Solving the online logistics dilemma: A practical guide toward profitability
E-commerce businesses have allowed shoppers to have sky-high delivery expectations, but these companies have not given sufficient thought to logistics complexities and costs. As we assess retail today, many online operations have never made a profit. A smart, structured approach using a clear framework can start to reverse years of losses.
Online retail sales revenues have been a consistent success story since the advent of the Internet. In Europe, for example, e-commerce revenues rose by 15 percent to €530 billion (US$632 billion) from 2015 to 2016, according to Ecommerce Europe, a Brussels-based industry group. A survey this year by PwC showed that 60 percent of global shoppers prefer online to brick-and-mortar stores when purchasing books, music, movies, and video games; that portion is 40 percent for fashion and 23 percent for groceries.
However, this incredible top-line growth has rarely been matched on the bottom line. Among other factors, cost-effective online delivery has proved an incredibly difficult problem to solve.
Many companies rushed headlong into e-commerce in part because they thought they had to match competitors and in part because of the supposed promise of future profits. But in their haste to gain a slice of this growing online pie, they rarely properly assessed the complex and costly logistics of online retail. Shoppers were often promised very fast and free standard delivery, and this simply created high expectations that made little financial sense for the company. A recent survey by PwC Germany showed that 91 percent of German online shoppers expect free delivery.
Exhibit 1 illustrates this trade-off between shopper satisfaction along the whole ordering and delivery journey, and the underlying fulfillment costs.
Recent Strategy& benchmarking analysis across European retailers suggests an optimistic breakeven model of €3.50 (US$4.18) as a minimum cost-to-serve per shopper delivery for simple parcel fulfillment. Anything below this level indicates an average loss-making business model that will be unsustainable in the long term. (For the purpose of our analysis, cost-to-serve means the logistics costs that are incurred from the point at which goods are received at a warehouse until delivery to the shopper’s doorstep.)
A separate survey of Strategy& online experts shows that although more than 80 percent of luxury brands run online operations profitably, the percentage drops to less than half of those selling fashion goods and less than 10 percent for groceries (Exhibit 2).
This report, drawn from our experience working in retail markets worldwide, sets out pragmatic solutions to tackle this industry-wide pain point. A structured approach to online logistics can help companies satisfy a new norm in shopper expectations — free high-speed delivery — while maintaining acceptable levels of profitability.
The framework solution
There is no one-size-fits-all approach, but Strategy& has developed a step-by-step framework to help companies evaluate all elements of their online business (Exhibit 3).
The six-point plan sets out the key questions that companies need to address in order to create a customized and cost-efficient online logistics business.
- Which interfaces with the shopper do my online operations need?
- Where should I store and replenish my products to fulfill online demand best?
- How can I benefit from full end-to-end supply chain transparency to optimize inventory, product flows, and cost?
- What is the best way to handle returns?
- When is it better to outsource parts of or even my entire online supply chain?
- What does a smart delivery pricing model look like?
Tailored consumer interfaces
There are three main ways of selling online: the pure e-tailer model with no brick-and-mortar presence, such as Amazon’s main business or Coolblue, a Dutch e-commerce company; the traditional retailer wanting to add an online sales channel alongside its stores, such as MediaMarkt, a German consumer electronics retailer, Rewe, a German grocery chain, or Wilko, a British housewares chain; and the original brand manufacturers now selling through the Web, such as Nike or Estée Lauder.
In all these models, the most important decision is how the product reaches the end-user. Doorstep delivery, or pickup from a local retail store (so-called click and collect) or a parcel delivery depot — such as a locker — are the two main options. Everything else works back from this to build a network and stock replenishing infrastructure that will support sales in a cost-efficient way.
A key consideration is the product being sold. Companies shipping low-cost items such as groceries or low-value fashion items such as T-shirts will find it difficult to absorb high delivery charges, so an in-store or external pickup makes more sense. This is becoming a common choice for grocery retailers, which have the added complication of handling perishable goods.
On the other hand, shoppers buying an expensive brand-name item, such as a designer handbag, will expect a higher level of service, with the item delivered directly to their door. More expensive home delivery can be profitably accommodated as the shipment costs are only a fraction of the product’s value. And when bundled with an additional home service — such as the assembly of furniture — home delivery naturally becomes the first choice. Retailers should have a solid understanding of the service level needed for different product types to make the final choice, as highlighted by the IKEA case study.
Case study: IKEA
IKEA is a global home furnishing retailer that offers a wide range of well-designed functional products at low prices. Wim Blaauw, deputy customer fulfillment manager at IKEA, is convinced that neither a broad pure physical store network nor a pure online channel will be enough to keep shoppers happy in the future. “At IKEA, we understand our physical store network as a competitive advantage and integral part of our fulfillment infrastructure complemented by fulfillment centers and our last-mile network. We expect competition to evolve more around the scope of the service offer[ing] rather than around lead time,” he says. He adds that although shoppers expect parcel deliveries with short lead times, they are content with slightly longer lead times for larger furniture deliveries — but only in combination with delivery precision. “Real competitive advantage will evolve from a superior shopper experience, as well as through additional and relevant services such as assembly service and hassle-free returns management,” he says.
There are many variations within both categories, ranging from the required speed of delivery to the actual pickup location. Each option has different logistics requirements and associated costs, so companies may be better served by narrowing their range of offerings in line with their shoppers’ needs instead of attempting a pitch-perfect omnichannel experience.
Given these arguments, many of the most popular items sold online, such as low-value fashion, groceries, and simple consumer electronics, could logically often be delivered to a pickup location rather than directly to the door, cutting out the resulting final-mile costs. However, shoppers now expect what is often unprofitable for a retailer. The challenge is to factor this new norm into practices that make business sense and serve the shopper in line with his or her needs, as highlighted by the emmasbox case study.
Case study: emmasbox
emmasbox is a startup founded in 2013 in Munich offering market-leading “click and collect” parcel lockers for food and nonfood retailers, as well as locker management software and interfaces to retailers’ systems. The company has partnered with nonfood retailers and large grocery chains in the operation of grocery lockers — for example, with supermarket chain Edeka at railway stations in Stuttgart and Berlin, and with Interspar for lockers in Austria. Michael Reichelt, emmasbox founder, believes that in the future as much as 40 percent of all grocery orders will be picked up from parcel lockers. “A lot of consumers do not want to commit to being at home at a fixed time for home delivery. More convenience means for them picking up their order spontaneously on their way home,” he says. Reichelt adds, “Retailers first need to understand their online shoppers’ needs in order to build up profitable online operations and to reach a win-win situation toward more shopper satisfaction, as well as increased online profitability.”
At the end of the day the company needs to analyze the type and value of the product being sold, as well as the expected service levels, to see what kind of online delivery service makes sense for the business from a cost perspective.
Optimal picking footprint
The next problem is identifying the optimal way to replenish and store goods before delivery. Again, the type and value of the product being sold is a major factor.
In general, items with high value and relatively small metric volume, such as luxury items, should be stored in a more centralized way, because the cost of inventory and working capital outweighs the higher transportation costs that come from being farther away from shoppers.
Products with a lower value but a relatively large metric volume, or those with other complex delivery requirements — such as some housewares or temperature-controlled food — should be stored closer to demand, as the transport cost will outweigh inventory costs. For low-value and low-volume items, such as some do-it-yourself products or small consumer electronics, the challenge is in handling. Exhibit 4 outlines the key product characteristics and the logistics focus and tools they require.
The ideal scenario is that the business is able to build some flexibility into the process rather than fixing the storage location. If luxury goods companies, for example, are clearly able to identify where all their products are at any given time, they are able to decide on a per-order basis whether it makes more sense to pick from the central warehouse or a retail store. This flexibility can be a key differentiator, allowing companies to battle each other with lead times as short as 30 minutes.
German e-tailer Zalando has taken this concept one step further, delivering products not only from its own online site but also from any partner retail store, an expanded network that it uses as decentralized inventory. Partner stores use Zalando packaging so the shopper enjoys the same branding experience but benefits from the superior delivery speed.
As shown in Exhibit 4, innovative technologies also play a key role in the best picking footprint. Depending on the logistics focus in question, there are an increasing number of disruptive technologies that can help to overcome challenges such as reducing the carbon footprint and navigating regulated inner-city environments. Such technologies include drones and electric vehicles. Recent PwC research in Germany showed that there is strong support among online shoppers for regulators to introduce more incentives for the use of electric vehicles to enable parcel delivery. Warehouse automation and even disruptive new warehouse types will set the standard for tomorrow’s picking footprints. Consequently, in the future it will not be enough to know where picking takes place; understanding of how to use the best technology will also be needed.
End-to-end optimization and transparency
To ensure successful online logistics, the flow of products through the network needs to be constantly monitored. Omnichannel retail makes planning more complex, and therefore applying traditional processes to manage inventory may no longer be effective. Companies will need to apply a more segmented approach, considering a multitude of dimensions such as service levels, shelf life, basket sizes, product value, and product volume.
The increasing availability of big data analytics will be invaluable in helping not only to identify where products are at any given time, but also to predict the likely future flow through the supply chain. IBM, SAP, and Microsoft are just a few of the growing number of platform and software providers working on predictive data and end-to-end transparency solutions. Some of the benefits of this approach are pointed out in the E2open case study.
Case study: E2open
E2open is a global cloud-based, on-demand supply chain solution provider. For Shawn Lane, the company’s senior vice president of sales and marketing, using artificial intelligence as a crucial component in predictive analytics is essential for profitable online logistics. “Across retail and consumer goods companies we see a higher amount of 3PL [third-party logistics] participants for manufacturing and logistics, as well as strong cycle-time pressure driven by rising shopper expectations on product availability and delivery speed,” he says. “To keep up with this, and to optimize stock inventory and costs across the network, retail and consumer goods companies are focusing on their end-to-end supply chain transparency and optimization.” Such companies are, for example, accelerating inventory visibility and demand planning from a monthly to a daily forecast by employing artificial intelligence, which uses pattern recognition technology to analyze diverse data — including point of sale, weather, and social media — to more accurately predict demand and associated volume flows. “This way, our retail and consumer goods clients have been able to achieve, on average, a 30 to 40 percent inventory reduction across their supply chain network, which translates into 1 to 3 percent savings in their net earnings,” Lane says.
We also see major potential for change when it comes to matching the frequency of delivery cycles to online ordering patterns. Current distribution networks operate a daily cycle: Products are picked during the day, shuttled overnight to the destination hub, and sorted for daytime delivery. Online ordering occurs throughout the day but tends to peak in the evening. Therefore, moving smaller volumes around the logistics cycle more than once a day ensures adequate replenishment of warehouses as well as optimizing delivery speed. This could lead toward an additional delivery cycle, which involves overnight picking for early collection from a warehouse, with daylight transport to the destination hub, or evening home delivery.
A successful e-commerce operation starts with an in-depth knowledge of the internal cost-to-serve and the specific cost drivers of the business. It will also require deep collaboration with suppliers to understand their costs of doing business.
Ultimately, the aim is to be able to pinpoint an exact cost-to-serve for each parcel delivered to the shopper’s door, broken down by factors including product, speed of service, and delivery method. Only a handful of leading online retail and consumer goods companies currently have this full transparency in supply chain costs. However, in the future this will be key to helping companies make decisions based on the profitability of each item sent.
Companies should strive for as much standardization as possible to achieve economies of scale and improve productivity. They will also need to develop the right information technology systems to be able to track and report the costs for each and every process.
Although carrying out this end-to-end cost analysis can be a complicated process, it pays dividends in both efficiency and profit.
One of our clients that implemented this analysis of the cost-to-serve was able to identify significant room for improvement in packaging. First it cut the number of packaging options it offered, and then it decreased the number of costly failed home delivery attempts by developing a parcel size that was a better fit for shopper mailboxes.
Smart return handling
Initial delivery is one consideration, but returns also have a major and sometimes unsustainable impact on costs.
Many clothing companies have offered to take back unwanted goods at no cost because shoppers were otherwise wary of buying without being able to try. Some of these companies have found the return rate more than 50 percent of the forward shipment. That is a huge expense. Consider that the cost to retrieve a product and reintroduce it to the supply chain can be three to five times higher than the forward shipment.
Typically, returns are either collected from home or returned to a nearby drop-off location such as a store. Here traditional retailers have the advantage; by requiring the shopper to enter the store, they are creating traffic and can give a refund or voucher for consumption at that point. A pure e-tailer will have little choice but to pick up from home or an external drop-off point.
The easiest way to handle returns is to try to avoid them in the first place. The fashion industry has technology that will allow clients to see online what they would look like wearing a new garment before buying, thus reducing the likelihood of a nasty surprise at home.
Delivery employees are also increasingly recognized as part of the sales force, giving advice or waiting for the shopper to try on the garment and taking it back immediately if he or she is dissatisfied. This allows using idle vehicle capacity on the way back to the warehouse for those immediate returns — at no additional cost. A growing number of companies, including luxury e-tailer Yoox Net-a-Porter, are offering just such a “you try, we wait” service, with instant returns. Lamoda, a Moscow-based fashion e-tailer, has experienced the benefits of such smart return handling, as shown inthe Lamoda case study.
Case study: Lamoda
Lamoda is one of the leading fashion e-tailers in Russia, Ukraine, Belarus, and Kazakhstan. Faced with immature third-party logistics markets and infrastructure, vast geographies, and a seasonal business, the company needed to build up superior internal logistics capabilities and a large network of its own last-mile operations in more than 50 cities to maintain its delivery promise. Florian Jansen, Lamoda cofounder and managing director, says smart return handling is key to driving the business. “By implementing new processes such as try-on service and incentivizing the [van] driver toward selling, we managed to limit return costs significantly,” he says. “Our scalable infrastructure — especially around Moscow and St. Petersburg — further allows us to process large volumes of returns very cost-efficiently and at high speed, and to get stock on our webpage again in no time.”
These measures lower the return rate but will not eliminate all returns. Therefore, it makes sense to turn the remaining returns into a business opportunity. Since poor return handling naturally results in a negative shopper experience, it is important to make returns as hassle-free as possible. Zalando, for example, operates a high-speed home or workplace pickup service for returns in some European cities. This allows the company to increase the frequency of contact with shoppers, which in turn helps build loyalty — and maximizes profitability.
Make-vs.-buy vs. crowdsource
Once the right physical infrastructure to support online sales has been identified, e-commerce businesses need to decide whether to create their storage and distribution capacity in-house or rely on external expertise. That decision should be based on a realistic assessment of whether building capability in-house actually fits with the company’s core competencies and makes sense from a cost point of view.
This is all the more important given the rise of disruptive, capital-intensive technologies for online logistics, such as automated warehousing or the complex last-mile solutions landscape. The priority should be clarity on where and how to smartly invest in online logistics without overspending while ensuring flexibility and scalability.
Existing postal operators, or delivery companies such as DHL, often have the best infrastructure and volume consolidation at hand for frequent home deliveries; therefore, most online businesses will outsource transportation to third-party providers.
For warehousing, the main three online business models will have different needs. Pure e-tailers consider logistics to be both a core business and a differentiator. Many of them, such as U.K. fashion and beauty retailer Asos, have developed world-class operations.
Traditional retailers will also already have a warehousing and logistics chain that can be adapted for online fulfillment. However, that doesn’t always provide the most efficient option. An online order is a very different proposition logistically, when order size, packaging, and speed are taken into account. In-store shoppers at the cheese counter will hardly want to compete for service with company pickers trying to fill online orders. Exhibit 5 explains when outsourcing or crowdsourcing makes the most sense.
Whether or not to outsource warehousing and logistics is an important question for branded manufacturers, such as Adidas or Estée Lauder, which also offer sales directly from their own websites. Most consider product development and marketing to be their core activity, so adapting their existing warehousing logistics for online delivery when there are alternatives may not make good business sense.
Five years ago in Europe, there were few options if you needed to outsource warehousing. But today, although by no means a commodity, there are viable external logistics providers. Traditional delivery companies, such as DHL and UPS, have developed an expertise in this area and aim to offer a specialized and economical service. There are also logistics providers such as Bleckmann that focus mainly on online fulfillment services.
Emerging new business models promise to provide more options and greater flexibility in the future — based on crowdsourcing models. One example for last-mile delivery is Instacart, a U.S. crowdsourcing solution. It can offer outstanding flexibility when dealing with low volumes and can also accommodate the complex requirements often present in the grocery sector. Consumers place their orders through the Instacart app, which prompts an instruction to a so-called personal shopper — employed on a freelance basis — to buy the chosen items at the relevant store. (The stores, including Costco and Target, operate in partnership with Instacart.) The personal shopper delivers the purchase to the shopper’s door. Other market entrants offer similar services, including Shipt, a U.S. provider based in Alabama that partners with what it says is “a local community of reliable shoppers” to deliver a wide range of groceries.
Smart pricing policies
For many companies, handing back full delivery costs to consumers who take free delivery for granted may be a hard road. There are parallels with news organizations, which initially gave away online content free and now charge to help pay costs. Here, various models, from subscription-only access to packages involving a limited number of free articles a month before payment is required, have successfully encouraged readers to open their wallets.
E-commerce companies could look at similar structured pricing models, potentially offering cheaper or free options just for those prepared to wait longer for their goods. Another option is paid membership such as Amazon Prime, which includes access to expedited shipping among other benefits. Another alternative is a high charge for delivery during the popular evening window but free delivery during the midday period.
Ultimately, anything can be delivered anywhere, and some companies are going the extra mile to make personalized service a differentiator, delivering products to an on-demand location where the client may be having lunch or playing golf. Extra charges for those additional services or special use cases will be worth considering as a way to cover a larger portion of the company’s total fulfillment cost pie.
Is all this effort worthwhile? We answer with a resounding yes. Online sales will continue to soar, and the rewards are great for those who can get the process right. Using the Strategy& framework and approach, companies will be able to pinpoint the costs of each element in the chain and determine a cost-to-serve per parcel for each route to the shopper. This practical guide on how to build the best-fitting and most cost-efficient online supply chain for your company advises you to look at a number of key aspects:
- Companies need to accept that they do not have to offer all routes to the shopper to build a successful online business, but they do need to take a differentiated view on home delivery versus pickup options depending on shopper expectation. Factors such as the type and value of the product being sold will help companies reach that differentiated view.
- A business can then answer how best to pick and pack its products, again using this differentiated approach as well as its service promise and the right innovative technologies to overcome today’s fulfillment challenges.
- Real end-to-end supply chain cost transparency needs to be built to understand drivers of the cost-to-serve, identify unnecessary cost elements, and improve product portfolio and processes. Together with new technologies to analyze and predict volume flows, this will provide an invaluable aid in managing inventories, goods flows, and the associated handling and costs.
- New technologies and processes will help companies become more efficient in handling returns. Businesses need to understand why returns occur and how best to use that shopper touch point.
- Companies need to thoroughly assess whether outsourcing all, part, or none of their online supply chain will be the most cost-efficient, taking into account market considerations, internal technology investments and capabilities, economic rationale, and supplier management options.
- Smart delivery pricing models are key to retaining shoppers, bearing in mind the all-important balance between providing the service levels the client has become accustomed to and the price required to make the business profitable.
Online profitability is in reach, and there are boom times still to come, so companies have every incentive to make sure they get it right to derive the most benefit to their top and bottom lines.