Make Your Ecommerce Channel More Profitable

Vertically integrated fashion retailers have an easy dotcom business model compared to retailers who sell others’ brands. This relative ease comes from having an extra ~15 percentage points of margin to play with, no direct competition, an established supply chain model, and real constraints on assortment.

A retailer of third-party brands (for example, Sports Authority selling Nike, Under Armour, etc.) has none of these advantages. Hemmed in by the industry’s heavy promotion, direct price competition, rising pay-per-click advertising fees, free shipping offers and the high return rates inherent in fashion, margins tend to be so pinched in this model that even seemingly small decisions – by vendor, by category, and by promotion – can have significant impacts on the channel’s overall profitability. Just ask Amazon.

In addition, the multi-brand retailer must decide whether to ship from its own warehouse, which naturally limits the assortment, or have the vendor fill the order, for a fee. Because many vendors have the capability to offer inventory from their broader catalog, connected in real time to the retailer’s, this option is used often to limit inventory risk and expand the assortment into “long tail” territory. Very convenient, but does this option increase profits?

The key to sustaining and growing the ecom channel’s profitability is to start with a detailed understanding of its profit model, which is very different from stores’. First, in modeling variable and fixed costs, you’ll find variable costs are higher, and fixed costs lower, as a percentage of sales than in stores. Second, the capital requirements are less. You’ll find that the operating margin required for a healthy return on capital is far lower than in stores, especially if much of your inventory is virtual, held by the vendors. This profit model will also allow you to quantify the marginal profitability for a transaction at stores (assuming you do at least a back-of-the-envelope calculation) vs. ecommerce. The answer may surprise you.

The next step is to examine in depth the direct profitability of what you sell, how you sell it, and where you fill it. For example, filling from your warehouse has very different economics than a vendor shipping direct to the customer. The profitability of products that tend to ship with free shipping and get returned more often will likely be less than those that aren’t. Brands and categories you have to heavily promote or advertise to generate traffic, well, ditto. To analyze the impacts of all these variables interdependently, you’ll need to construct a direct product profitability (DPP) model, down to the order-item level. This will enable you to quantify the direct contribution of any segment of the business.

These profit and DPP models will give you a good foundation for making decisions that will significantly improve the profitability of the ecommerce channel. However, even this work will not give you the complete picture. In “omni-channel” management accounting, ultimate channel profitability depends on attributions of showrooming vs. webrooming, plus dozens of other assumptions.