Online retail and e-commerce model runs on thinner margins

10 November 2021 Consultancy.uk 4 min. read
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As the trend to digitalisation inevitably ramps up competition in the ecommerce space, retailers will have to learn to live with the tighter margins online shopping brings. According to new analysis, the UK retail industry alone could lose more than €9 billion in profits, as it seeks to adapt to digitally-centred consumption.

In recent years, the boom of ecommerce has offered many brands a new lease of life – as digitalisation and the creation of omni-channel shopping experiences has boosted convenience and reduced costs for the consumer. Due to these factors, as well as the proliferation and improvement of available digital shopping channels, the online shopping market had already grown steadily across the world. It accounted for more than one-fifth of total non-food consumer goods sales in the UK alone, long before the Covid-19 pandemic drove even more shoppers to do their business digitally.

Across Europe, the impact of Covid-19 has caused step-changes in the proportion of online sales. According to new research by Alvarez & Marsal (A&M), by 2025, over 20% of bricks-and-mortar retail sales are expected to shift online, across Europe. The UK is expected to be the most deeply penetrated market on this basis, with 33.5% of sales expected to occur online by 2025. However, while online shopping has long been lauded as a lifeline for retailers – which have spent recent decades struggling to remain profitable via traditional models – as the market becomes ever-more saturated, the researchers found that the trend online will likely accompany falling profitability.

Online penetration across Europe expected to accelerate to 20% by 2025

In the case of the UK, there could be an estimated reduction in pre-tax profit margins from 5.5% at the finish of the financial year 2019 to just 3.2% by the end of 2025. Throughout this period, the UK retail industry is expected to lose around €9.3 billion of profits, in contrast with a scenario where online retailing had remained as prevalent as it was prior to the Covid-19 pandemic.

Tighter margins

A&M’s report analysed the profit margins of retailers across European markets, and compared it with online penetration rates. Delving into the situation, the analysts found that online-only retailers typically operate on considerably lower margins than multi-channel and bricks-and-mortar business models. At present, the pre-tax profit margins for pure online retailers across Europe resides at just 1.4%, compared with 5.4% for the total industry – and with rising competition and a greater use of online channels across the entire market, these challenges will likely intensify, particularly in categories like apparel where A&M anticipated “a greater proportion of spend will migrate.”

Pre-tax profit margins have fallen as penetration rates rise throughout key European markets

One major pressure points faced by ecommerce operators – but not felt by bricks-and-mortar stores –  is the cost of returns. While trying products like clothes on in-store means traditional retailers can avoid some of this, and physical returns are brought in by the customer, receiving an increasing volume of online returns will drive further profit erosion for retailers. Left unchecked, this could create increasingly complex and fragmented logistics channels, in efforts to cater to customer expectations for fast and efficient service.

With younger shoppers almost twice as likely to return goods than their older counterparts, this is a problem which will only get bigger in the coming decades. For example, A&M estimated that UK consumers aged between 18 and 24 returned about 16% of products purchased online, compared with 7.5% by consumers aged 65 years and older.

Profits are expected to fall at a faster rate than before the pandemic, driven by a more aggressive consumer migration towards online

According to Erin Brookes, Managing Director and Head of Retail and Consumer, Europe, A&M, retailers must brace themselves for “a make-or-break moment” to prevent profits from heading rapidly downwards. It is too late to return to the -pre-Covid-19 levels of digitalisation, too, so retailers need to acknowledge changing consumer behaviour if they are to adapt and survive.

Some categories such as furniture and jewellery – which shoppers view as ‘less convenient’ than traditional shopping, due to a preference for ‘touch and feel’ browsing – will see some shift in spending, but ultimately will be most likely return to pre-pandemic conditions. But beyond this, as Brookes notes, European consumers now expect to permanently shift approximately 20% of their spend across apparel, homewares and electricals online – an almost fourfold increase from the early stages of the pandemic in May 2020.

Advising methods which these retailers might use to change tack, Brookes explained, “This includes successfully transitioning away from some physical stores and re-imagining the purpose of others. Investments in efficient online operating models such as reverse logistics, strategic partnerships and intelligent data and technology are essential.”