Understanding the Profitability of Omnichannel Retail is a Problem

As ecommerce grew at double digit rates, while in store sales grew at less than the rate of inflation, retailers were looking for a way to turn their stores into a competitive weapon. Rather than just offering consumers the choice of buying online or buying in the store, a retail omnichannel strategy involves a lot more paths to fulfill an order or to process a return. Flow paths can include buying online/ship from store; buy online/pickup at store, shop at store/have item shipped from a different store, and many other options as well. These different options offer consumers more choice and more convenience. As a result of this, the market for omnichannel order management (OOM) systems grew briskly.

Then came Covid. Consumers did not want to go into stores. The need for new omnichannel capabilities – particularly curb pick-up and ship-from-store – soared. These new order fulfillment paths allowed retailers to rapidly grow sales.

But one thing you notice as you go to omnichannel software vendor’s web sites and examine customer case studies, the case studies may talk about retailers growing their revenues by 100% or more, but none talk about how much profitability grew. If growing sales come with much higher fulfillment costs, profitability can take a hit. In some cases, we have seen retailers that use to enable a particular omnichannel path, like ship-from-store, discontinue that path as it became clear profitability was taking a hit.

Omnichannel Order Management Systems are Complex

For retailers, implementing a sound omnichannel strategy can be difficult. First, the rules used to enable an OOM system can be staggeringly complex. There can be rules to allocate inventory based on understanding which stores have the ability to ship from the store or support curbside pickup, rules about what times of the day the orders can be dropped to the store, rules that are based on cost minimization, rules that favor one channel over another, or rules that even allow an unprofitable ecommerce order to be fulfilled for a very profitable customer. And as a retailer’s marketing strategies and fulfillment costs change, the rules must also continuously change.

While cost optimization should not always be the prioritized rule in an omnichannel allocation engine, the fulfillment costs, and resulting margin, should always be understood.

Retailers Struggle to Understand their Omnichannel Costs

Kathleen Fischer, a director at Körber Supply Chain, rank ordered the profitability of different omni flow paths for me. In general, she asserted, the order profitability by flow path would be the following: 1. Ship from warehouse (robotics and other automation can be used to lower labor costs),  2.  Having a customer pickup items selected for them in the store (this eliminates the last mile shipping expense and can also drive foot traffic to the stores), 3. Drop shipping (having a retailer’s supplier ship directly to a retailer’s customer – there are no fulfillment costs for the retailer with drop shipping, but these tend to have lower margins), 4. Shipping from the store, and 5. enabling the “endless aisle” – providing in-store customers with the opportunity to order products that are either not normally sold in the store or that are currently out of stock by shipping from multiple locations.

However, good omnichannel fulfillment decisions don’t depend on what is typically true. Retailers need a sound understanding of their end-to-end costs to create the hierarchy of rules the OOM system uses to execute the orders.

In general, retailers can model the transportation costs associated with an omni-order. Some providers of OOM have better solutions for this than others. Kinaxis offers an OOM that is built on a supply chain collaboration network (SCCN) tech stack. The Kinaxis solution can capture the exact transportation costs associated with every order and use the true transportation costs when making the decision of how to fulfill an order. Other solutions mostly use costs based on history and use those static average costs when building their decision trees. If rates change, or surcharges are not properly captured, the costs become inaccurate. Vijay Natarajan, who heads up the SCCN business unit at Kinaxis, points out that because the Kinaxis OOM captures each fulfillment activity it is also a better solution for understanding emissions.

For retailers understanding of store level labor costs associated with fulfillment is where the biggest problem lies. Retailers’ understanding of these costs lags what has been achieved in other industries, or even that retailer’s understanding of their costs in their own upstream supply chain.

One example of the detailed costing this is used in warehouse fulfillment, but not in store fulfillment, involves engineered labor studies. In large warehouses, industrial engineers use stop watches or other work measurement techniques to determine how long it should take to do a particular task. These measures are highly detailed. For example, once a warehouse labor management system is configured it can calculate that for a picker to move from aisle 1 to aisle 6, and then move to slot AB16 and pick five items, should take 4 minutes and 26 seconds. As a result, companies with these systems have a very detailed understanding of their costs. No retailer has this depth of understanding of their store labor fulfillment costs.

Perhaps one reason that retailers have lagged in nailing down their true profitability is that according to a market study by the ARC Advisory Group apparel retailers buy more OOM systems than any other industry. There tend to be higher margins in this industry. This means that even if fulfillment costs are higher than these retailers understand, most orders will still contribute to profitability. Nevertheless, it is poor business practice for any company not to know the true drivers of that company’s profitability.