Why Omnichannel Is So Hard

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Over the past decade, \”omnichannel\” has become one of the most common buzzwords in retail. Retail executives, industry consultants, and analysts all agree on the importance of integrating the brick-and-mortar and online channels so that customers can move seamlessly between them. Yet while there\’s consensus about what retailers should do, adapting to this new way of doing business isn\’t simple.

Of course, some prominent retailers like Target have made omnichannel look easy. Target got a late start, having made a boneheaded move to outsource its entire ecommerce business to Amazon from 2001 to 2011. Yet it has rapidly shifted to an omnichannel strategy in recent years with great success.

[callout]Closing poorly located, low-volume stores is critical for maintaining brand standards and eliminating fixed costs considering lower 4-wall sales volumes. On the other hand, those very same store closures can lead to the loss of customer relationships, thereby negatively impacting ecommerce sales that generate strong variable profits.[/callout]

That said, many retailers have struggled mightily to implement omnichannel strategies consistent with profitable growth. This is largely because viewing the brick-and-mortar and ecommerce channels as a unified whole (which every good omnichannel retailer tries to do) makes it much harder to make good business decisions.

The Measurement Problem

A key precept of omnichannel retail is that customers don\’t think of the brick-and-mortar and online channels as being separate from one another. (Indeed, a customer\’s purchase journey could entail switching between channels multiple times.) Therefore, retailers should design and manage the physical and digital sides of the business as an integrated whole rather than in a siloed fashion.

However, treating the business as an integrated whole where everything potentially affects everything vastly complicates decision making. In the days before ecommerce, analyzing a store\’s performance or deciding whether to open a new store was straightforward. Executives could measure a store\’s projected or actual revenue and contribution profit and make modest adjustments to account for the impact on nearby stores.

By contrast, in an omnichannel world, tallying up the sales made inside a store\’s four walls doesn\’t capture its full revenue or profit contribution. Each store also has some impact on digital sales (and, by extension, profits). But while it\’s easy to observe that a store\’s sales and profit contribution extends beyond 4-wall metrics, there\’s no foolproof way to measure that omnichannel contribution.

The difficulty of attributing sales and profit when everything potentially affects everything makes it harder for management teams to make good decisions about where to open and close stores, whether to invest in renovations or upgrades, and how to structure their supply chains, among other things.

Field Report on Macy’s

Macy\’s recent experience highlights the unique challenges of decision making for omnichannel retailers. While the iconic department store isn\’t exactly known for innovation, it has put omnichannel initiatives at the center of its corporate strategy for more than a decade.

Unfortunately, Macy\’s has struggled with weak revenue trends since 2015, despite consistently reporting double-digit growth in digital sales up until 2019. Meanwhile, its adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) margin contracted from 14 percent in fiscal 2014 to around 9 percent in fiscal 2019. That drove a 40 percent decline in adjusted EBITDA and a greater than 50 percent drop in adjusted operating income.

Given that Macy\’s profitability has declined as its sales mix has shifted towards digital-initiated transactions, it would be natural to assume that the brick-and-mortar channel is more profitable than ecommerce. Yet in an investor presentation earlier this year, Macy\’s said that the digital channel\’s contribution margin is \”mid-single digits higher than stores.\” What gives?

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As shown in the chart, digital sales generate significantly lower gross margins than in-store sales due to the cost of shipping. Macy\’s estimates that lower selling and labor costs and real estate costs more than offset that headwind, helping the digital channel come out ahead.

However, because Macy\’s is an omnichannel retailer, this basic analysis doesn\’t capture all the dynamics at play. Macy\’s executives have repeatedly noted that when the retailer closes a store, ecommerce sales decline meaningfully in that area. The impact is magnified when Macy\’s closes its only store in a trade area.

This means that Macy\’s can\’t rely solely on 4-wall sales and profit analyses when deciding whether to close stores. For example, some of the stores\’ real estate costs should properly be attributed to the digital channel because the stores are needed to support e-commerce sales.

The same could be said for store labor costs. While Macy\’s can cut employees\’ hours if in-store sales volumes decline, at some point it\’s no longer possible to reduce labor costs while keeping the store open. Additionally, Macy\’s has received heavy criticism for messy store environments. Ultimately, this indicates that the retailer needs more store employees to keep its stores tidy and avoid alienating shoppers (including omnichannel customers).

In short, the digital channel may well have higher contribution margins for Macy\’s due to the stores\’ higher fixed costs. However, due to the linkages between the digital and store channels, the mix shift in Macy\’s business towards e-commerce hasn\’t led to a corresponding margin improvement. Instead, margins have deteriorated significantly.

Better Data Analysis (and Better Data) Needed

The Macy\’s example highlights how omnichannel strategies complicate decision making. On the one hand, closing poorly located, low-volume stores is critical for maintaining brand standards and eliminating fixed costs considering lower 4-wall sales volumes. On the other hand, those very same store closures can lead to the loss of customer relationships, thereby negatively impacting ecommerce sales that generate strong variable profits.

Big data analytics can help retailers make sense out of such cross-cutting considerations so that store-related decisions (like remodeling vs. closing a dated store) are made from an omnichannel perspective that includes secondary impacts on ecommerce.

Yet retailers shouldn\’t expect big data alone to solve the decision-making conundrums that go hand in hand with omnichannel strategies. There\’s a saying in the data science field: \”garbage in, garbage out.\” The outputs of any analysis are only as good as the data inputs.

Modern data analysis techniques may be able to tease out the likely enterprise-wide impact of closing a store versus keeping it open. But data analysis won\’t be able to compare those options to alternatives like changing to a new store format if there\’s little or no data about alternative store formats.

That\’s probably why Macy\’s is experimenting with a variety of new smaller-format store types, ranging from off-price to luxury. These smaller-format stores will support Macy\’s omnichannel business by handling functions like order pickup and returns. Once the company builds a critical mass of test stores in these newer formats, it should have enough data to evaluate options beyond the binary choice of closing a store or keeping it open.

The lesson is that even advanced analytics won\’t point the way to optimal omnichannel strategies without good input data. For retailers struggling with the omnichannel transition, it may be necessary to devise a strategy to generate useful data that could inform future analyses rather than rushing to develop a strategy based on incomplete data.

Thus, while retailers need to rely more on analytics to make good decisions in an omnichannel environment, creativity and ingenuity are just as important as ever. Retailers that can master the art of purposeful experimentation followed by analysis and iteration will have the best chance of finding and scaling omnichannel strategies that enhance their long-term success.

Full disclosure: The author owns shares of Macy\’s.

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