More free shipping and higher customer acquisition costs are cutting into online retail profit, says retail analytics firm DynamicAction. Smarter buying and a surgical approach to promotions are two ways retailers can combat this trend.

It became more difficult for retailers to make a buck selling online in the first quarter of 2019, as retailers spent more on marketing and free shipping offers while winning fewer new customers, according to client data aggregated by retail analytics firm DynamicAction. But there were signs some retailers are making better merchandising choices that can improve future results.

Overall, customer profitability decreased 4% in the first three months of the year versus the same period last year, DynamicAction says, driven in part by an 8% increase in orders that included free shipping and a 25% year-over-year increase in marketing spend. DynamicAction CEO John Squire says marketing spend increased an even higher 92% during the 2018 holiday season and some of that higher spend “bled into Q1.”

Despite retailers increasing their advertising budgets, new customer acquisition decreased by 11%, DynamicAction says. The analysis is based on more than $12.4 billion in online sales during the first quarter, $5.3 billion in North America, roughly 1% of online retail sales volume in the U.S. and Canada, and $7.1 billion in Europe.

High-spending customers can many times come out flat or even negative on profitability.

Over the last five years, Squire says, customer acquisition costs have increased by 50%, while the average value of an online order has changed little. Increased online competition is at the heart of the profit problem, he says.

“When you look at the different opportunities consumers have to transact online and the number of retailers and brands going direct to consumer, there are only so many purchases that are going to be made,” Squire says.

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In addition, he says retailers increasingly are competing for premium ad positions on just three big online platforms—Google, Facebook and, more recently, Amazon—driving up marketing costs. Plus, Squire says, “the increase in use of free shipping is certainly weighing on the profitability of each order.” The 8% year-over-year increase in free shipping stems from a combination of retailers offering free shipping more often, along with more online shoppers finding free shipping offers and taking advantage of them. Online retailers are also paying more to have orders delivered to customers’ homes, Squire says.

While DynamicAction did not release data on the percentage of its clients’ online orders that shipped for free, market research firm Rakuten Intelligence says it’s increasingly uncommon for online consumers to pay for shipping. According to Rakuten Intelligence, 88.5% of online orders shipped free in 2018, little changed from 88.7% in 2017. But Rakuten Intelligence data suggests more retailers held the line on free shipping during the November-December 2018 holiday season, as only 88.8% of orders shipped free during that period compared with 89.7% a year earlier. (Rakuten Intelligence data excludes purchases on eBay Inc., Etsy Inc. and through the Amazon Fresh grocery service, as well as some other online orders.)

There were some positive signs, however, in the DynamicAction Q1 data. For instance, SKU availability—how often a product a shopper searched for online was available for purchase—increased 14%, while inventory not viewed—items consumers didn’t viewdecreased by 12%. Those statistics indicate online retailers are doing a better job of buying more of the products consumers most want, and less of items that sell slowly, Squire says.

How to increase profit

One way retailers can rebuild profit, he says, is by keeping a close eye on products that are selling well and reordering them early in the selling season to take full advantage of consumer demand. For brands that manufacture their own products, Squire says, that means having factories ready to produce more hot-selling items in time to sell them before demand cools.

Another key to profitability is for retailers to identify their best customers, which are not necessarily the ones who buy the most.

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“Many retailers have trained customers to look for friends and family offers, promotions, free shipping and pricing and promotional offers,” Squire says. “Add all those things together and high-spending customers can many times come out flat or even negative on profitability.”

“Our advice is focus on your most profitable customers and look for ways to build relationships with them, while finding ways to wean yourself off of the least profitable customers,” he says.

Retailers also can be more surgical in promotions, he says, especially when a product is selling well and likely to sell out even without a discount. Cutting even a day off a promotion on a product that’s flying off the online shelf can improve the bottom line, Squire says.

Finally, he says there are “basic hygiene aspects of merchandising” that can improve profit. For example, if a product is out of stock in black, Squire says, don’t feature that style in black in a Google ad or as the lead product on a homepage.

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