Sharing the credit - the enemy within

Continuing my series briefly looking at organisational impacts of multichannel.

In a previous post I took a look at the basic stages of organisational development as a retailer becomes "more multichannel". On of the first aspects of this journey that typically needs attacking - and realigning - is the question of incentives and KPIs. Put more crudely: "whose sale is it anyway?" This is part of a wider topic of avoiding "channel conflict" i.e. ensuring that your channels collaborate and not compete. Incentivising appropriate behaviour throughout your organisation forms an essential part of a channel conflict avoidance strategy.

Firstly, let's take a look at how NOT to do it. Apologies for a screenshot in German, but I think it's pretty clear what's going on:

Ah yes, we have stores. And it's not fair if the website "steals their sales" so let's make sure that we show a more expensive price online than for the stores, and so defeat this invading enemy. Plausible, except that our brand slogan is "I'm not stupid" (because I shop here and it's great value); and now you can see quite how stupid you would be to shop online. And in fact, the site let you change your home store and see that the price was different in Vienna than in Salzburg. As you can imagine, this concept (Media Markt Austria in early 2010) didn't last all that long.

I'm not entirely sure why they needed expensive consultants to tell them this wasn't sensible, and in fact that the answer was fairly simple: whenever a sale gets made online, a store should get the credit. Different clients I've worked with use slightly different rules, but the basics are always the same: online sales are split, usually geographically by delivery postcode, and the benefit from those sales, either directly as increased sales/margin or indirectly in some sort of "commission", is allocated to the nearest store.

This has the benefit of neatly dealing with all those cross-channel stories too. Online sale, return to store? No longer does it make the store look bad, because the store "got" the sale in the first place. (OK, you might have to increase the acceptable KPI for stores because online sale typically generate proportionately more returns, especially in categories like fashion). Similarly collect-in-store is dealt with. Whose sale was it? Obviously the store where the collection took place.

Such approaches do need a little bit of dexterity in back-end accounting. Typically this is done by treating the website sales as "virtual". In other words, any ecommerce team-members that might be targeted on online sales still get credited for their efforts by accumulating the sales which pass through the website, but these sales are not rolled-up into the overall P/L (because the store sales are used for this), they are just tracked for KPI purposes.

Overall, it's another big change from traditional brick-and-mortar only: store managers and store staff need to really care about the website and regard it as their friend not their enemy.

Asos vs Amazon; Delivery vs Marketing

In the P.S. to my last post on delivery charges, I highlighted the gem in the small print of Asos's latest annual accounts: reclassifying delivery costs as a marketing expense. This seemed an interesting enough idea to take a look at what Amazon does, and in fact to generally compare the two. (Especially in the light of rumours that Amazon is considering making a bid for Asos, presumably along the same lines as its Zappos move a couple of years ago).

So, a trawl through the latest Amazon 10-K, and sure enough, Amazon also makes a similar comment:

"While costs associated with Amazon Prime memberships and other shipping offers are not included in marketing expense, we view these offers as effective worldwide marketing tools, and intend to continue offering them indefinitely."

Slightly different approach, but basically the same statement: free/discounted shipping is a marketing cost. How big a cost? Helpfully Amazon provides the information. In 2011, income from shipping fees was USD 1.5 Bn, and shipping costs were USD 3.9 Bn i.e. the net cost of this "marketing tool" was an eye-watering USD 2.4 Bn worldwide! Compare this with the actual spend on marketing of USD 1.6 Bn. Shipping offers cost Amazon 5.1% of turnover (up from 4% the previous year), compared to marketing at 3.8% of turnover. In reality, 5.1% actually understates the figure, because the turnover includes a substantial slice of income from services and fees (such as marketplace and hosting); with these excluded, the shipping offer actually represents almost 6%.

A look at the same numbers for Asos reveals shipping fee income of GBP 10.7M, 2.2% of sales compared to Amazon's 3.5%. Asos doesn't actually directly break out the cost of its shipping, but it is possible to estimate it from the other numbers published, to be around GBP 25.5M, around 5% of turnover. So the net cost to Asos of treating shipping as a marketing expense is GBP 14.8 M, or around 2.9% of sales. Not quite as startling as Amazon, but certainly comparable. However Asos spends a slightly higher percentage of revenues on "true" marketing, around 4%, so it has not YET reached the point like Amazon where free/subsidised shipping is its primary marketing tool. Judging from the statements made in the accounts regarding ongoing developments in this area, however, it won't be too long before this is so.

Of course the other big difference between the two is that Asos can afford it! It is genuinely profitable - net profits are around 8.3% of turnover, despite continuous investment in overseas growth, new IT systems etc i.e. all the excuses that Amazon seems to use to explain its perpetual hovering around the boundaries of break-even: profit was 1.7% of turnover in 2011, and it actually made a loss in 3Q12.

Obviously this difference is not unconnected with the difference in gross margins. Asos has gross margins of 49%, Amazon only 22%, a situation it dismisses with the explanation:

"We believe that income from operations is a more meaningful measure than gross profit and gross margin due to the diversity of our product categories and services."

While this is probably plausible, measuring gross margins for an online (or mail-order for that matter) business is not meaningful in another way; I believe the right measure should anyway be delivered margins i.e. including delivery fees, shipping costs and returns processing. And given Amazon's mix of categories, the underlying implication in these numbers is that quite possibly Amazon is operating some categories below break-even delivered margin.

Getting off-topic a little, investors seem to still believe in the Amazon go big or go broke strategy, and don't require it to make reasonable profits, presumably on the assumption that if it eventually stops investing in growth then actually the underlying business is profitable. If you are the punting type, you might fancy a bet on the dual scenario that the US as a whole follows the trend in some states to put purchase taxes on an even footing between offline and online, and then that BestBuy (and others) accept the logic published recently by Media Markt (see my previous post) and go for a big cut in gross margins themselves, thereby putting themselves on a more even footing on price with Amazon. Whither then Amazon?

What then should a true multi-channel retailer do with regards to this whole "shipping as marketing" idea? Firstly, take a look at this photo, taken in a London Underground station recently:

Amazon Locker, Hammersmith Station

Yes, it's one of Amazon's attempts at click-and-collect. But... there's no in-store additional sales to help the business case along. As I suggested recently, customers like click-and-collect, but retailers like it even more because it leads to incremental sales. And a certain lack of convenience doesn't seem to hamper customer take-up: Marks-and-Spencer stores, for example, are not exactly handy in general - they tend to be in town-centre locations not residential areas, especially outside of London.

My proposition then, is that multi-channel retailers should reinforce click-and-collect, using the same mindset that leads Asos and Amazon to treat fulfilment as marketing cost, but focussing on stores as a competitive advantage. The most obvious way to do this is some sort of coupon/voucher that is valid for further spending when associated with a collection. I'm not aware of this being done yet, but I'm sure someone somewhere is already on to it - the results will be interesting.

 

Not all channels are equal - at least in the eyes of the finance team

One of the more bizarre obstacles I have encountered when working with clients adding eCommerce as a totally new channel to an existing brick-and-mortar retail operation is the accounting treatment. OK, I'm asking for accountants to use their imagination - not always an easy stretch.

But actually the equivalences between brick-and-mortar and virtual channels are very important for two reasons. One, they are essential to properly understanding the business case. Two, they are even more essential to moving from multiple channel to true multichannel in a later phase of the strategy.

I'll start with the less controversial ones. Of course it's all a matter of opinion, but this is my starter for 10 (well OK, 6):

1. both channels probably have warehouses (strictly DCs - distribution centres - for stores, and FCs - fulfilment centres - for online). Some retailers even manage to combine both operations in one location, despite this being actually quite a tricky blend of operational processes.

2. both channels have a store operations team. In a store, there is a store manager, sales assistants etc. Online, there should be a web-site operations management team, organised in various ways. They perform approximately equivalent roles.

Now the going gets a bit trickier.

3. Brick and mortar has store fit-out. Online has a website. If you are going to compare (and eventually seamlessly blend in true multichannel) they need to be treated similarly from a business case perspective. Quite often this means equating store-fitting opex with IT capex, although as SaaS models such as Demandware increase in popularity maybe this distinction may become less acte.

4. Brick and mortar has stores. Online has delivery/fulfilment costs. In the former case, you operate places on the high street to which you distribute your goods for customers to receive. In the latter, you take them to customers' homes for them to receive. The processes are logically equivalent. Fulfilment costs are typically a high part of the cost of an online channel. Store rental is typically a high part of the cost of a brick-and-mortar channel.

And now for the really controversial part.

5. Standard delivery fee income is NOT sales. It is a contribution to your marketing budget. If you accept that delivery/fulfilment costs are equivalent to store rental costs, then delivery fee income is not a way to reduce the fulfilment budget. Imagine the store equivalent: suppose you could charge each customer a few pounds service-fee to be allowed to use the checkout in your stores. Surely you would not really treat this as "sales", (and count it into gross margins)? In the same way as free delivery is a huge driver of trade on a website, allowing your customers to checkout in stores for free does actually help persuade customers to make a purchase.

OK, you might book it into your general ledger as income. But for business-case purposes, and for targetting the web channel, don't treat it as sales income.

6. Non-standard delivery fees are somewhat different. They fall into 3 kinds. Firstly expensive charges for expensive deliveries such as for pallets or 2-man products. In this case, the fees should genuinely be offset against the delivery cost. Secondly, delivery-related services such as installation. These are sales. You have persuaded the customer to buy an extra (service) product. Thirdly options like express delivery, where you may feel it is appropriate to treat these as a (service) product with an associated cost-of-goods/service and resulting margin.

For most retailers, looking at things through this "equivalence" perspective has a number of major benefits:

1. it allows a level playing field comparison of channels, and avoids distorting behaviour leading to artificial channel conflicts.
2. it makes the trade-off between the different capex and opex elements of the business cases for each channel far more transparent
3. it reduces the sense that margins are being distorted by multichannel
4. it makes a seamless transition to true multichannel much easier to implement later on, especially for truly cross-channel activities such as click-and-collect

Even if you don't like my particular equivalences, select some that you feel are appropriate to your particular business model.