The cost of e-commerce

The cost-of-living crisis has created numerous challenges for retailers, not least a material increase in the cost of doing business. This is being felt across the board, but it is the online model that is coming under the most intense cost-pressure. This is being driven by:

• Fulfilment costs: logistics costs continue to rise, exacerbated by fuel, energy, staffing and real estate costs. (ASOS’s logistics costs as a proportion of revenue has grown from 22.1% in 2021 to 24.2% in 2022).
• Soaring returns: reducing product return costs is a major challenge for online retailers, and will be a key lever for enhancing profitability. (For fashion, c.30% of items ordered online are returned, vs. c.10% for items bought in-store. The cost of returns ranges from £10 to £15 per order).
• Business rates: since the revaluation at the end of March, business rates on warehousing space have increased significantly, hitting online pureplays hard. (By contrast, rates for physical retailers have reduced, by as much as 10% overall and significantly more in some places – the rates bill for Selfridges’ London store has nearly halved).
• Cost-of-living: price rises are supporting the value of online ordered goods but falling volumes are putting pressure on operators’ profit margins. (Zalando’s profit margin has slipped from 2.8% in 2020 to -1.7% in Q1 2023).
• Brand exposure: gaining exposure to customers online, including social media platforms, and generating clicks has become expensive as more online operators compete for limited screen time. (Marketing costs are estimated at US$20 per US$100 of fashion items sold by US ecommerce operators.)

When combined with flat-lining ecommerce penetration rates, these cost-pressures are shining a spotlight on the viability of the online pureplay model. Recent research from Mazars claims that more than 50% of online retailers went insolvent in the year to April 2022 – this follows the collapse of some big pureplay operators (notably Made.com and Missguided), and online brands being snapped up by some of the major omni-channel retailers.

After years of physical retail suffering from elevated costs in relation to ecommerce, the cost of doing business in-store has now reduced significantly, and is often lower than online. In addition to the business rates differential mentioned above, rents are at historically attractive lows for retailers, between 30% and 40% below than when they were at their peak.

And omni-channel operators are successfully using their store portfolios to further reduce overall costs - this is where omni-channel has a huge advantage over online. For instance, major omni-channel retailers are encouraging consumers to visit their stores by charging for delivery, and in particular for postal returns, as demonstrated in Figure 1.

Figure 1: Major omni-channel and ecommerce operators: Product return fees

_{Source: JLL, company websites}

A quick glance at the recent financial performance of online vs. omni-channel retailers is instructive here (Figure 2). While Nike and Next’s profitability has remained relatively stable, ASOS posted an adjusted loss before tax of £87.4m in its latest six month period. It is reported that a small number of customers had a disproportionally negative impact on its financial performance - 6% (or 1.5 million) of ASOS customers accounted for c.£100m of losses from product returns. 

Click & collect is another advantage that omni-channel has over pureplay. This is not purely a cost-saving benefit – stores also profit from increased retail spend and impulse purchases. A key growth area here is likely to be click & collect lockers – according to analysis from Ricoh, assuming a 400-store portfolio, automated click and collect lockers can deliver annual savings of c.£3.5m.

To conclude, this is not an argument for physical over online retail - there is of course room for online-only retailers, particularly niche ones. In reality, most retailers will tread a middle ground with an omni-channel offer, using technology to drive behaviours in-store rather than pushing people to make purchases online.

More broadly, retailers and investors are recognising the appetite for in-person experiences and are investing in stores and developing new destinations, further boosting physical retail. So, while it is too soon to predict a new golden era for bricks-and-mortar retail, the direction of travel is definitely encouraging in a way it has not been for several years, driven by positive consumer trends and the real financial benefits afforded by store portfolios.