Then, if an order placed online is fulfilled from store merchandise, employees at the store have to pick, pack, and ship individual orders to a shopper's home.
Not only has that same outfit now shipped twice, at the retailer's expense, but the "last mile" or the final leg of the delivery journey is far by the most expensive.
So back to our example. The $100 outfit, with a $40 cost, now has associated operating costs of $48 when ordered online but shipped from a store, leaving a profit margin of 12 percent, a full 20 percentage points lower than a pure in-store sale.
The cost of returns
AlixPartners explains that the cost of returns is not discussed in the models as it's very difficult to factor in numerically, but it is critical to understand, as it's especially costly for online purchases.
Clothing items bought online are returned three times more than items bought in-store on average. But processing those online returns can be six times more expensive compared to in-store.
Industry standard suggests 30 to 40 percent of all clothing bought online ultimately gets returned. This makes sense given it's very hard to know how clothing will fit and feel without seeing it in person first. Plus, consider that many consumers may order the same clothing item in several sizes or colors online, only ever intending to keep one.
So, if the items are shipped for free to the shopper, and returned at no cost to the shopper, that leaves the retailer absorbing shipping costs both ways on up to 40 percent of all clothing items bought online.
But stores do offer a higher chance to recapture some profit.
If a retailer has a store network, like in our model examples, many consumers will choose to return in-store and then there's a much higher chance the consumer will buy something else on that trip. Target says one-third of shoppers that pickup online orders in store buy something else.
An in-store return can lower the cost somewhat, since return shipping may not be paid by the retailer if the item stays in store and can be resold.
But, there is a cost to re-process the item, and it may end up being shipped back to a distribution center, but this time in bulk with other items. In other cases, it's a lost sale entirely and the item counts as a loss, along with all the other returned goods that can't be resold.
Making online less expensive
Most retail experts think that both stores and online options give retailers the best chance for success to optimize the shopping experience. The big question is what percent of sales should come from each channel to achieve maximum profitability, and when will the industry hit that equilibrium.
There are a number of actions retailers can take to increase their online profit margins including growing the size of the online sales channel to scale the overhead and the investments, Madden said. Additionally, retailers should look for ways to lower shipping, or consider upping free shipping minimums. Figuring out how to lower return frequency is a big cost saver, as is encouraging shoppers to bring their online returns into stores for hopes of picking up additional sales.
Testing the model: J.C. Penney's experience
While the AlixPartners models will approximate the cost many apparel retailers are facing across channels, the profit margin of course will vary from retailer to retailer depending on many factors, decisions, investments and capabilities.
J.C. Penney said its profitability order is a little different, with in-store being the most profitable. The order online, pick up in-store option is the second most profitable, followed by order online, ship from distribution center, and lastly order online, ship from store.
On its fourth-quarter earnings call, J.C. Penney CEO Marvin Ellison said 77 percent of online purchases touched the store in 2016. Ellison further explained to CNBC "every time an online order touches the store, it actually helps the margin. The real pain point is the fulfillment price, it's always cheaper to ship from a distribution facility to a store than to a consumer."
So for the department store, there are two reasons the order online, pick up in store option is the second most profitable method.
First, J.C. Penney says when an online order is picked up in store, at least one-third of those customers will make an additional purchase in store of about $50. (Incremental sales were not captured in the AlixPartners models.)
Second, the same-day pick up feature uses inventory already in the store, so no shipping to store is necessary. But, the department store's "free ship to store" feature — which takes four to seven business days and is offered free for orders over $25 — is done using Penney's weekly delivery trucks to lower that shipping cost. Because its stores are replenished with new merchandise each week, it's cost-effective to load that same truck with jcp.com orders that customers have chosen to pick-up in that store.
J.C. Penney spokeswoman Daphne Avila said that even though it's least profitable to fulfill an online order by shipping from the store, it's "still more advantageous to 'save the sale' and not disappoint a customer. In the past, we lost the sale if our distribution center couldn't have the item in stock. Now we're developing an enterprise-wide view of our inventory so we can better meet customer demand."
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