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.

Are shrinking stores inevitable in consumer electronics?

"Dixons to scale back high street presence."

"Best Buy has set plans to reduce its store square footage by 10% in the next five years."

The continuing threat to the business model of consumer electronics retailers posed by the internet seems to have elicited a consistent response: "honey I shrunk the stores." Or in the case of Comet/Kesa, sold the stores.

These retailers are determined to protect margins. Protecting margins means that price-based competition from pureplays eats into store sales. Ergo, fewer/smaller stores.

Protecting margins is rather understandable when you look at the panicky 15.5% drop in the share price of BestBuy when margins took a 0.9% hit during the last holiday season.

And yet curiously gross margins are historically quite high. US GAAP helpfully forces retailers to publish true gross trading margin figures. And Best Buy's margins look like this:

Pretty steady in other words, and despite the recent drop due to trying free-delivery for the holiday season, historically really rather high. Take a quick look at the longer historical trend:

In other words, since the dawn of the internet age (and of course the dawn of the Chinese manufacturing age), Best Buy has enjoyed historically high margins.

Dixons and Comet are rather coy when it comes to stating gross margin figures. When they are down, they tend to say things like "significant margin pressure" while when they are up they crow about "0.4% increase in gross margin". Solid data is rather absent, but a trawl through the financial reports for the last few years seems to imply a reduction of somewhere between 2% and 3%, recovering slightly recently, hardly a disaster.

Dixons and Comet's sales, of course are another story (although this doesn't - yet - seem to be such a problem for BestBuy). Effectively they've traded preserving margin for lost sales. But is this the only approach?

German giant Media Markt-Saturn thinks not. OK, they've got an extra problem - their stores are partly owned by franchisees, so announcing a programme of store closures is not really an option. Instead they've decided to go straight to the heart of the matter, and announced that they will reduce prices... by 5%-6%.

In other words, they've decided that they are actively going to try to protect sales (and their franchisees), by accepting a loss of margin instead, and planning for this strategically.

It has to be said that they've had a rather torrid time trying an alternative approach. This horror-story is from their 2010 pilot in Austria (where they tried it out before risking their core German market):

My online customer journey:

1. I'm attracted to MediaMarkt by their slogan "I'm not stupid, (because I shop at Media Markt)"
2. I go onto the site, where I have to declare my home store (instant loss of 50% of customers)
3. I find that a) prices are cheaper at a different store; b) their online price is not cheap at all
4. I decide I am indeed stupid because I shop at Media Markt. I go somewhere else, probably online
5. I decide that Media Markt are also stupid, because their pricing strategy is a disaster area

The net result of this monsterpiece was the departure of the CEO and Finance Director, and a fresh think.

And now they've had a fresh think, they've reached a completely different conclusion from Best Buy. Quite simply, they have recognised that store price = online price is mandatory, (which is a conclusion all true multichannel retailers eventually reach: the customer experience is just absurd otherwise.) And then they've drawn the logical consequence from this - prices will have to fall:

You can find the full presentation at this link.

The summary is actually quite simple:

1. we have to have one price across all channels
2. in order to do this credibly, we have to reach down to median internet price or lower
3. to do this prices have to fall, by about 5% from shelf price, and 3% from customer price (customer note: it's probably worth trying to negotiate a bit in a MediaMarkt or Saturn store)
4. in order to make this possible, we will reduce the cost base (but not the store base) and also simply accept lower margins

It will be interesting to see if BestBuy follows suit. And if so, what it does to their share price if a 0.9% margin drop can reduce the value of the company by 15.5%... But then they are currently enjoying historically distorted high margins!