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Will Moving To Online Kill Your Business Model?

Tim Crighton • 22/06/2020

Throughout the COVID-19 pandemic we’ve been told retailers need to move to online. But what if moving to online kills your business model?  

When Penneys, the Irish brand of Primark, opened this week in the Republic there were round the block queues in Dublin and Cork with customers prepared to compromise their social distancing in order to race back to a store in search of a bargain. But what is the allure of these mega shops and brands, when we are told that omni-channel and online is the future of retail? 

For those who saw my first article in this series, you will have read how retailers with seasonality, especially those in fashion and fast fashion, are facing considerable disruption to their supply chains from store closures during lockdown. The Telegraph newspaper estimates that lockdown has caused £1.8Bn of damage a week to the fashion and apparel sectors.  

The reality is that retail logistics and retailing are now more closely linked than ever and logistics is behind a lot more retail change than most customers realise.  

The boom in online grocery during COVID-19 has been well documented. For anyone that’s joined one of our webinars over the past few months, you will have heard us talking about our expectation that online grocery penetration rates will rise from their historic trend of 6-7% to between 12-15%. A structural shift which has probably accelerated what we would have forecast last year, by at least 5 years. But beware of profitless prosperity. There is an age-old rule in retail – 'Turnover is vanity. Profit is sanity'. Grocery is the lowest margin of the retail categories. Customers are price conscious and comparison of like-for-like product is relatively easy. We all probably have a view on where the various grocers sit in a pricing hierarchy. These businesses run on slim margins and rely on market share and volume to achieve their profits.  

The supply chain and logistics models these businesses employ are critical to their efficiency and value proposition. This is most apparent when we look at the grocery discounters; Lidl and Aldi. They have been hugely successful in scaling their businesses in the UK and most of us have probably experienced at least one of their stores. As a customer, we know they feel a bit different to the more established grocers. The stores are certainly smaller. They have less density of product, usually one branded product and one own brand. But they are highly price competitive and their model has been built around delivering quality at low prices. Something which has won them a growing share of the UK grocery market.  

In order to achieve this both businesses rely on a very lean model and a logistics strategy known as ‘case' or ‘pallet’ picking. In simple terms this is moving large volumes of the same product; whole cases or pallets of products into a store. It is this movement in bulk here which is critical. Reducing the variable element of the supply chain cost in the ‘cost to serve’ for each product. CTS is the metric by which retailers measure efficiency and it is the sum of the costs of buying, transport, stocking and transacting a product over the checkout. For retailers who have built businesses around a highly competitive low price offer, their business relies on reducing these costs to the minimum. It doesn’t just apply in grocery, we also see it in fashion. 

E-commerce fulfilment relies on a different logistics model, known as ‘singles’ picking. In this scenario a ‘picker’ within the warehouse would go and identify a single item in the distribution centre for a customer order, this would then be packed individually, or consolidated in an order with several single items before being packaged and dispatched to the customer. Not only does this mean retailers need to meet the costs of shipping (or pass these to the customer) but they also face significantly higher costs inside their warehouses. These processes are less labour efficient and therefore erode margin for the retailer. For pure play online retailers this additional cost is part of their architecture and can be accepted as a component of the model, given they are not paying for the costs associated with a physical store estate. For retailers with a hybrid (omni-channel) proposition it can be challenging. You have a business built on the metrics of moving product into store in volume, but you need to compete online with a very different model and cost make up.  

We also see this same issue impacting retailers looking at store format changes. We have seen the likes of Ikea, Homebase and B&Q rolling out small format stores in shopping centres and urban areas. In all of these cases they are responding to demand from customers to be more accessible, but these small stores have less space and less room for stock, meaning the supply chain must adapt and often we see a move from case picking to singles picking to support that new offer. Not all distribution centres and transport fleets are optimised for this, meaning this transition can be operationally challenging and expensive. 

We spend a lot of time working with our customers to design, adapt and construct logistics and fulfilment facilities which support their retailing strategy, enabling them to keep up with the demands their customers are placing on their business.  

For some businesses, most famously perhaps Primark, they have shunned a move online, as they have a model built around the movement of product in bulk through their logistics network and stores. A move online, with the increased costs this would incur, wouldn’t be possible at the price point that they’ve established. Incurring these costs would mean inflating the price of products, which may undermine their market position, and so for some retailers, physical stores remain the best way to deliver value to their customers.   

As we learn exactly what the ‘new normal’ for retail is post COVID-19 this is a space we will need to watch carefully. But it should give landlords of retail and logistics hope. There remains opportunity in both asset classes, but more than ever, sites need to be carefully selected and the role they play in the occupier’s strategy and cost model needs to be fully understood. 

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