You Can't Make It Up on Volume!

Have you ordered groceries online? If you have, you may have found it incredibly convenient. However, new research confirms my intuition, namely that many retailers struggle to make online grocery sales profitable. Knowledge@Wharton recently featured research by Professors Marshall Fisher and Santiago Gallino on this topic. The two scholars published an article in Harvard Business Review titled "How Grocery Stores Should Respond to the Growth of Online Markets."  Interestingly, the authors point out that Trader Joe's does not offer online grocery sales.  Having written a case study about Trader Joe's, I love how they buck the conventional wisdom and profit greatly by doing so.  

Why are online grocery sales unprofitable for many retailers?  The authors found that, "Traditional in-store shopping requires 30 minutes of employee labor per customer. When a customer comes inside the store to pick up an online order, an additional 27 minutes of labor is needed. Curbside pickup adds 32.6 minutes, and delivery adds 37 minutes."  These labor costs are hard to recoup.   Given thin margins and intense price competition in the industry, retailers struggle to charge enough to offset these costs. 

Some retailers seemed to think that they would eventually become profitable through economies of scale.  However, the problem is that a key cost driver is the labor involved in serving the online customer in grocery stores.  That cost is largely variable, and it does not come down as you scale up.  Gallino explains: “Many grocery retailers have been pushing for this with the hope that scale will bring profitability. But we’ve been in this effort for a number of years now, and it’s not true. There is a physical reality that scale is not going to fix. Broadly speaking, it’s very challenging to make a profit.”  In short, the research confirms the old joke that, "you can't make it up on volume."  If variable costs exceed price, then no amount of scale is going to make you profitable.  

Companies should take a key lesson away from this research, and it extends well beyond online grocery sales. Firms need to have a good handle on fixed vs. variable costs, and they must understand the contribution margin per item. If the contribution margin is negative, then economies of scale will not likely save you. How might increasing volume lead to lower costs and more profits? If variable costs come down through something such as volume discounts in procurement, that would be helpful. Or, if variable costs come down because of a steep learning curve, that could make a service or product more profitable as volume increases.