By Antony Karabus, CEO, HRC Retail Advisory

As described in last week’s Q&A Interview in Retail-Insider, shifts in consumer behavior and expectations have permanently changed the Canadian retail landscape and as a result, physical store traffic and store sales are being meaningfully impacted as customers move online.

Retailers' profits and losses are being pressured, with the bottom line 'feeling the heat'. This is requiring retailers to rethink prior assumptions about the role of physical stores as well as ongoing investments in e-commerce, store level technology and more specifically omni-channel strategies.

How Did We Get Here?

Over the past five years, these changes in shopping behavior have forced retailers to establish duplicate infrastructures to enable consumers to interact with the retailers when, where, how and in whatever channel they desire.

In addition, numerous brick-and-mortar retailers are experiencing a loss of market share to Amazon.com, which is growing North American merchandise sales at almost 30% annually, versus a low- to mid single-digit increases in top-line sales for most traditional brick-and-mortar retailers with online operations.

Moreover, Amazon continues to add distribution centers and categories (while going deeper into its existing ones), while promising shorter shipping lead times, coupled with additional benefits for Amazon Prime members.

Added Infrastructure Costs

In response, retailers have tried to battle against the 'Amazon effect' while also meeting the needs of a consumer-centric environment. In a number of instances, retailers have made substantial investments in omni-channel while many have neglected their physical stores — which still provide most of their sales and virtually 100% of their operating profits.

But what has played out on the Profit and Loss Statement is what’s troubling. The historic, largely fixed-cost infrastructure of retailers’ physical store channel has now been joined by a variable-cost-driven infrastructure to enable online sales.

The combination of the historic fixed-cost store-cost structure and the variable-cost e-commerce-cost structure has added significant operating and capital expenditures without, in most instances, adding aggregate top-line sales for the total retail company. This is coming about a result of a shift in sales from the physical store channel to the e-commerce channel.

HRC Advisory Starts this Process by Asking Some Key Questions

So, the need to meet consumer demands for online shopping while protecting profits has created a conundrum for retailers. HRC recommends five key tactics to address these issues:

First, retailers should assess their business operations, organization structure, capabilities, policies and processes in an effort to create a sustainable and profitable model in this complex retail environment.

The Key Tactics HRC Retail Advisory recommends are:

1. Decide which omni-channel capabilities will be most valued by each retailer’s particular customer, rather than investing in all capabilities. When the retailer has decided which is the most relevant capability for their business, ensure all the upstream and downstream processes and tools are equipped to deliver on the promise

2. Prioritize and decide on important decisions such as price-matching, free shipping, free returns, direct-to-customer dedicated fulfillment centers and full inventory visibility.

3. Establish the right methodology to better exploit data and related insights to drive customer-focused decisions.

4. Determine how to rethink and enhance real estate decisions in the light of the channel sales productivity issues.

5. Ensure store, supply-chain and home-office infrastructure cost is properly sized and structured to profitably serve store and omni-channel customers to enhance shareholder returns. This needs to be a bottom-up assessment, not just an attack on head-count and the “ easy targets “ of store labor and marketing costs.

Comprehensively and objectively addressing and considering these issues on a bottom-up basis should assist retailers to address their competitive position relative to competitors and pure-play e-retailers, and to making the right capital and operating investments to protect and even enhance earnings in the face of this new retail environment.

Understanding This New Retail Operating Economic Model

Based on HRC's proprietary research, retailers are incurring a significant increase in the cost of enabling and fulfilling online orders and related returns, relative to the cost of physical store orders. These numbers are without allocating the cost of shared services infrastructure (such as IT, finance, human resources, payroll, executive management and other areas) to the online channel’s P&L. This additional cost burden is not sustainable in the long term if one considers the historically low earnings margin experienced by retailers.

Meanwhile, for public companies, there’s been a bit of bias on Wall Street/TSX. Shareholders and analysts have not been patient in expecting earnings from traditional retailers who are hard at work transforming their businesses to better compete and remain relevant, while they’ve been extremely patient in waiting for acceptable profits from Amazon and other pure-play retailers. And in the current climate, traditional brick-and-mortar retailers face extreme pressure from financial analysts, shareholders and activists not only to maintain, but deliver higher earnings.

The result is an increasing de-leveraging of physical store cost infrastructure as sales per square foot decline with the shift to the online channel. The exception to this de-leveraging reality is when major competitors exit the market or experience restructuring and significant store closures, allowing the remaining retailers to increase their market share in the sector, albeit in the short term. And the de-leveraging of store-cost infrastructure increases as the e-commerce penetration rate of total sales in the market increases.

Going on the Offensive

The best response to this new cost of doing business is for retailers to “take command of the game” and really go deep into leveraging their strengths and inherent advantages relative to Amazon and other pure-play e-tailers rather than trying to compete directly with these emerging competitors.

This is the Walmart effect of the 1980’s and 1990’s, but is being repeated at a much more rapid and complex pace. So while it would be a mistake to take on Amazon head-to-head at which it does best, retailers can deploy some offensive strategies. And the absolute best offensive tool that a traditional brick-and-mortar retailer has is its ability to introduce an online customer to a tactile experience in its stores, which means rethinking the role of the physical store so that it becomes an omni-channel service center and a holistic introduction to the brand, rather than just being a place to transact.

Some of the advantages of this approach include:

• Introducing customers to physically experience the brand and the product in a store.

• Reducing the rate of return of online orders as customers can ensure the product fits, and is suitable for their needs.

• Increasing the total value of the online order by purchasing complementary items when they are in the store to pick up their online order.

• Reducing the shipping cost of the sale and potential return and provide numerous convenient locations for customers to pick up or return online orders.

With the above significant advantages, retailers should encourage online customers to visit the store in nontraditional ways such as:

• Same-day pick-up, utilizing inventory already in the store.

• Free shipping to stores for online orders.

• Samples, free gifts or discounts on additional items when customers pick up online orders in stores, to encourage additional browsing.

• Being invited to attend special invite-only events in stores, including book signings, product tastings, fashion trunk shows and so on.

And in order to effectively enable these “BOPUS” (buy online, pick up in store) and “BORIS” (buy online, return in store) omni-channel capabilities, retailers need to strengthen their inventory management practices to minimize the likelihood of disappointing online customers.

Antony Karabus is chief executive officer of HRC Retail Advisory, a leading retail consulting firm based in Toronto and Northbrook, IL. A version of this article recently appeared in WWD.com.

*Top photo: www.shopparkroyal.com.