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  First Thoughts

    Dan Gilmore


    Supply Chain Digest

Feb. 16, 2017

Supply Chain News: Irrational Shipping Prices and the Demise of Brick and Mortar Retail

Store Troubles Accelerated because Retailers, UPS, Undercharge for Ecommerce Pick, Pack and Ship


In 2015, I wrote a column titled "Amazon's Stock Price and the Fate of Omnichannel Commerce" based in part on a presentation I had just given on ecommerce at a supply chain forum at Penn State.

The thrust of that piece was this, before I take the thinking even further:

Before my presentation, a retail executive gave an interesting presentation on omnichannel, which included this emphatic statement: "There is no free shipping!"

Gilmore Says....

The simple reality is that in most cases, the in-store price should in fact be lower than the on-line price.

What do you say?

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He explained: "The last time I negotiated with UPS or FedEx or the United States Post Office, none of them were talking about shipping our orders for free."

The situation of etailers giving away shipping simply can't last, he argued. It has to end or no one will make any money. That's when another supply chain executive said (paraphrasing) that "Our board and shareholders expect a given rate of return and profitability, and it will be difficult or impossible to hit those objectives if free shipping continues.”

My question to the speakers: "Is that a prediction or just a hope?"

Not long ago, this viewpoint would certainly have been correct - the financials would push etailers away from free shipping eventually. Heck, it wasn't that long ago that many companies, certainly catalogers selling direct to consumers, used shipping as a clear profit center. What a quaint notion in 2017.

Of course, now Amazon sets the bar. Its free two-day shipping with Amazon Prime is hugely popular, and it also discounts most other shipping.

This is plenty costly. In 2016, Amazon had an incredible $8.97 billion just in shipping revenue - its shipping sales alone would make Amazon about the 50th largest US retailer.

The problem: it spent an equally incredible $16.16 billion on shipping last year - and that is just shipping, not other fulfillment costs. So Amazon had a net loss of $7.19 billion in shipping during 2016.

That surely contributed - at one level - tp net profit margins of just 2% of sales, though that is better than the losses or breakeven results it saw a couple of years back. I say β€œat one level,” because obviously those shipping losses play a key role in the tremendous revenue growth - still close to 30% for merchandise - Amazon enjoys.

And Amazon's stock price keeps rolling along. It dipped a few percentage points when it released its Q4 results in late January, falling just a bit short on the top line from Wall Street estimates. But that stock price is up about 127% over the past two years, and 358% over the past five years. Amazing.

The main point of my piece in 2015 then was this: In a normal world, as that retail executive pointed out, Amazon's lack of profitability would lead to the stock also getting hammered. But of course it has that incredible growth, and investors continue to believe that all this investment will eventually pay off in big profits some day. And it just might - though they have been saying that for at least a decade. Maybe in 2025.

I added that if Amazon's stock did take a plunge over lack of profits, it just might be forced to ease up on free shipping to shore up the bottom line. But the stick price just heads up instead.

It simply may be that for quite some time Amazon will force free shipping and thus ecommerce losses on all on-line merchants no matter how irrational it seems to its competitors.

So here in 2017, I am going to take this a step further. The free/highly discounted shipping policies of Amazon, other retailers, and even UPS itself is accelerating the demise of brick and mortar retail at a faster rate - perhaps much faster - than would otherwise be the case. This is an incredibly important point.

In other words, is the growth of ecommerce - and major financial woes in some but not all sectors of brick and mortar retail - something of a fraud, based on irrational shipping charges by virtually everyone in the market?

We know what is happening with shipping and on-line retailers. But did you see the rather astounding news that profits at UPS were down in Q4 - because it saw too much growth in its ecommerce business?

UPS says it makes greater margins on its traditional B2B business, because there are fewer, generally closer stops, often delivering many parcels at a time, versus onesies with trucks driving around neighborhoods like yours and mine to make a stop at house here and there.

So, costs per delivery in B2C are generally higher than B2B for sure - but margins obviously are a factor of both cost and revenue. So UPS (and we assume FedEx) either can't or for some reason hasn't taken ecommerce delivery rates to the point that they can earn equal margins with B2B.
And why is that? In large part because retailers such as Amazon and almost everyone else are giving away or deeply discounting the shipping to consumers, so they have to negotiate like the dickens with UPS/FedEx to avoid losing even more money.

And that's because consumers either just won't pay for it, or have been trained not to buy if shipping costs are actually realistically charged.

And it gets worse for about everyone but Amazon. Why? Because for Amazon, every on-line order is new revenue and margin. But for traditional retailers, much of their ecommerce sales (it varies) are cannibalizing sales at their brick and mortar stores, where profits are much higher for each sales dollar, after considering order picking and shipping costs, returns, etc. required for ecommerce.

There is some debate about where brick and mortar retail is right now. Some say the numbers show it is in decent shape. But ecommerce sales are growing 15% year over year every quarter, and by definition that has to be largely coming out of brick and mortar business - consumers are not spending more overall on retail shopping.

Clearly the growth in on-line is a big factor in the wave of brick and mortar store closings (Macy's, JCPenney, Sears, The Limited (going purely on line), Men's Warehouse, Aeropostale, Abercrombie & Fitch, many others.).

Many shopping malls are in deep trouble. We recently reported on the growing trend of mall owners defaulting on loans for troubled mall properties and simply handing the keys over to lenders, who will have to close the properties or somehow revitalize them.

The US Commerce Dept. said true retail sales (excluding autos, restaurants and other things that sometimes get reported in retail sales numbers) were up 2.9% in 2016. That's OK, but: (1) it includes inflation, so knock a percentage point or so off that; (2) it includes the rise in ecommerce sales, so deduct a bit more; and (3) some retail sectors are faring much worse.

That would include department stores (sales down 5.6% for 2016), apparel stores (up just 0.8%), and electronics stores (down 3.2%). I will note that Amazon's apparel sales are expected to reach $28 billion in 2017, moving past current number 1 Macy's, which analysts predict will see $22 billion in apparel revenues, a 4% drop from 2016.

So here is the trillion dollar question: what would be happening with the growth of ecommerce sales, causing all this change and turmoil, if actual shipping costs were reflected in the price consumers have to pay for delivery? I'll tell you what would happen: the growth in ecommerce would slow dramatically. I've seen presentations from folks like CEO Patrick Byrne on how shipping prices dramatically move the sales needle up or down. I know my family's own habits in on-line ordering.

The simple reality is that in most cases, the in-store price should in fact be lower than the on-line price.

So retailers are moving business to money losing ecommerce channels, thereby seeing need for fewer actual stores, because they don't charge what it costs to pick, pack and ship on-line orders. Abetted in part by UPS and FedEx undercharging for B2C deliveries.

All, in the end, driven by Amazon, though someday that retail exec quoted above will finally be right, and investors will demand that shipping costs are indeed paid for by the buyer - after much of brick and mortar is gone.

Other media, email me if you want to discuss this subject in more detail.

Do you agree with Gilmore's analysis - or not? What would happen if retailers actually charged what it costs to pick, pack and ship ecommerce orders? Let us know your thought at the Feedback section below.

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