The true cost of online shopping, the EU will see 35 billion euros in reduced profits

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Covid-19 has deeply impacted retail sectors across Europe. Enforcement of store closures, social distancing measures and increased concerns over viral transmission has elevated ‘digital’ to new heights throughout the customer journey, according to a report from Alvarez & Marsal (A&M) , a global professional services company, business performance improvement and turnaround management services.

The research contains information drawn from a consumer panel of over 3,000 households in six European countries (UK, Spain, Switzerland, France, Italy and Germany) and an analysis of over 250 European retailers, representing over 2,000 billion euros in spending in 2019/20.

Online shopping has led to falling margins and increasing competition

The figures show that pre-tax retail profit margins in six key European markets studied fell from 6.4% to 4.5% due to online shopping, suggesting that as retail penetration electronics increase, margins decrease.

The early stages of the pandemic saw a dramatic shift towards e-commerce in major European retail markets, as consumers embraced new avenues to purchase goods and services. Growth in online sales has grown rapidly, with markets such as the UK recording online penetration rates reaching almost 40% in 2020. Across the six regions, the proportion of online sales has increased from average from 12.1% in 2019 to 14.8% in 2020.

For many companies struggling to stay relevant and survive the disruption, their transition is likely to mean a difficult readjustment as business models are aligned with the ‘new normal’. Profitability will be under intense pressure as operating models that disproportionately prioritize physical channels struggle to rebalance costs as the Internet accounts for a growing share of sales.

A&M research shows that just under a third of European consumers believe their shopping habits will change permanently because of Covid-19, with a significant and permanent shift towards online shopping, in especially for clothing, household items and electrical appliances. In some countries like the UK, a permanent change in buying habits affects almost four in ten buyers. The majority of consumers intend to continue to shop more online after the pandemic, but the magnitude will vary widely by category, demographics and country.

For clothing, the extent of the change online varies by age group of consumers. Younger and middle-aged shoppers are more likely to permanently change their online clothing spending compared to senior shoppers. Only 17.0% of people over 65 plan to change their online fashion spending after the virus goes away, compared to 27.3% for those 35 to 44 in the countries analyzed.

Pressure of online returns

As the online momentum builds, return online volumes will inevitably increase, putting intense pressure on profit margins. Returns management is what retailers call reverse logistics, which is inversely costly. Buyers now expect fast and inexpensive shipping, placing much of the financial burden of delivery on the shoulders of retailers. According to Quartz, “Return rates vary by category, but in the case of clothing, buyers may even purchase multiple items with the intention of returning most. Each return involves expenses such as shipping, customer service, inspection and sorting of goods, sometimes their repackaging and repair, storage and sometimes liquidation. As e-commerce grows, the volume of returns keeps increasing.

The switch to the Internet will leave many retailers exposed to cost structures disproportionately weighted to their physical channel, while facing increased variable costs as the Internet accounts for an increasing share of sales. Many retailers will end up with more physical outlets than they can commercially justify, often tied to inflexible lease structures that will hamper their ability to rotate business models as quickly as needed.

The in-line model is run on thinner profit margins

Pure online retailers typically operate with considerably lower margins than multi-channel and traditional business models. A&M’s analysis shows that the average pre-tax profit margins for pure online retailers in the main European markets analyzed were 1.4%, compared to 5.4% for the industry as a whole. where price, service and quality transparency puts additional downward pressure on margins.

A&M predicts that an acceleration in online growth will lead to a drop in profit margins to 3.2% by 2025 for the six European countries analyzed, against 3.7% for a “no Covid-19 impact” scenario. Total benefits will be 11 billion euros lower by 2024/2025, compared to the scenario where Covid-19 does not impact consumer behavior for the six European countries analyzed. Aggregated over the five-year forecast period, this represents around 35 billion euros of reduced profits in the main European countries analyzed.

As the European retail industry goes through a period of transformation, companies need to take a more detailed, data-driven approach to profitability. The move to the web will put the greatest pressure on store-dependent operating models, forcing businesses to align with more digitally-centric customer journeys.

Article source: The Shape of Retail: The True Cost of Online by Alvarez & Marsal

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