It’s never been easy to make a buck in retail, and the investments required to sell online have only made it tougher.
Costs associated with websites, mobile apps and omnichannel services like in-store pickup contributed to the decline in retail profit margin, according to accounting and consulting firm Deloitte. Profit margin decreased to 6.7% in 2019 from 9.7% in 2012. That rebounded to 8.6% in 2022, helped by pandemic-fueled demand for goods over services and government stimulus checks, says Lupine Skelly, retail, wholesale and distribution research leader at Deloitte.
Profitability — as defined as median EBITDA [earnings before interest, taxes, depreciation and amortization] — was lowest for retailers in such non-discretionary categories as grocery, drugstores and warehouse clubs. It was highest for such discretionary categories as apparel, home goods, department stores and specialty. Retailers that sell primarily online and other direct marketers were in between.
“Online isn’t super profitable,” Skelly says. “It’s still a costly business unit for retailers.”
Higher costs played a big role in the 2012-2019 decline in retailer profitability Deloitte uncovered from an analysis of 99 publicly traded retailers, Skelly and Deloitte U.S. research leader Rodney R. Sides explained in a 2021 article in the MITSloan Management Review. A recent update based on an analysis of 86 public retailers — the number declined due to bankruptcies — showed profits bounced back during the pandemic, Skelly tells Digital Commerce 360.
However, Skelly says, retail executives Deloitte interviewed recently are concerned that profits could be pressured again in 2023 by higher costs due to inflation and consumer resistance to paying higher prices. That, she says, makes it essential that retailers focus on containing costs, including those associated with online sales.
How retailers can cut costs and boost profits
Skelly highlighted three areas where retailers can contain online-related costs:
- Free shipping: “Free shipping can’t last,” she says. “It’s getting to a breaking point.” She encourages retailers to waive shipping fees only for their best customers or as part of loyalty programs.
- New online features: Retailers should take a hard look at adding new online services that often involve fees to technology providers. As an example, she cites the growing popularity of buy now, pay later. She says BNPL services typically cost up to 50 cents per transaction plus 10% of the value of the sale. “That can add up pretty quick,” she says.
- Returns: Returns can cost retailers 15%-30% of the sale value in handling fees, which is ruinous for online retailers that only make about 5 cents in net profit for every dollar of sales, Skelly says. She says tools that help online shoppers visualize products can cut returns by 40%, and “return bars” run by vendors that take returns for many online merchants can cut costs by 20%. She also advises retailers to credit shoppers quickly for their returns as calls from consumers wondering when they will be reimbursed are common, and each call typically costs about $5.
Merchandise and selling costs for different retail categories
The costs associated with selling online show up in Deloitte’s analysis of return on assets. Profits as a percentage of invested assets kept declining for online retailers and direct marketers during the pandemic, even as they bounced back for other retail categories.
Online and direct retailers also spent the highest percentage of their revenue on selling, general and administrative expenses. That likely reflects the costs associated with operating websites, marketing online and printing catalogs.
However, those direct-to-consumer retailers on average spend the least on merchandise as a percentage of revenue.
For most retailers, the cost of goods sold as a percentage of revenue declined in 2022 from 2019, after rising during the earlier period. The exceptions were retailers in the grocery and drugstore category, a likely result of persistently high food prices in recent years.
Overall, SG&A expenses and cost of goods sold add up to 90.5% of revenue for internet retailers and direct marketers. That’s less than the 93.9% for highly competitive, low-margin categories like grocery and drugstores. However, it’s above the 88.6% for higher-margin categories like apparel and home goods.
But in all retail categories, profits are tight, which means containing costs is a priority. And while the Deloitte analysis was based on publicly traded retailers, which tend to be larger companies, Skelly says smaller retailers likely are being squeezed even more by rising costs, given that they typically lack the technology resources that can reduce costs.
“I would assume smaller players are probably seeing this even more,” she says.
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