The launch of the Network as a sales channel has allowed millions of companies to start up their distribution in a much simpler way.
On January 1, 2002, the peseta died after 133 years of history. That year, the euro came into circulation in twelve states of the European Union. The entry in into the common currency signified for countries like Spain a more agile and simple access to a much larger market and, therefore, multiply the capacity of growth of the economy. As for the rest of the countries that joined the euro, the National Currency and Stamp Factory issued the so-called euro coin, which was nothing more than a sealed bag with 12.02 euros (13.4 dollars), equivalent to 1,999.96 pesetas, with the aim for citizens to familiarize themselves with the new currency.
Although we had to bid farewell to the blonde, the new currency was well received by the Spaniards. Politicians immediately warned that without the peseta the country lost its ability to influence the economy and ceased to be able to play the devaluation game. The Spaniards, on the other hand, were surprised when they went to buy the first loaf of bread, the first newspaper or drink their first coffee. The hundred pesetas had been transformed, overnight, into a euro and, with it, the Spaniards had lost part of their purchasing power.
Ecommerce has become the new engine of commerce. The launch of the Network as a sales channel has allowed millions of companies to start up their distribution in a much simpler way and, in addition, reach hundreds of countries in the world without having the necessity of a physical presence in them. But, as ecommerce evolves, the channel begins to show its less friendly face. On the stage, all companies in the fashion business (with few exceptions) strive to reduce the benefits of the Network, while behind the scenes they list their weaknesses. Like the euro, the online channel also has its dark side. What are the seven traps of ecommerce?
Like the euro, the online channel also has its shadows
Dilutive impact. This has been the most repeated expression in recent years by fashion business analysts. As ecommerce has increased the share in the total sales of the operators of the sector, stock market and business analysts have begun to insist that the unit margin of online sales is usually lower than that of physical sales, while companies like Inditex have struggled to say otherwise. “The online sale does not dilute the benefit and does not have lower margins than the global activity of the group,” said Pablo Isla, president of Inditex, in 2018 at the event of the results presentation of the distribution giant.
But in a cocktail in which discounts and adverse weather conditions also come into play, the truth is that fashion giants have suffered on their margins in recent years. Since 2011, Inditex has reduced, year after year, its gross margin: if in 2011 it stood at 59.3%, in 2014 it fell to 58.3% and in 2017 it stood at 56.3%. In 2018, Inditex managed to raise it to 56.7%, a trend that has remained in 2019 thanks to better inventory management. In the case of H&M, the gross margin went from 60.1% in 2011, to 58.8% in 2014 and 54% in 2017. In 2018, the trend has brushed up, with a margin of 52.7% at the end of its fiscal year.
Ecommerce was created at the end of the seventies, but it did not reach the general public until the end of the nineties, when giants such as Amazon or eBay started running. In 1999, the same year that Alibaba was born, online sales reached 150,000 million dollars worldwide. According to the latest data from the United Nations Conference on Trade and Development (Unctad), in 2017 a quarter of the total population of the planet had already bought online, firing the volume of ecommerce up to 29 billion dollars, including both B2B and B2C operations. The United States long leads the global ranking followed by Japan, China, Germany and South Korea.
Fashion was a relatively late sector in the Network, which first reached articles in which the physical aspect is trivial or is inexistent, such as books or services, travel, and hotel reservations. In Spain, the weight of online fashion sales has increased from 1.5% in 2012 to 7.4% in 2018, according to data collected from Kanta of the Online Fashion Report in Spain 2019. The load is greater in markets such as the United Kingdom or Germany, which have a greater tradition of catalog sales.
In the British market, 28.2% of fashion sales are already made through the Network, and in Germany the share reaches 24%. France and Italy are also slightly above Spain, with rates exceeding 10%. But the absolute king on a global scale is China: 40% of clothing purchases are made through the Network, twice as much as in 2012. Euromonitor's forecasts for the period 2018 to 2020 were predicted that online fashion sales would grow by 10% on average annually, while total sales would deteriorate.
The intermediary trap
With the same illusion with which a Spaniard took out the first euro coin out of his pocket on January 1, 2002, companies in the fashion sector saw ecommerce as the hen of the golden eggs. “It seemed as though everything that was put into sales went straight to the bottom,” explains Esmeralda Martín, co-founder of Muroexe.
Fashion companies jumped into the Network thinking it was a channel without hurdles
The first ecommerce trap came with the channel’s own configuration. Fashion companies jumped into the Network thinking it was a channel without hurdles, in a sector very used to working with different links and distributing margins here and there. Traditional agents, distributors and stores have become ecommerce in other intermediaries, which are less but much stronger.
From packaging and transport giants to the masters of social networks that, in the background, are the owners of the audience that the fashion wants to reach. Without forgetting technological platforms or means of payment. All, to a greater or lesser extent, scratch a portion of each sale.
On the other hand, ecommerce has somehow made the predominant model in the fashion industry take a few steps back. The great fashion distribution was able to eliminate links in the value chain and made brands reach the end consumer directly through the store, getting greater control of the data and monopolizing the entire margin. Ecommerce has forced brands to have to share again, this time with giants of the audience like Facebook or with traffic giants like Amazon, Zalando or Alibaba.
The second trap
Ecommerce has also proved to be a territory paid for discounts and promotions, a real problem for brands that are increasingly finding it difficult to defend their sales prices to the public at the beginning of a campaign. On the one hand, because in ecommerce discounts and promotions are a much more important sales motivator than in a physical store, an increase in both traffic and conversion into a channel which in general, converts much less than the physical.
Martín argues that the online platform “has been one of the greatest drivers of discounts, since triggering sales on ecommerce is achieved through prices and discounts.” In the case of a startup such as Muroexe, full-price sales are around 80% of the total in physical stores, while this ratio drops to 60% on the online platform, a fact that concurs with the average of the sector in Spain, according to Kantar. “You don’t go shopping online, but on the street you do, and the price threshold is lower in the digital world,” adds Martín. On the same wavelength, Eduardo Zamácola, CEO of Neck & Neck, warns that, if you do not make discounts, “you leave behind bargain hunters”, who are more abundant in the Network.
On the other hand, the importance of discounts in the online store has to do with the breadth and depth of the product in digital store and in the physical store. “Our online store has all the assortment and has much more stock than what the smaller physical stores usually have,” recalls the manager of a company in the sector; “from here, when a customer goes to the physical store and you don't give him what he wants or doesn't buy or the customer buys it online,” he added.
Therefore, the same promotion in the physical world and in the online store has different results, with a much higher discount sales rate on ecommerce than in physical stores. “It’s not that the online world is more promotional, but the customer knows that in some places he finds the product and in others he doesn’t,” the executive adds. “Online sales are more price-oriented, discounts and special offers; in fashion it has become the norm,”says Johan Hagberg, a professor at the University of Gothenburg specializing in retail digitalization.
Online scandal: trap 3 and 4
A red jersey purchased at any store of any brand. Its price could be placed at fifty euros (55.6 dollars) of sale to the public, with VAT included. Taking into account a cost of a garment of 15 euros (17.7 dollars), the margin for the brand is about 35 euros (39 dollars). How are they distributed in the event that the sale is made on the street or on the Web? Transportation, shop or staff will influence the first case, while in the second scenario only packaging and shipping come into play for example.
Indirect costs include aspects such as general marketing costs
“The scandal of online sales must include direct operating costs and, in addition, they must be assigned a part of the general costs,” says Luis Lara, managing partner of Retalent. Explicitly, according to Lara, several direct costs must be deducted from the gross margin that are only linked to the online store and costs shared with other channels, but also serve the digital distribution. Some examples of direct costs are direct marketing, distribution costs, personnel costs, system costs, payment gateway, and insurance. Likewise, indirect costs cover aspects such as general marketing costs, plant personnel costs, infrastructure, systems and financial costs.
“The cost structure is different: logistics weighs much more, whereas employees less; In addition, there are other added costs such as marketing; but rising is easier and faster online,” says Hagberg. “It is difficult to know if an ecommerce is profitable or not, because physical stores are important for it: how do you separate what is online sales and what is physical,” he adds.
What is the highest cost linked to the online operation? Experts agree that, although sometimes it may not be taken into account, the most prominent of these is the cost of collection. In fact, if the rental premises carries an important load in for a physical operation, in the case of online sales the equivalent is the cost of attracting users on the Web. “People say that you save the 12,000 euros (13.000 dollars) of rent every month, but in reality you are putting another 12,000 euros (13.000 dollars) in digital marketing, in SEO, in SEM and in protecting myself from Zalando who purchases the name of my brand on Google”, exclaims an executive of the sector.
Half a decade ago, newcomers to the sector such as Hawkers saw Facebook platform as a tool
“The online user recruitment market works like the stock market: the more demand, the more the prices of a certain title rise,” explains a director of a fashion start up. Half a decade ago, newcomers to the sector such as Hawkers saw on platforms like Facebook a tool to attract potential customers and became owners and masters of all the tricks to maximize modest investments. As this channel has been uncovered as essential for online sales, fashion giants from sectors such as luxury (without margin problems) have also began to go into it, in this case with unlimited budgets. This factor has caused a price increase that can end up expelling smaller companies.
“Google and Facebook earn more money with Zalando than Zalando with them; the acquisition cost is increasingly high, because operators are concentrated - says Sergio Odriozola, former director of companies such as Mango and Zalando and Bain’s consultant; if you have a store, you save that investment in part, because you're already getting it offline.”
In addition, capturing a user for the first time in comparison to retaining a customer it does not have the same impact to the margin. “In many cases, companies make the first sale even while losing money, because fishing for that user has costs a fortune," says the founder of Muroexe; it is essential to capture, but loyalty is more relevant.”
“There is an expression that says that the CAC (acquisition cost) is the new rental,” says Israeli Ayelet, a professor at Harvard Business School. “Many young companies financed by venture capital try to increase their sales by investing heavily in customer acquisition, sometimes spending more than it really costs,” adds the expert; companies should invest their money and their efforts also in retaining consumers, making the acquisition process more efficient and attracting better customers.”
If in the acquisition costs the kings and lords are companies like Facebook and Google, in the costs of the technological platform are names such as Salesforce, Shopify, Bluecommerce or Prestashop, while in payment methods the star is Paypal. This is another of the great costs associated with the online operation, although many brands do not charge it directly on the Network, since they consider that they are linked to the website.
“First we made our own development, but it was a big mistake because you are patching - Eduardo Zamácola maintains in reference to Neck & Neck-; it is friendlier to have an external development than an inhouse one”. The problem? Once again, commissions and margins. Once a solution such as Salesforce is integrated (which in the case of a company of the size of Neck & Neck can involve an investment of around 600,000 euros), the brand must pay a monthly fee, heading to which a percentage must be added by each transaction, as well as additional fees for each app or improvement in the basic platform package. To all this we must add the impact of the payment methods, as a percentage of each sale.
Logistics: Trap 5
“The logistics structure depends on the promise you are generating to the customer: Aliexpress sells in seven days and serves it from China, says Javier Vello, an EY partner, who gives an even more graphic example: “when Abercrombie & Fitch had no competition in Spain, the orders took 21 days to arrive; when you start competing and you see that if you don't offer shorter times you lose the sale you have to react”.
The need to achieve more and more speed has involved millions of investments by companies
The need to achieve more and more speed has involved millions of investments from companies
The need to achieve more and more speed has involved millions of investments from companies, both in logistics and technology. “In the field of logistics, many companies have had, for example, to adapt the way they manage their warehouses to be able to serve orders for ecommerce by units, for the final customer, and not by lots, which is what I used to do when destiny was the point of sale -develops Luis Lara-; all this has meant a great investment in systems and infrastructure that, beyond the concrete profitability in each company, has allowed them to continue existing, with what can be said to have been profitable”.
However, Vello clarifies that “many of the investments made in logistics are more OpEx than CapEx, because they correspond to third-party operations”. In this regard, the EY partner points out that investments in CapEx have not yet been amortized.
In the United States, the norm was marked by Amazon, with free the next day deliveries via its prime membership. In Europe and in fashion, Zalando ruptured the market since its launch in 2008 offering free deliveries and returns with a period of one hundred days.
In recent years, Inditex has launched 19 logistics centers only for ecommerce
In recent years, Inditex has launched 19 logistics centers only for ecommerce (stock rooms, in the terminology of the group) worldwide, it plans to add another fourteen until the end of this year, all of them outsourced. The company also offers same-day delivery service, which companies like Amazon or El Corte Inglés also offer, at an additional cost. Asos has also strengthened its infrastructure with the opening of a new logistics center in Atlanta to serve the US market, which until now was managed from the United Kingdom.
Returns are another weak point of online commerce, especially in fashion. In addition to the difficulties generated by fitting and sizing, in countries used to distance selling (first with the catalog and then with the Network) users have become common practice to buy more garments than desired and then return them. In countries like Germany the ratio can reach 40%, while the global average is between 20% and 30%.
“You have to collect the returns and process them quickly, because in less than a week the customer wants the payment; if you have sent nine euros, the cost of reverse logistics can reach seven euros, ”explains a director of the sector. The cost includes, in addition to the courier, the handling, the revision of the garment, the re-labeling… “Sometimes this process is simplified by taking the return to the stores so that the employee himself does it,” explains another senior executive; there is an opportunity cost because idle time is used, but you end up filling the stock store that is not always needed.”
The days of free shipping and returns is about to end
But the party of free shipping and returns seems about to end. After years of open bar for the consumer, Correos, Seur, MRW and DHL, among other operators, have raised the prices of the courier to recover margins, forcing retailers and pure players to decide if they assume that increase or transfer it to the consumer . Coinciding in time, Amazon banned its vendors at the end of 2019 using the Fedex parcel service.
Several of the giants have chosen, not without difficulties, to make the consumer pay, trying different formulas to balance service and profitability. Zalando was the first to uncheck free shipping and began testing in 2019 the minimum shipping in Italy. H&M continued to establish different minimum amounts according to the volume of purchases made by the customer per year, and Boohoo raised shipping costs and extended delivery times.
Asos, meanwhile, updated its return policy to avoid serial returns, announced that it would investigate unusual patterns and raised the price of premium shipping up to £ 14.99. However, only a few months later he had to back down, lowering it back to £ 9.95 and offering a discount to all premium members, according to a report by RBC Capital Markets.
“We are all monitoring the trend that marks those who start to make money: the ecommerces, explains an executive; this is why we will all end up charging the consumer.” The same director points out that “the threshold with which the game is played goes from 4 euros (4.4 dollars) to 9 euros (10 dollars),” charging the client between 4 and 5 euros (5.6 dollars), the brand does not recover the entire shipping cost, whereas between 7 (7.8 dollars) and 9 euros it does.
Asos updated its return policy to avoid serial returns
“The big challenge is deliveries, operators will have to seriously think about that,” reflects Odriozola; In Zalando a test was made to send orders from a Benetton store in Italy that operated as a sort of sorter center; the future will go there”. One of the options that experts point to gain profitability in online operations is to take advantage of the physical distribution network, a fixed cost that most companies already takes on. “For a customer to go to the store is much more profitable - explains a CEO of one of the largest Spanish groups in the sector-; If you give the customer the option of in-store pickup and you charge the shipping home the store pickup is triggered. And that is what we all want.”
Trap 6: invisible costs
In addition to logistics (“which has had to make a deep reflection on its business operation without lessons learned,” says Vello), other departments of fashion companies have been transformed in recent years through the impact of ecommerce. One of them is the system, the technological platform had to be developed to make the necessary connections, and another one is that of the retail department, which has had to modify its structure by transferring buyers from one channel to another. Human resources have also been forced to evolve, modifying kpis and variables and introducing and retaining new (and often more expensive) profiles to companies.
“Well-understood ecommerce does not affect only one area of the company. It does it to all areas, from the way of working branding and conceiving collections to aspects of detail how to make campaign or product photos, and many other key processes of the company, such as systems, infrastructure, and naturally, to people and the organization,” says Lara.
Human resources have also been forced to evolve with the emergence of ecommerce
The advent of digital in fashion companies has meant turning the organization around and, as Lara points out, “there are still many who continue to work with structures created for a physical only world and, worse, with a corporate culture that is more or less passively opposed to omnichannel. ” According to Vello, a new “balance of forces” has been established in the organizational chart of the companies: “before purchases and operations were in force, now logistics and digital have taken strength and also think”.
Chief customer officer, digital officer, chief data officer or head of innovation are figures that have emerged in the structures of fashion companies, leading teams that did not exist a few years ago, from people dedicated to innovate (“how is the profitability of innovation measured?”, Vello questions) to a myriad of men and women working in call centers.
The deadly trap
“If you analyze the operating account of the online channel, you clearly see the exact cost one by one and, if you compare them with the retail, you realize that it has a brutal impact - laments the director of operations of a Spanish company-; you would need to have 10% or 15% more margin on a garment that you sell online than in a store”. “Ecommerce is fundamentally a matter of margin: if you have a low margin and high returns, you will never be profitable,” adds another executive; you need to have a certain unit margin or, if not, you have to charge for shipping”.
Ecommerce is also a volume game
This race to accelerate everything, including ecommerce, which plays against the profitability of companies. “If you are a company like Primark, you will never earn money - they reflect from the sector; if you are Mango you can do it by managing returns well”.
But it’s not just about returns and speed. Ecommerce is also a volume game. And, on the one hand, the maximum potential of ecommerce has not yet been reached, as a relevant part of the population remains outside the channel. On the other hand, a large number of companies are increasing their online sales, while totals stagnate, that is, one channel cannibalizes the other and dilutes the margin of fashion. “If ecommerce is helping you acquire some clients that you didn’t have beofre, the impact is not dilutive,” says Javier Vello; It is dilutive when you sell the same thing, because you are putting an extra cost on the physical store network.”
But ecommerce has an even more momentous effect on fashion: the seventh trap. If the Internet was to eliminate entry barriers and allow even greater competition in the sector based on creativity, brand and product (eliminating high transfer and rental costs), the current configuration of e-commerce makes, again, fashion returns To be a giant game. Less barriers to competition and the arrival of new players? No. It is the same sector, but with new kings.