specifically earmarked for their e-commerce (on-line) channel. Consider the following scenario. A customer is in Seattle, WA. They order a product on-line that is in the retailers e-commerce warehouse in Chicago, IL. The customer wants next-day delivery. The retailer responds by using a very high priced expedited delivery to get the product from Chicago to Seattle. This delivery service charge is either passed on to the customer, or it reduces the overall profitability of the sale. All the time, the same product is sitting in the retailer’s Seattle store only a few miles from the customer. Sure, we can offer the customer the option of picking the product up in the store, but what about customers that don’t want to go to the store? How do retailers offer Amazon like fulfillment in a cost effective way (for the customer and for the retailer)?
Using this same thought, what about retailers with multiple outlets in the same market? A customer is in the store, they want a product, but the store doesn’t have it. In the majority of the cases the customer leaves the store disappointed and goes to a competitor’s store in the same area to find a substitute. Using the same philosophy as fulfilling e-commerce orders the retailer can now arm the associate with a different option. “We don’t have the product you want. However, we can have it at your house by 5:00 pm today. Will that work?” Leveraging the other store (or stores) in the market, the associate is able to promise same day convenience to the customer. Yes, you can offer pick-up in the other store as well, but again, the ultimate convenience is not asking a customer to drive out of their way to get what they want.
Let’s recap this. Using local store’s in the e-commerce fulfillment process allows retailers to offer same day convenience to customers without dramatically increasing shipment costs and eroding profits. Secondly, in markets with multiple outlets, retailers can now leverage the market’s inventory to satisfy customer needs in the most convenient manner. Finally, if the inventory does not exist in the market, the option of shipping from other locations (distribution centers or stores outside the market) can be leveraged to satisfy the customer.
In retail, there are a number of productivity measures used to evaluate store performance. One is conversion rate, which is the number of purchase transactions (invoices) divided by the number of customers entering the store (aka “traffic”). Another is average ticket (invoice), which is the total dollar volume of sales (revenue) divided by the number of invoices. A third measure is revenue per visit (how much money do we make every time a potential customer walks in the door). This is simply the store’s revenue divided by traffic. However, you can get the same result by multiplying conversion rate by the average ticket. The table below shows these measures and an example of the metrics for a single day in a store.
- (a) Sales: $4,000
- (b) Traffic: 300
- (c) Invoices: 85
Metric Value Formula(s)
- Conversion 28% (c)/(b)
- Avg. Ticket. $47.06 (a)/(c)
- Rev. Per Visit $13.33 (a)/(b) or (((c)/(b))*((a)/(c)))
The idea is very simple. Every time a customer walks into your store you want to sell them something. Ultimately you can drive Revenue Per Visit higher in a couple of ways. (1) Convert more customers or (2) Increase the average ticket (increase the number of items being sold or increase the value of the items being sold).
In the example above, the store receives $13.33 for every customer that walks in the front door of the store. Let’s assume the store receives two online orders to fill at the same average ticket value ($47). The result would be a 29% conversion and revenue per visit of $13.65. Replicate that over a full year, and across a chain, it begins to become quite significant.
Yes, this is a very simplistic example. Some will argue that I am not accounting for the shipping cost to the customer. However, these costs, for a local delivery, will be significantly less than shipping from a centralized warehouse hundreds or thousands of miles away. What about labor? Ah, let’s get to that.
The second largest expense, behind inventory, for most retailers is store labor. A favorite metric for most retailers is percentage of labor dollars to sales. “Leveraging” store payroll is when sales rise faster than labor. Again retailers work hard to find an optimal mix of labor, just like inventory. Too much labor with low sales de-leverages payroll. Not enough labor can impede a store’s ability to drive revenue.
In our example above, we don’t assume we need additional labor to handle the two additional orders. As a result, the revenue increases and the labor dollars remain unchanged. In other words, we leverage payroll. Of course if a store is inundated with online orders there may be incremental labor needed. However, if a store reaches the volume of orders needed to drive additional labor it should be seen as a good problem to have.
Some will argue that moving a shipping process to stores increases the likelihood of inconsistencies in order fulfillment. There are validities in this argument. However, these risks can be mitigated if the retailer does their homework up front. Some may argue that we don’t increase revenue across the chain by using this model. They will argue that we simply move revenue from on-line into the stores. My counter to this is that this model will increase the percentage of inventory sold at full price versus being marked down. In addition, it will significantly decrease phantom stock outs (when the product exists in the chain, but a customer can’t find it). I.e., I do believe this model can increase top line and decrease freight if executed correctly.
What is the homework I spoke of earlier? Below are ten items retailers will need to account for in order to operate in a distributed fulfillment model.
- Improve accuracy of node (store) level inventory.
- Create a real time process to update a central repository of inventory by location and SKU (stock keeping unit).
- Implement an order routing model that can account for many inventory nodes and optimize multiple factors (available inventory, length of delivery, freight, etc.)
- Understand geographic origins of current online demand by product line and use this to change store allocation models to account for online demand.
- Build a financial model and associated monitoring metrics to determine if the model is working as planned.
- Determine impact to store metrics (inventory turnover, revenue sharing with online, etc. e., how does the new model impact traditional metrics?)
- Create quick pack models to make it easy for stores to pack product for shipment.
- Pilot the model in a market (perhaps a district or region) to gauge customer receptivity and how stores interact with one another.
- Negotiate “final mile” delivery contract(s) for all store locations.
- Deploy chain wide and promote your new capabilities.
Depending on the retailer, any one (or all) of these items could be a significant task. For example, improving inventory accuracy will mean developing an understanding where inaccuracies occur in the supply chain/store and closing the gaps. Order management and routing, which would encompass centralized inventory management, is likely the largest technology component that most retailers would have to undertake to prepare for a distributed fulfillment model.
Retailers are all at different points in their evolution. The key to making a distributed fulfillment model work is to anticipate the issues, take steps to mitigate the issues, test, and learn.
Using this model opens up a world of possibilities for retailers. It offers the ability to leverage their substantial investment in brick and mortar locations, it will dramatically improve inventory productivity, it will leverage labor, and it offers significantly improved convenience for customers. The model also sets up nicely for providing subscription services (but that is a topic for another article in the future).
Finally, getting back to how I opened this article. Les Wexner pointed out in the WSJ article that he believes the “fascination with the smartphones will fade.” On this point, I very much disagree. We are now dependent on mobile technology for so many elements of our day-to-day life. Text messages, social media, access to the anything on the Internet at any time, calendars, email, directions, music, photos, news and stock updates, sports updates, games, and this list could continue for a long time. Major investments are underway to 5G networks that will offer 10x the speed of current 4G LTE networks. We are just touching the surface on augmented and virtual reality on smart devices. While the form factor may change, mobile technology does represent a new norm in the way humans work and interact and there is no going back.
Smart retailers will not view mobile as competition to the physical store. They should view mobile as a means to augment the physical shopping experience and to leverage new capabilities to create an engaging and convenient experience. Combining the power of mobile technologies with a flexible distributed fulfillment model offers new levels of service that will define the new norm of retail in the coming years.