Making money multichannel

How to understand cross-channel customer behaviour

eCommera

In partnership with WPP and Google

Making money multichannel

Published March 2011 ©eCommera 2011

eCommera

02–03

Making money multichannel
Michael Ross,
Co-founder and Director, eCommera.

Peter Fitzgerald,
Retail Director, Google UK.

David Roth,
CEO EMEA and Asia, The Store, WPP.

Highlights
• Online retailers need to rethink their models of growth and profit – the economics of physical retail cannot be successfully replicated online. • Data is critical to profits – properly gather and leverage data on profits, customers, products and marketing. • Cross-channel customer behaviour, accelerated by the use of mobile, makes everything more complicated – understanding and responding to the new complexity of customer behaviour becomes a critical driver of profitability.

Offline retailing has long been a lucrative and profitable sector. As ecommerce gathers pace, many retailers have assumed that they can apply the same principles and make the same high profits online. The numbers tell a very different story. Many online retailers took a long time to get to profitability (Amazon, Overstock, Zappos); others are still trading but not yet profitably (Bluefly, figleaves, Ocado); and many went bust without ever making a penny (etoys, webvan, boo, pets.com).

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This article offers an insight into the economics and customer behaviours that can help to make money online:

1. Online retail economics
It is increasingly clear that there are real differences in how to make money from online retail compared to physical retail. For retailers this is a hard adjustment the economics of physical retail are well understood and the route to success tried and tested, but they cannot simply be replicated online. We assess the differences in the three core economic fundamentals of retail profitability for online retail: a) Store economics. The P&L of an individual store. b) Growth. The dynamics and strategies for profitable growth. c) Trading. The day to day dynamics of sales, stock and margin.

2. The cross-channel effect
The economics of the “online” channel are increasingly complicated by the cross-channel effect. Some customers Research Online and Purchase Offline (ROPO); others research offline and purchase online. Retailers need to recognise this ROPO effect in order to understand multichannel economics.

3. The mobile effect
The lines between offline and online retail are increasingly blurred by the rapid evolution of mobile. Customers’ use of mobile and its impact on their purchasing behaviour complicates retail models, but understanding mobile use and grasping the opportunities it presents are now fundamental to future retail profitability.

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04–05

1. Online retail economics
Physical retail: Store economics in physical retail means the relationship between gross margin, rent and staff that drives an individual store’s profitability - a formula known by every successful retailer that makes their format work. vs. Online retail: The order is king – “store” economics in the online world are driven by profit per order and volume of orders.

How do the three economic fundamentals of retail profitability differ between online and offline? And how do you crack their code to make money online?

a) “Store” economics
In the offline world, the critical costs of rent and staff are variable per store but fixed per sale. Online, the critical costs are either variable per order (picking, packing, packaging, postage) or are crystallised per order (marketing, promotions). Online profitability requires a focus on orders as the variable unit, rather than thinking of online as just another store.

Cracking the code: “store” economics
The challenge is to get the right cost structure per order. However, not surprisingly, there is no one right answer. Average order values for successful retailers can be £10 or £1000; some retailers charge for delivery and returns, others do not; many retailers have aggressive promotional campaigns and are generous with vouchers, others never discount. We have seen very successful retailers with 1% conversion rates, and unprofitable ones with 4% conversion rates. We advocate a 4-step approach to getting to the right store economics: 1. Understand where you are today. Many retailers simply don’t even look at an ecommerce P&L, let alone one structured around the underlying drivers (Figure 1). 2. Understand what happens to profit when you pull different levers. For example, a free delivery above £50 promotion will increase average order value, increase conversion rate and reduce delivery revenue. However, the key question is what it does to profit per order and volume of orders. Understand the impact of a voucher for new customers vs. increasing marketing spend per order. Understand the impact of reducing retail prices vs. a targeted promotion.

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Making money multichannel

3. Be prepared to make bold decisions to get to the right P&L structure for growth. Limit vouchers, increase delivery charges, prune marketing spend. We’ve met a number of online retailers who lose money on every order and then try to make it up in volume! 4. Keep optimising. Improve the site funnel – examples include: new payment methods, better on-site search, improved navigation, personalisation and product recommendations. These will often have little impact individually but will nudge conversion up over time, with consequent impact on both volume and profit per order.

Figure 1: The drivers of online profit
Average order value Gross profit per order

×
Gross margin

Trading profit per order

-

Delivery revenue/cost per order Promotion cost per order

Gross trading profit

×

Marketing cost per visit

Marketing cost per order Number of orders

÷
Conversion rate

×
Online visitors

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b) Growth
Physical retail: Growth is driven by two dynamics - (i) growth in square footage (i.e., new stores or store expansion) and (ii) same store sales (like-for-likes). Once a retailer has a successful format, growth is simply a matter of finding more locations. vs. Online retail: Growth online is a new paradigm, driven by building and nurturing a customer base. Zara has opened, on average, a store a day for the last few years. Each store brings new footfall and new customers. The strategy may be hard to execute but is simple to conceive – footfall is a given of the physical world where rent equals guaranteed visitors. In contrast, footfall online needs to be sought and bought. Retailers with offline brands clearly get a base level of traffic “for free” but if they don’t play in the online marketing world, they are simply leaving prospective customers for their competitors. Growth online is driven by three very different dynamics: i. Customer acquisition – the number of new customers acquired in a period. ii. Customer retention – the percentage of customers who re-purchase, their order frequency and spending pattern. iii. Range expansion (unconstrained by shelf space) which widens the customer acquisition net, and fuels repeat customer activity. Cracking the code: growth Driving profitable growth online requires sophisticated marketing optimisation: how much to spend acquiring and retaining a customer, how much to spend overall on marketing and how best to allocate this spend across various marketing touch points. Building on the order economics above, we advocate a 3-step process to cracking growth: 1. Marketing profitability. Understand the profitability of each keyword, affiliate, banner and email, as well as the sensitivity of profitability to different attribution windows. In addition, understand the incrementality of each marketing event - just because someone clicked on your advert, doesn’t mean that they wouldn’t have purchased anyway. All this is critical to understanding the relationship between marketing spend and new customer acquisition (the “supply curve” of customers). 2. Customer economics. Understand lifetime value economics through mining repeat purchase dynamics. Translate this into a customer-driven business plan which exposes the trade-off of growth vs. profitability – i.e., what percentage of lifetime value should be invested in customer acquisition. Many retailers believe that growth is inexorable and then are surprised when sales plateau. The reality is that this is a mathematical inevitability. Every retailer has a churn/attrition rate – to continue to drive growth, retailers need to ensure that they are acquiring more customers than are churning. 3. Customer-product economics. Understanding the role of products in the customer lifecycle is also critical - products may have low sales but could be key to acquiring high value customers. Other products may look unprofitable but are great add-on purchases. Mine on-site and off-site search to identify adjacent categories which can drive customer acquisition and retention.

06–07

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Making money multichannel

Using this analysis, retailers can understand their optimal “zone of growth” – too high and it’s either unprofitable or unsustainable, too low and you are leaving customers for your competitors (Figure 2). Again, there is no right answer but the smart retailers are clear about whether they are trying to drive cash, medium-term profit or long-term growth – and can then adjust their path accordingly. Too many retailers make the mistakes of benchmarking growth rates against retail like-for-likes, creating unrealistic top-down targets, extrapolating from historical rates or focusing too much on top-line sales.

Figure 2. Understanding retailer’s optimal growth rate Annual growth, %

Too fast (unsustainable) Optimal zone of growth Too slow (underpotentialised)

2007

2008

2009

2010

2011

2012

2013

Actual Forecast

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c) Trading
Physical retail: Trading offline means balancing the day-to-day choices around sales, stock and margin. vs. Online retail: Trading online has the additional challenges of efficient buying and routing of traffic, and managing product just-in-time. Applying the physical trading dogma online is guaranteed to sub-optimise profits. Retailers can make much better trading decisions if they properly leverage the data available and take advantage of the new opportunities open to them: • New information. Retailers can distinguish between products that aren’t selling or aren’t viewed, and ensure traffic levels are optimised and evenly distributed. Retailers can understand price elasticity and product substitutability. Data that is expensive or impossible to access offline is typically free and easy to access online. • New costs. The online world brings new and different costs. The fundamental challenge is that it is now remarkably easy to lose money on a product by spending more money driving traffic than you generate in gross margin. • New levers. Traffic can be turned on and off. Depending on the category (and product substitutability) traffic can be elegantly rerouted to products that are in-stock, overstocked or high margin at the click of a button. Products can be offered with differing “promises” – from pre-orders to back orders. The reality is that customers will commit to products they’ve never touched (from an iPad to a designer bag) and will wait for the products they want. Display is now decoupled from delivery. Cracking the code: trading Every category has its own trading dynamic – the levers you pull day to day to optimise the trade-off of sales, stock and margin. The dynamics vary depending on the supply chain, lead time, margin, minimum order quantities and product lifespan.

08–09

Some examples show how:
Characteristics of products Long life and low obsolescence Seasonal life with upfront stock commitments Short-life and flexible manufacturing commitments Low margin and obsolescence Trading challenges Driving stock turn without losing sales Sell-through, i.e., maximising cumulative gross margin Stock turn and sellthrough Add-on purchases and optimising promotions or bundles New online challenges Using online data to optimise stock turn Optimising the distribution of traffic to drive sell-through Using online data to derisk the supply chain Managing product profitability

Category Beauty / jewellery / continuity fashion Branded fashion

Fast (CMT) fashion

Electronics

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Making money multichannel

The key to online profitability is to leverage the new data, understand the new costs and take advantage of the new levers to make better, faster, more nuanced trading decisions (Figure 3). Successful retailers: 1. Understand product profitability, in particular which products make money, which lose money and which make nothing. 2. Identify appropriate actions that distinguish between different zones of profitability. Marking down product for clearance can be either pointless (if customers aren’t viewing it) or expensive (vs. a targeted marketing campaign). 3. Organise to take action, to ensure that budgets, processes and decision making facilitate the right trading decisions.

Figure 3: Understanding product profitability
High 106% 100% Medium Low Zero Negative

80% Cumulative profit

60%

Manage availability

Low views, in stock

Stock no views

Views no sales

Products not profitable

Customers not profitable

40%

20%

0% Products arranged by profitability (descending)

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10–11

2. The multichannel effect
Physical retail: Customers browse and purchase at the same time. All sales are easily credited to a store and – in many cases – an individual salesperson. vs. Multichannel retail: Customer behaviour is complex. Some customers browse online and purchase offline, others browse offline and purchase online. Understanding the fundamental economics of online retail and how to make money in this new environment is a key starting point for any multichannel retailer. However, it is no longer enough. As cross-channel becomes more widely adopted by customers, it complicates and blurs the boundaries between online and offline. Understanding the economics of multichannel retail is not easy, but it is worth the effort. Modern customers embark on a complex and progressively non-linear journey, shopping across multiple sales channels but with an abiding expectation of receiving a consistent, endto-end brand experience. Aside from the operational challenges this creates for retailers in terms of stock availability and delivery, retailers are also required to think about engaging with a different type of customer; one with an unprecedented degree of access to product information before, during and after venturing in store. The ROPO effect is everywhere. It is estimated that today some 60% of EU sales are affected by web research prior to purchase on the high street. Customers who shop across multiple channels are not better, they are just different and need to be understood. To fully understand the ROPO effect retailers need to clearly differentiate between correlation (how customers are behaving) and causality (what is driving that behaviour). The more retailers understand multichannel behaviour and how to respond to it the more they can drive an “unfair” share of the online pie. The key questions to answer include: • What are the key customer journeys (establishing correlation between online and offline)? How do customers use each channel and in what order? Which pathways are used by your most valuable customers? Which pathways are most profitable? • What causes multichannel activity (how can customer behavior be influenced)? Is online driving offline, or is offline driving online? How does online marketing spend drive offline purchases? How do emails gathered in store drive online purchases? To what extent can multichannel behaviour be encouraged, and does this drive greater loyalty?

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Making money multichannel

Cracking the code: multichannel To fully understand your multichannel economics and drive profitability from them, we recommend the following approach: 1. Decide on a cross-channel identifier such as an email address, credit card or loyalty card. This can either be done systematically or as a one-off exercise. The key is to find a representative sample of customers whose behaviour can be analysed. 2. Data mining. Once the data is gathered, apply data mining techniques to look for patterns and generate hypotheses. 3. Run tests to understand causality – e.g., by geography/segment. This is critical in order to be confident that the observed effect is robust (and can form the basis of a business case). The profit tree below (Figure 4) incorporates the multichannel effect. Retailers who crack these economics – and very few in the world have done so – are at a significant advantage. They are able to make online (and offline) marketing investments that they know to be profitable but which often leave competitors scratching their heads.

Figure 4: The drivers of multichannel economics
Average order value Customer value

-

Gross profit per order Delivery revenue/cost per order Promotion cost per order Marketing cost per order

×
Gross margin

Trading profit per order

Gross trading profit

×

Marketing cost per visit

÷
Conversion rate

Offline influenced profit

Number of orders

×
Online visitors

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12–13

3. The mobile effect
Physical retail: Customers are either in your store, or they are not. vs. Mobile: Customer can scan products, check prices, browse competitor sites and purchase on their mobile from anywhere (including in your store). Channels are increasingly blurring and converging. Adding to the growth of cross-channel purchasing behaviours is the rapid acceleration in the use of mobile devices. The channel becomes less of a separate aspect of retail, as it becomes retail itself. The key to success is understanding customer behaviour and customer economics. So how is the use of mobile affecting retail? The notion of the “connected customer” is a relatively recent, but nevertheless transformational, concept in the changing retail landscape. The increasing penetration of smartphones and the likely surge in various sizes of tablets will continue to compound the ROPO effect. The mobile is more and more an extension of the individual. A recent quote from Eric Schmidt at DLD suggested that people will increasingly be in two states: asleep or connected. The most simplistic way of looking at mobiles is to see it as “just another browser”. Retailers simply need to ensure that their sites are “shoppable”. These “mobile economics” – typically 2%5% of online sales – are relatively easy to understand and manage. The challenge is that mobile is increasingly taking on a more complex role in the buying process that necessitates thinking about mobile in a new way. Their impact on retail sales will be far greater than ever previously imagined. Already barcode scanning is standard smartphone functionality, and the mobile-as-payment option is coming soon. We have identified three transformational retail trends caused by mobiles: 1. Price comparison. Many retailers report customers in their stores scanning barcodes with the real possibility that they are buying online from competitors. Certainly, in-store price checking will become a ubiquitous part of shopping. Haggling – a common feature of retailing in the 1800s - may be returning! 2. In-store information. Best Buy (in the US) has already begun including Quick Response (QR) codes in its stores to help customers learn more about products, for example by linking to site reviews.

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Making money multichannel

3. Near-store offers. Retailers – such as Marks and Spencer –are piloting proximity marketing schemes where offers are triggered to people within a certain radius of the store. In due course, this will evolve into localised yield management where a store manager – if sales are slow – can trigger a promotion that will be broadcast to customers (or noncustomers) within X miles of the store. But this is just the beginning. As retailers take advantage of the personalised nature of the mobile, we will see the emergence of dynamic pricing – making the best price/offer to an individual customer based on everything we know about them. Yield management – taken for granted in the travel industry – will come onto the high street. *** The economics of the online world are very different to physical retail, and highly complex. Multichannel and mobile make this even more complicated. And yet retailers who stick their head in the sand and continue to apply physical retail dogma face a risky future. As ecommerce and online influenced sales, take an ever greater share of retail sales, those who fail to understand the new economics of retail risk systematic underperformance.

eCommera

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eCommera is a pioneering provider of intelligent ecommerce trading solutions, enabling brand owners and retailers to sell efficiently and intelligently across multiple channels. A selection of our clients include Asda Direct, Hamleys, House of Fraser, Magasin Du Nord, Horze and the London 2012 store.

eCommera Limited 1st floor 84-86 Great Portland Street London W1W 7NR www.ecommera.com Tel: +44 (0)207 2915800 Email: trader@ecommera.com

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