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Making money

multichannel
How to understand cross-channel
customer behaviour

eCommera
In partnership with WPP and Google
Making money multichannel

Published March 2011


©eCommera 2011
eCommera
02–03

Making money multichannel


Michael Ross,
Co-founder and Director, eCommera.
Peter Fitzgerald,
Retail Director, Google UK.
David Roth,
CEO EMEA and Asia, The Store, WPP.

Highlights

• Online retailers need to rethink their models of growth and profit – the economics
of physical retail cannot be successfully replicated online.

• Data is critical to profits – properly gather and leverage data on profits, customers,
products and marketing.

• Cross-channel customer behaviour, accelerated by the use of mobile, makes


everything more complicated – understanding and responding to the new
complexity of customer behaviour becomes a critical driver of profitability.

Offline retailing has long been a lucrative and profitable sector. As ecommerce gathers pace,
many retailers have assumed that they can apply the same principles and make the same high
profits online. The numbers tell a very different story. Many online retailers took a long time to
get to profitability (Amazon, Overstock, Zappos); others are still trading but not yet profitably
(Bluefly, figleaves, Ocado); and many went bust without ever making a penny (etoys, webvan,
boo, pets.com).

www.ecommera.com
This article offers an insight into the economics and customer behaviours that can help to
make money online:

1. Online retail economics


It is increasingly clear that there are real differences in how to make money from online retail
compared to physical retail. For retailers this is a hard adjustment the economics of physical
retail are well understood and the route to success tried and tested, but they cannot simply
be replicated online. We assess the differences in the three core economic fundamentals of
retail profitability for online retail:
a) Store economics. The P&L of an individual store.
b) Growth. The dynamics and strategies for profitable growth.
c) Trading. The day to day dynamics of sales, stock and margin.

2. The cross-channel effect


The economics of the “online” channel are increasingly complicated by the cross-channel
effect. Some customers Research Online and Purchase Offline (ROPO); others research offline
and purchase online. Retailers need to recognise this ROPO effect in order to understand
multichannel economics.

3. The mobile effect


The lines between offline and online retail are increasingly blurred by the rapid evolution of
mobile. Customers’ use of mobile and its impact on their purchasing behaviour complicates
retail models, but understanding mobile use and grasping the opportunities it presents are
now fundamental to future retail profitability.

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04–05

1. Online retail economics

Physical retail: Store economics in physical retail means the relationship between gross
margin, rent and staff that drives an individual store’s profitability - a formula known by
every successful retailer that makes their format work.
vs.
Online retail: The order is king – “store” economics in the online world are driven by
profit per order and volume of orders.

How do the three economic fundamentals of retail profitability differ between online and
offline? And how do you crack their code to make money online?

a) “Store” economics
In the offline world, the critical costs of rent and staff are variable per store but fixed per sale.
Online, the critical costs are either variable per order (picking, packing, packaging, postage)
or are crystallised per order (marketing, promotions). Online profitability requires a focus on
orders as the variable unit, rather than thinking of online as just another store.

Cracking the code: “store” economics


The challenge is to get the right cost structure per order. However, not surprisingly, there
is no one right answer. Average order values for successful retailers can be £10 or £1000;
some retailers charge for delivery and returns, others do not; many retailers have aggressive
promotional campaigns and are generous with vouchers, others never discount. We have seen
very successful retailers with 1% conversion rates, and unprofitable ones with 4% conversion
rates.

We advocate a 4-step approach to getting to the right store economics:

1. Understand where you are today. Many retailers simply don’t even look at an ecommerce
P&L, let alone one structured around the underlying drivers (Figure 1).

2. Understand what happens to profit when you pull different levers. For example, a free
delivery above £50 promotion will increase average order value, increase conversion
rate and reduce delivery revenue. However, the key question is what it does to profit per
order and volume of orders. Understand the impact of a voucher for new customers vs.
increasing marketing spend per order. Understand the impact of reducing retail prices vs.
a targeted promotion.

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Making money multichannel

3. Be prepared to make bold decisions to get to the right P&L structure for growth. Limit
vouchers, increase delivery charges, prune marketing spend. We’ve met a number of online
retailers who lose money on every order and then try to make it up in volume!

4. Keep optimising. Improve the site funnel – examples include: new payment methods,
better on-site search, improved navigation, personalisation and product recommendations.
These will often have little impact individually but will nudge conversion up over time, with
consequent impact on both volume and profit
per order.

Figure 1: The drivers of online profit

Average order
value
Gross profit per
order
×
- Gross margin
Delivery
revenue/cost
per order
Trading profit
per order -
Promotion cost
per order
Marketing cost
Gross trading
profit
× - per visit
Marketing cost ÷
per order
Number of
orders × Conversion rate

Online visitors

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b) Growth 06–07

Physical retail: Growth is driven by two dynamics - (i) growth in square footage (i.e., new
stores or store expansion) and (ii) same store sales (like-for-likes). Once a retailer has a
successful format, growth is simply a matter of finding more locations.
vs.
Online retail: Growth online is a new paradigm, driven by building and nurturing a
customer base.

Zara has opened, on average, a store a day for the last few years. Each store brings new
footfall and new customers. The strategy may be hard to execute but is simple to conceive
– footfall is a given of the physical world where rent equals guaranteed visitors. In contrast,
footfall online needs to be sought and bought. Retailers with offline brands clearly get a base
level of traffic “for free” but if they don’t play in the online marketing world, they are simply
leaving prospective customers for their competitors. Growth online is driven by three very
different dynamics:

i. Customer acquisition – the number of new customers acquired in a period.


ii. Customer retention – the percentage of customers who re-purchase, their order
frequency and spending pattern.
iii. Range expansion (unconstrained by shelf space) which widens the customer acquisition
net, and fuels repeat customer activity.

Cracking the code: growth


Driving profitable growth online requires sophisticated marketing optimisation: how much
to spend acquiring and retaining a customer, how much to spend overall on marketing and
how best to allocate this spend across various marketing touch points.

Building on the order economics above, we advocate a 3-step process to cracking growth:

1. Marketing profitability. Understand the profitability of each keyword, affiliate, banner


and email, as well as the sensitivity of profitability to different attribution windows. In
addition, understand the incrementality of each marketing event - just because someone
clicked on your advert, doesn’t mean that they wouldn’t have purchased anyway. All this
is critical to understanding the relationship between marketing spend and new customer
acquisition (the “supply curve” of customers).

2. Customer economics. Understand lifetime value economics through mining repeat


purchase dynamics. Translate this into a customer-driven business plan which exposes
the trade-off of growth vs. profitability – i.e., what percentage of lifetime value should
be invested in customer acquisition. Many retailers believe that growth is inexorable
and then are surprised when sales plateau. The reality is that this is a mathematical
inevitability. Every retailer has a churn/attrition rate – to continue to drive growth,
retailers need to ensure that they are acquiring more customers than are churning.

3. Customer-product economics. Understanding the role of products in the customer


lifecycle is also critical - products may have low sales but could be key to acquiring high
value customers. Other products may look unprofitable but are great add-on purchases.
Mine on-site and off-site search to identify adjacent categories which can drive customer
acquisition and retention.

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Making money multichannel

Using this analysis, retailers can understand their optimal “zone of growth” – too high and
it’s either unprofitable or unsustainable, too low and you are leaving customers for your
competitors (Figure 2). Again, there is no right answer but the smart retailers are clear about
whether they are trying to drive cash, medium-term profit or long-term growth – and can
then adjust their path accordingly. Too many retailers make the mistakes of benchmarking
growth rates against retail like-for-likes, creating unrealistic top-down targets, extrapolating
from historical rates or focusing too much on top-line sales.

Figure 2. Understanding retailer’s optimal growth rate

Annual growth, %

Too fast
(unsustainable)

Optimal zone
of growth

Too slow (under-


potentialised)

2007 2008 2009 2010 2011 2012 2013

Actual Forecast

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c) Trading 08–09

Physical retail: Trading offline means balancing the day-to-day choices around sales, stock and
margin.
vs.
Online retail: Trading online has the additional challenges of efficient buying and routing of
traffic, and managing product just-in-time.

Applying the physical trading dogma online is guaranteed to sub-optimise profits. Retailers
can make much better trading decisions if they properly leverage the data available and take
advantage of the new opportunities open to them:

• New information. Retailers can distinguish between products that aren’t selling or
aren’t viewed, and ensure traffic levels are optimised and evenly distributed. Retailers
can understand price elasticity and product substitutability. Data that is expensive or
impossible to access offline is typically free and easy to access online.

• New costs. The online world brings new and different costs. The fundamental challenge is
that it is now remarkably easy to lose money on a product by spending more money driving
traffic than you generate in gross margin.

• New levers. Traffic can be turned on and off. Depending on the category (and product
substitutability) traffic can be elegantly rerouted to products that are in-stock, overstocked
or high margin at the click of a button. Products can be offered with differing “promises”
– from pre-orders to back orders. The reality is that customers will commit to products
they’ve never touched (from an iPad to a designer bag) and will wait for the products they
want. Display is now decoupled from delivery.

Cracking the code: trading


Every category has its own trading dynamic – the levers you pull day to day to optimise the
trade-off of sales, stock and margin. The dynamics vary depending on the supply chain, lead
time, margin, minimum order quantities and product lifespan.

Some examples show how:

Characteristics Trading New


Category of products challenges online challenges
Beauty / jewellery / Long life and low Driving stock turn Using online data to
continuity fashion obsolescence without losing sales optimise stock turn
Branded fashion Seasonal life with Sell-through, i.e., Optimising the
upfront stock maximising cumulative distribution of traffic to
commitments gross margin drive sell-through
Fast (CMT) fashion Short-life and flexible Stock turn and sell- Using online data to de-
manufacturing through risk the supply chain
commitments
Electronics Low margin and Add-on purchases and Managing product
obsolescence optimising promotions profitability
or bundles

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Making money multichannel

The key to online profitability is to leverage the new data, understand the new costs and take
advantage of the new levers to make better, faster, more nuanced trading decisions (Figure 3).

Successful retailers:

1. Understand product profitability, in particular which products make money, which lose
money and which make nothing.

2. Identify appropriate actions that distinguish between different zones of profitability.


Marking down product for clearance can be either pointless (if customers aren’t viewing
it) or expensive (vs. a targeted marketing campaign).

3. Organise to take action, to ensure that budgets, processes and decision making facilitate
the right trading decisions.

Figure 3: Understanding product profitability

High Medium Low Zero Negative


106%
100%

80%
Cumulative profit

60% Manage Low views, Stock Views Products not Customers


availability in stock no views no sales profitable not profitable

40%

20%

0%

Products arranged by profitability (descending)

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2. The multichannel effect

Physical retail: Customers browse and purchase at the same time. All sales are easily
credited to a store and – in many cases – an individual salesperson.
vs.
Multichannel retail: Customer behaviour is complex. Some customers browse online and
purchase offline, others browse offline and purchase online.

Understanding the fundamental economics of online retail and how to make money in this
new environment is a key starting point for any multichannel retailer. However, it is no
longer enough. As cross-channel becomes more widely adopted by customers, it complicates
and blurs the boundaries between online and offline. Understanding the economics of
multichannel retail is not easy, but it is worth the effort.

Modern customers embark on a complex and progressively non-linear journey, shopping


across multiple sales channels but with an abiding expectation of receiving a consistent, end-
to-end brand experience. Aside from the operational challenges this creates for retailers in
terms of stock availability and delivery, retailers are also required to think about engaging
with a different type of customer; one with an unprecedented degree of access to product
information before, during and after venturing in store.

The ROPO effect is everywhere. It is estimated that today some 60% of EU sales are affected
by web research prior to purchase on the high street. Customers who shop across multiple
channels are not better, they are just different and need to be understood.

To fully understand the ROPO effect retailers need to clearly differentiate between correlation
(how customers are behaving) and causality (what is driving that behaviour). The more
retailers understand multichannel behaviour and how to respond to it the more they can drive
an “unfair” share of the online pie.

The key questions to answer include:

• What are the key customer journeys (establishing correlation between online and offline)?
How do customers use each channel and in what order? Which pathways are used by your
most valuable customers? Which pathways are most profitable?

• What causes multichannel activity (how can customer behavior be influenced)?


Is online driving offline, or is offline driving online? How does online marketing spend drive
offline purchases? How do emails gathered in store drive online purchases? To what extent
can multichannel behaviour be encouraged, and does
this drive greater loyalty?

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Making money multichannel

Cracking the code: multichannel


To fully understand your multichannel economics and drive profitability from them, we
recommend the following approach:

1. Decide on a cross-channel identifier such as an email address, credit card or loyalty


card. This can either be done systematically or as a one-off exercise. The key is to find a
representative sample of customers whose behaviour can be analysed.

2. Data mining. Once the data is gathered, apply data mining techniques to look for patterns
and generate hypotheses.

3. Run tests to understand causality – e.g., by geography/segment. This is critical in order


to be confident that the observed effect is robust (and can form the basis of a business
case).

The profit tree below (Figure 4) incorporates the multichannel effect. Retailers who crack
these economics – and very few in the world have done so – are at a significant advantage.
They are able to make online (and offline) marketing investments that they know to be
profitable but which often leave competitors scratching their heads.

Figure 4: The drivers of multichannel economics

Average order
value
Gross profit per
order
×
Customer value
- Gross margin
Delivery
revenue/cost
per order
Trading profit
per order -
Promotion cost
per order
Marketing cost
Gross trading
profit
× - per visit
Marketing cost ÷
per order
Number of
Offline orders × Conversion rate
influenced
profit
Online visitors

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12–13

3. The mobile effect

Physical retail: Customers are either in your store, or they are not.
vs.
Mobile: Customer can scan products, check prices, browse competitor sites and purchase
on their mobile from anywhere (including in your store).

Channels are increasingly blurring and converging. Adding to the growth of cross-channel
purchasing behaviours is the rapid acceleration in the use of mobile devices. The channel
becomes less of a separate aspect of retail, as it becomes retail itself. The key to success is
understanding customer behaviour and customer economics.

So how is the use of mobile affecting retail?

The notion of the “connected customer” is a relatively recent, but nevertheless transformational,
concept in the changing retail landscape. The increasing penetration of smartphones and the
likely surge in various sizes of tablets will continue to compound the ROPO effect. The mobile
is more and more an extension of the individual. A recent quote from Eric Schmidt at DLD
suggested that people will increasingly be in two states: asleep or connected.

The most simplistic way of looking at mobiles is to see it as “just another browser”. Retailers
simply need to ensure that their sites are “shoppable”. These “mobile economics” – typically 2%-
5% of online sales – are relatively easy to understand and manage.

The challenge is that mobile is increasingly taking on a more complex role in the buying process
that necessitates thinking about mobile in a new way. Their impact on retail sales will be far
greater than ever previously imagined. Already barcode scanning is standard smartphone
functionality, and the mobile-as-payment option is coming soon.

We have identified three transformational retail trends caused by mobiles:

1. Price comparison. Many retailers report customers in their stores scanning barcodes with
the real possibility that they are buying online from competitors. Certainly, in-store price
checking will become a ubiquitous part of shopping. Haggling – a common feature of
retailing in the 1800s - may be returning!

2. In-store information. Best Buy (in the US) has already begun including Quick Response (QR)
codes in its stores to help customers learn more about products, for example by linking to site
reviews.

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Making money multichannel

3. Near-store offers. Retailers – such as Marks and Spencer –are piloting proximity marketing
schemes where offers are triggered to people within a certain radius of the store. In due
course, this will evolve into localised yield management where a store manager – if
sales are slow – can trigger a promotion that will be broadcast to customers (or non-
customers) within X miles of the store.

But this is just the beginning. As retailers take advantage of the personalised nature of the
mobile, we will see the emergence of dynamic pricing – making the best price/offer to an
individual customer based on everything we know about them. Yield management – taken for
granted in the travel industry – will come onto the high street.

***

The economics of the online world are very different to physical retail, and highly complex.
Multichannel and mobile make this even more complicated. And yet retailers who stick their
head in the sand and continue to apply physical retail dogma face a risky future. As ecommerce
and online influenced sales, take an ever greater share of retail sales, those who fail to understand
the new economics of retail risk systematic underperformance.

eCommera
www.ecommera.com
eCommera is a pioneering provider of
intelligent ecommerce trading solutions,
enabling brand owners and retailers to sell
efficiently and intelligently across multiple
channels. A selection of our clients include
Asda Direct, Hamleys, House of Fraser,
Magasin Du Nord, Horze and the London
2012 store.

eCommera Limited
1st floor
84-86 Great Portland Street
London W1W 7NR
www.ecommera.com
Tel: +44 (0)207 2915800
Email: trader@ecommera.com

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