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.

Will Amazon Buy Nordstrom Next?

Back on May 11th, NYU Professor Scott Galloway appeared on Kara Swisher's Recode Decode podcast. During that conversation, he predicted that Amazon would acquire Whole Foods. One month later, Jeff Bezos made his move. Amazon purchased the organic supermarket retailer for $14 billion. Yesterday, Professor Galloway appeared on Swisher's podcast again. This time, he predicted that luxury retailer Nordstrom might be Amazon's next big acquisition target. He explained, "It would be cheap, it’s in Seattle, they’re operationally very sound, it’s a great company and they’re [Amazon is] trying to establish relationships with high-end brands, which they have been unable to do. Nordstrom has those and a lot of credibility, and a lot of wealthy households have a Nordstrom credit card."

Like many brick and mortar retailers, Nordstrom has experienced a sales slowdown as mall traffic has declined. In fact, news reports in June indicated that the Nordstrom family was considering taking the company private. Earlier this week, the company announced that it was opening a test store next month called Nordstrom Local. The Wall Street Journal explained the concept: 

Nordstrom Local, scheduled to open Oct. 3 in West Hollywood, Calif., will span 3,000 square feet, far less than the 140,000 square feet of one of Nordstrom’s standard department stores. It will contain eight dressing rooms, where shoppers can try on clothes and accessories, though the store won’t stock them. Instead, personal stylists will retrieve goods from nine Nordstrom locations in Los Angeles, or through its website. The stylists can also pull together looks for shoppers through a “style board” app.

Is this acquisition a real possibility? I can certainly see Professor Galloway's logic. However, as he notes in the podcast, the company is led by the Nordstrom family. Indeed, the firm's ownership structure could be a formidable obstacle. The Nordstrom family owns roughly 1/3 of the company, and family members continue to lead the retailer. Amazon would find it very difficult to acquire the company without the family's consent. However, Galloway's comments do make you wonder whether other retailers might be acquisition targets. As Amazon contemplates opening a second headquarters with up to potentially 50,000 employees, it's clear that Bezos' ambitions know no limits. Could a luxury apparel retailer be next? Nieman Marcus, anyone? They have been struggling. They announced an exploration of strategic alternatives several months ago. Perhaps they might be a target. They are not as operationally sound as Nordstrom's, and they have considerably more debt, but perhaps it's a more attainable target.

Amazon Reports Earnings for AWS

Amazon reported quarterly earnings yesterday.  For the first time, the company split out financials for its Amazon Web Services (AWS) business.  That unit provides cloud computing services.   Amazon indicated that AWS generated $1.57 billion in revenue and $265 million in operating income for the quarter.  Overall, Amazon reported revenue of $22.72 billion and a net loss $57 million for the company as a whole.  Amazon continues to argue that they are investing for the future, thereby explaining the continuing escalation of expenses and yet another net loss. 

Clearly, losses in the retail business are more substantial than previously thought.  AWS appears to be profitable, while the company as a whole lost money.  The earnings reports raises a few questions for me, inquiries that I believe many investors and analysts will be putting forth in the coming months.  

• Has Amazon been reluctant to split out financials for AWS because they know that it may cause more questions to be asked about the profitability (or lack thereof) of the core retail business?   
• Are the continuing losses related to investments and expenses that will eventually create a high profit retail business, or are those costs associated with many diverse lines of business that have been launched?  
• Is Amazon spreading itself too thin with so many strategic moves in a wide variety of areas?  
• Perhaps most importantly, what is the strategic logic for keeping AWS and Amazon's retail business together?  Will some investors begin to argue for a breakup at Amazon?

Stephen Colbert on the Amazon vs. Hachette Battle

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Retailers, Showrooming, and Mobile Apps

Keith Anderson of RetailNet, a leading retail market research firm, tweeted an interesting story today about Wal-Mart's mobile app.   We all know that brick-and-mortar retailers have been fighting a growing "showrooming" trend - the notion that consumers visit stores to see, touch, and interact with a product, but then purchase on-line from an e-commerce company such as Amazon.   Retailers have been working hard on strategies to counter that threat.  Wal-Mart recently updated its app to improve the "Store Mode" element.   That aspect of the mobile app tries to help consumers navigate the store to find what they desire.  The "Store Mode" includes the local advertising circular, a shopping list function, maps of the store layout, and a QR code scanner.   What is interesting about the results to date for this updated app?  According to this article, Wal-Mart reports  that, "12% of its m-commerce sales occur while customers are in stores, showing that consumers are using their smartphones to buy from Wal-Mart what Wal-Mart does not have in stock, or perhaps purchase an item they don’t feel like carrying home, like a big-screen TV."   In sum, a strong mobile app may help protect against the tendency for consumers to drift toward Amazon or another online player for their purchases.

We all know that many retailer apps left a great deal to be desired over the past few years.  However, they have been improving.  Retailers have added functionality that does help consumers navigate the stores more easily and much, much more.  For instance, take this initiative at Nieman Marcus, described in this article on springwise.com:

The US luxury retail store is now trialling its NM Service app, which provides sales associates with consumer data they can act upon in real time. Developed by Signature Labs Inc, the app can be downloaded for free from the App Store. Customers can then select to “opt-in” to participate in the service, and a sensor at a Neiman Marcus store will detect when they walk through the door and launch the app. NM Service will provide information on new products and future events taking place at the outlet, as well as listing the sales staff currently instore. Those sales assistants can also have a version of the app tailored to them, alerting them when a participating customer enters the store. Sales assistants will also be presented with information on the customer’s previous purchases at Neiman Marcus outlets and their online shopping history, and the app will display an image from the customer’s Facebook page so that they can be easily identified. Both customers and sales associates are able to send messages to each other.

These two examples stand at opposite ends of the spectrum: Wal-mart is the classic low-cost player, while Nieman Marcus is a highly differentiated luxury retailer.  However, these examples demonstrate that mobile strategies can be used not only to protect against the disruptive threat of online commerce, but also to enhance the in-store shopping experience.  People still enjoy visiting brick-and-mortar stores to see, feel, and try on items.  If retailers can enhance that visit and provide customers the information they want when they want it, they can compete more effectively not only against online players, but also against their direct brick and mortar rivals. 

How To Anger Your Best Customers

Have you ever become angry when you paid full price for an item, and then learned that the company had put that item on sale shortly after your purchased it?   We have all been there.   Now scholars have examined the long term effects of such deep discounting. 

Kellogg School of Management Professor Eric T. Anderson and MIT Professor Duncan I. Simester conducted a study to examine whether such deep discounting angered customers, particularly the company's best customers.  Beyond creating anger, they wanted to know if that negative emotional reaction affected long term sales.  Here's what the researchers did, according to Kellogg Insights:

"Anderson and Simester worked with a retailer that specialized in selling durable goods, like software, electronics, apparel, or books. In the past, the retailer had typically kept prices high but frequently offered small discounts and the occasional deep discount. Anderson and Simester worked with them to create test catalogs to determine whether and which customers would be antagonized by price changes. (Most of the retailer’s customers purchased via catalog at the time of the study.) The two types of test catalog were mailed according to the regular schedule and included 86 products, 36 of which were discounted by varying amounts depending on which test catalog people received. The deep-discount version offered the 36 items at an average of 62 percent off, while the shallow-discount version offered an average discount of 34 percent."

The scholars studied customers who paid full price for items and then received a catalog offering steep discounts.  “When you look at this segment of customers, what you see is that a substantial portion just stop buying,” Anderson said. “We call this the boycott effect.”   Customers offered the steep discounts placed substantially fewer new orders than those people who were offered smaller discounts!  Customers who received the steep discount catalog placed 14.8%  fewer subsequent orders than those who received the shallow-discount version. Moreover, many people who were offered subsequent deep discounts simply ordered nothing at all in the months that followed.   It turns out the "boycott effect" lasted for awhile.   The scholars found that customers who reacted poorly to the steep discounts tended to buy less items from that retailer for the next twenty months! 

Knowing Your Customer - By Channel!

Knowledge @ Wharton has published an article about a new report produced by Wharton’s Jay H. Baker Retailing Center and The Verde Group, a market research firm.   The report emphasizes that companies need to think carefully about the multi-channel shopper.  Retailers clearly have been spending time (appropriately) trying to provide some commonality for the customer regardless of how they shop (online, in store, catalog, etc.).  However, the report reminds retailers that the shopper in each channel has different wants and needs.  Therefore, one has to tailor the experience to suit that customer at that point in time.  The same individual may actually want a different experience in store vs. online - and some of those differences may be quite subtle, yet critical.   Here is a key excerpt from the article:

"Courtney (Paula Courtney, president of The Verde Group) notes that while the emphasis for many retail businesses has been on creating a seamless experience across multiple channels, the reality is that retailers need to spend more time addressing the specific needs of various channel users. “While it’s important to have consistent policies across channels, policies are different from experiences. This [research] suggests that an overriding emphasis on ‘consistent’ channel experiences is misplaced. Different channels attract different types of customers who demand experiences that are specific to their needs and preferences.”