7 minute read 11 Sep 2020
EY - Asian woman worker working with digital tablet v2

Six ways for retailers to drive rapid e-commerce growth

Authors
Hakan Civi

EY-Parthenon Partner, Strategy and Transactions, Ernst & Young LLP

Lived and worked in Europe, North America and Asia. Married with two children: daughter and son. Soccer fan. Gardening enthusiast.

Jim Doucette

Global and Americas EY-Parthenon Consumer Products and Retail Leader

Business strategist. Consumer behavior professional. Passionate about helping clients, developing people and building teams.

Yemi Alade

EY US Transactions Senior Director

Leader in business transformation and innovation. Curious about new possibilities in a collaborative environment. Passionate about inspiring and developing top talents. Husband, proud father of two.

7 minute read 11 Sep 2020

Developing strategies to accelerate online penetration and drive growth.

In brief

  • In a post-COVID-19 world, retailers need to rapidly address their e-commerce strategies.
  • The key to rapid online growth may be to develop merchandising strategies tailored to online shopping preferences and experiences.
  • Improving online penetration requires an integrated approach that combines leading practices across products, capabilities and profitability dimensions.

Over the past decade, e-commerce has become a vital part of the retail industry, experiencing between 14% and 17% annual growth, according to the U.S. Census Bureau.¹ In recent months, with the global upheaval resulting from COVID-19, e-commerce has become an even larger part of the retail business, rising from 16.4% of all sales at the end of 2019 to nearly 35% in March 2020. The online groundswell is likely to remain even after the pandemic.

Some traditional retailers that started as brick and mortar (B&M) retailers in the apparel, office supplies and consumer electronics sectors have evolved their business models to keep up with changing shopping trends. However, other sectors, such as retail pharmacy, sporting goods and outdoors, and hardware and home improvement, still have lower e-commerce penetration. Retailers in these sectors continue to bring in more than 90% of their revenue through in-store channels. In a post-COVID-19 world, these retailers may need to rapidly address their e-commerce strategies.

In a Future Consumer Index study conducted by the EY organization, we found that:

  • The “anxious consumer” will likely be the norm, even in the long term, impacting decisions on what consumers choose to buy and how.
  • Nearly 50% of respondents believe the way they live will notably change in the long term; 44% express a willingness to shift daily shopping habits, such as groceries, to online channels.
  • Companies may need to materially accelerate digital investment in operations and experiences that help make consumers feel safe.

Under these conditions, retailers may fall further behind without a focused plan to take their e-commerce to the next level.

We have identified six fundamental levers that retailers can use to improve online penetration and drive growth.

1. Develop a distinct online merchandising strategy, instead of re-creating the physical store on the web

What customers buy and how they buy online differ significantly from their in-store shopping behaviors. The key to rapid online growth may be to develop merchandising strategies tailored to online shopping preferences and experiences rather than simply recreating stores on a webpage.

An online category and stock keeping unit (SKU) selection replicating the in-store merchandise mix creates unique challenges for retailers and impedes growth:

  • Cluttered websites featuring products that do not interest customers may result in shopping fatigue and abandoned carts.
  • Unfocused marketing spend can result in lower return on investment (ROI).
  • Replenishment bottlenecking and holding inventory of unnecessary items may hinder storage of necessary items.

At one retailer, we found that 80% of online revenue resulted from 25% of product categories vs. 60% in store, even with a significantly smaller online assortment (Figure 1).

EY - E-commerce figure 1

2. Be nimble; quickly pivot to match shifts in customer demand

Product assortments that generate high online sales change quickly, driven by seasonality, innovative and online native products, and macroeconomic changes and disruptions.

Recent trends in pharmacy and sporting goods have shown that certain products can bring significant online growth; however, traditional retailers have captured very little of this growth:

  • E-bikes have experienced 72% growth, with digitally native e-bike retailers capturing large growth.
  • Eye care wearables have seen 36% annual growth, with one online brand now valued at US$1.75b as a result.

Meanwhile, COVID-19 has increased online demand for paper products, household chemicals and baby diapers at one national retailer by more than 1,000 percentage points in a very short period (Figure 2).

Pivoting assortments quickly to meet immediate customer needs can provide an opportunity for retailers to gain market share and accelerate conversion.

E-commerce sales for several products normally sold through B&M channels have recently spiked significantly due to COVID-19. For most retailers, nimbly responding to demand shifts in sector-specific product categories can yield large dividends.

EY - E-commerce figure 2

3. Apply the rule of 40% gross margin to drive price and product assortment

Most retailers likely cannot go to market online with their in-store cost structure. When closely examined, most online retailers have a fully burdened profit and loss (P&L) with low to negative earnings before interest, taxes, depreciation and amortization (EBITDA), even with gross margins approximately 20 percentage points higher than B&M retailers.³ Our research indicates that a minimum gross margin of 40% may be the critical threshold to support e-commerce cost burdens.

Pricing and product assortment strategies can be key levers to improve profit margin and achieve online growth. Retailers may need a deliberate pricing plan to protect margin. Strategies include:

  • Promoting own brands: private-label brands generally command higher profit margins than third-party brands do. Private-label substitution in low-margin, low-brand-differentiated products could improve overall EBITDA by as much as 5%.
  • Offering product bundles: popular low-margin products can be sold alongside complementary higher-margin products to minimize downward price pressure.

A comparison of a typical B&M retailer’s P&L to a blended P&L of 14 publicly traded digitally native retailers shows that, despite a lack of a store and personnel overhead, e-commerce carries its own significant costs (Figure 3).

EY - E-commerce figure 3

4. Develop a cost focus and find innovative ways to address structural costs

While the cost structure for online differs from B&M, most retailers largely commingle their online and in-store P&L. Profitable and rapid online growth often requires visibility into the stand-alone online P&L and a focus on achieving positive EBITDA.

A good starting point is to address the unique online cost drivers:

  • Shipping and fulfillment: retailers typically carry a shipping burden of 10% to 18% on their P&L. While customers expect free and rapid shipping, reliance on the legacy distribution and logistics network may not only fail to meet customer expectations but also may result in higher cost for rewiring processes and technology. It also can commingle P&L beyond the point of natural synergies. Emerging options include dedicated micro-fulfillment centers and dark stores, which can reduce last-mile delivery times and can reduce costs for high-volume items in certain markets.
  • Marketing: marketing creates a cost burden of 7% to 14% for digitally native retailers.⁴ Retailers may need to closely monitor the allocation of marketing dollars across product categories and facilitate higher ROI. Tightly controlled and distributed marketing spend can yield up to 400% to 500% returns.
  • Technology: the cost of standing up an omnichannel e-commerce solution and maintaining the underlying technologies can be significant. Retailers can leverage IT shared services effectively to lower technology cost burdens. The use of corporate back-office functions and shared services can also reduce selling, general and administrative (SG&A) expenses.

5. Focus on core capabilities first before moving to omnichannel

Our research indicates that most retailers associate online penetration with better technology and features that allow shoppers to have the same experience online as they do in store. While omnichannel is important to attract shoppers and sustain long-term growth, the initial focus can be on eight core capabilities (Figure 4), including:

  • Data integration and analytics: many retailers have data that exists in disparate systems. Retailers can use data to generate insights that inform every aspect of their operations, service levels and customer preferences. At one apparel retailer, integrating historical data into existing pricing workflows led to a 9% sales increase and a 12% margin increase.
  • Navigation and customer experience: creating a streamlined, more personalized web navigation experience can help direct customers to their precise needs and shorten the sales funnel. One online retailer saw sales increase by 40% after introducing a chat box with three specific options for the customer.

Retailers may invest in e-commerce-specific solutions for the core capabilities below to enhance operational effectiveness and foster higher traffic, better conversion and, ultimately, retention of shoppers.

EY - E-commerce figure 4

6. Use what others built to enhance capabilities and drive scale

Retailers may make targeted investments to build online capabilities to most effectively realize value. Two key investment strategies retailers with low e-commerce penetration may not be fully leveraging are:

  • Acquisitions: our research shows that low-penetration retailers have invested significantly less in inorganic growth options. Most retailers lack in-house expertise in areas key to online success, such as online marketing and personalization, yet they are not using acquisitions of digital native and pure-play online companies to address these capability gaps. We tracked 81 retail e-commerce deals since 2017 (Figure 5).
EY - E-commerce figure 5

Deal rationale

  • Only 6 out of 81 deals involving retail e-commerce were made by retailers with low online penetration.
  • Retailers generally lagged in e-commerce-specific acquisitions.
  • Consumer packaged goods companies joined digitally native retailers and tech giants in strategic acquisitions to add capabilities

Distributed commerce: distributed commerce is another way to augment a retailer’s online presence. It can enable retailers to shorten the sales funnel by allowing transactions to be completed on third-party platforms. Distributed commerce can be achieved through several different types of customer experience enhancements, such as one-click purchasing, voice ordering through smart speakers, and augmented reality and virtual reality experiences. With $4 trillion worth of merchandise abandoned in online shopping carts worldwide, enabling quicker transactions on multiple high-traffic points-of-sale can allow retailers a path to increased revenue and a decrease in abandoned carts, according to a 2015 BI Intelligence report on shopping cart abandonment from Business Insider.

Create deliberate online growth strategies to achieve long-term success

Improving online penetration may require an integrated approach that combines leading practices across products, capabilities and profitability dimensions. The online channel will become a growing part of the retail business, considering that the recent crisis has likely moved customers out of stores and onto the internet and is forcing most retailers to pivot to a new way of reaching consumers.

Retailers that made ad hoc pivots without specific and deliberate e-commerce strategies, anchored by the right capabilities, may have done so at the expense of profitability while also not fully capturing market share potential. Retailers can immediately begin to address these six identified areas and may improve their chances of long‑term success.

In a post-COVID-19 world, the retail industry is poised for market consolidation, which can present opportunities for retailers with low e-commerce penetration with liquidity and cash flow to invest in opportunistic acquisitions.

  • Show sources#Hide sources

    ¹ Estimated Quarterly U.S. Retail Sales (Adjusted): Total and E-commerce” from the US Census that reports e-commerce sales from 1999 to 2020.

    2 Change in average daily sales from February 2020 to March 2020

    ³ B&M retailer typical P&L from Aswath Damodaran, NYU; http://pages.stern.nyu.edu/~adamodar/

    ⁴ Digitally native retailer typical P&L from EY analysis of 14 publicly traded digitally native e-commerce retail companies.

Summary

E-commerce has become a vital part of the retail industry over the past decade. In recent months, with the global upheaval resulting from COVID-19, e-commerce has become an even bigger part of the retail business. Retailers bringing in most of their revenue through in-store channels will need to rapidly address their e-commerce strategies or they risk falling behind. We have identified six fundamental levers that retailers can use to improve online penetration and drive growth.

About this article

Authors
Hakan Civi

EY-Parthenon Partner, Strategy and Transactions, Ernst & Young LLP

Lived and worked in Europe, North America and Asia. Married with two children: daughter and son. Soccer fan. Gardening enthusiast.

Jim Doucette

Global and Americas EY-Parthenon Consumer Products and Retail Leader

Business strategist. Consumer behavior professional. Passionate about helping clients, developing people and building teams.

Yemi Alade

EY US Transactions Senior Director

Leader in business transformation and innovation. Curious about new possibilities in a collaborative environment. Passionate about inspiring and developing top talents. Husband, proud father of two.