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February 22, 2016

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Retailers and the Digital Paradox

by Ravi Kalakota

The challenges facing retailers are legion. Traffic at many shopping centers has dwindled, price competition is heating up, and 65+ million Americans are Amazon Prime customers — locking them into a system where they can get free delivery on millions of items and access to exclusive movies, shows and video games.

Digital induced pain for retailers is going to get worse in 2016 and 2017.  The gap between what consumers are expecting from retailers and what they are receiving is getting wider.  Consumers are spreading their buying activity across channels, forcing retailers to spread out their digital investments.  This puts significant stress on execution, product/platform management, design and leadership.

Evidence of this value migration from physical to digital is mounting every day.

Against that backdrop, Wal-Mart is closing over 269 stores as it retools portfolio. Macy’s said that it will shutter over 36 stores as store traffic declines faster than expected, and Finish Line said that it would close 150 stores by 2020.  Gap,  J.Crew,  American Apparel, Sears and Kmart, Target, Nordstrom are all facing similar headwinds.

Starbucks CEO Howard Schultz laid out his thoughts on the future of retail, “three years ago we began to envision that there would be a seismic change in consumer behavior, and that seismic change was due in large part to e-commerce and smartphone shopping.”  

It’s fascinating to watch retailers trying to shift tech/platform strategies to deal with digital disintermediation, showrooming, physical-to-digital channel integration, mobile shoppers, same-day delivery/fulfillment, programmatic targeting, online native models and now the new buzz.. virtual and augmented reality.

While most retailers seems to know what to do….they are unable to execute consistently or effectively. A talent gap in many cases. Others are hindered by legacy IT apps and infrastructure. Others by silos of data or necessary next generation technology capabilities like A/B testing, data science and machine learning.

This retail UX and shopper evolution is a continuation of the trend from 1960s.  

Retail Digital

Analog to digital transformation

Analog to digital transformation (the mega-theme for the past 20 years) is forcing many companies to continuously rethink their digital operating and execution model.

With digital, value is migrating from outmoded business models to new business designs that are better able to satisfy customers’ priorities.

Digitalchallenges

However, digital transformation has not been an easy road for any retailer.

In order stay relevant, retailers are being forced to do two conflicting things:

  1. Cannibalize the brick-and-mortar business before competition does,  and
  2. Invest heavily in digital platforms while near-term profits are elusive.

Consider the case of Nordstrom to illustrate this transformation leadership dilemma.

  • Nordstrom reported disappointing earnings (Feb 2016). Comparable sales for the fourth quarter for full-line and outlet stores decreased 3%.
  • Nordstrom’s inventory increased a whopping 12%, a sign that Nordstrom shoppers aren’t clearing the shelves.

Nordstrom, like other retailers, is moving aggressively from analog to digital operating model but they are not immune to the e-commerce curse:  constant investments into core platforms (e-commerce, fulfillment, service) and no profits in the near term.

Nordstrom, like other retailers,  has to invest heavily in e-commerce to avoid digital disintermediation.  According to CFO Michael Koppel, part of what’s dragging down the company’s profits is its attempt to keep up with online retailers like Amazon or fast fashion powerhouses like Zara. “E-commerce now represents over 20% of our sales, a notable increase from 8% five years ago.

“This business model has a high variable cost structure driven by fulfillment and marketing costs in addition to ongoing technology investments. With our increased investments to gain market share along with the changing business model, expenses in recent years have grown faster than sales.

The margins are further eroded from promotions and over-stock clearance.

In this hypercompetitive world, delivering an engaging Customer Experience is not any longer a strategic approach to achieve some of the retailers business objectives but a mere survival necessity.  Koppel said: “In evolving with our customers, we made significant investments to enable customers to shop in multiple ways. This has resulted in market share gains, but also structural changes to our operating costs.”

Digital Management Conundrum/Nightmare

DigitalRoadmapThe shift from e-commerce -> digital is obviously causing nightmares everywhere. Nordstrom isn’t alone, with Koppel’s comments echoing those of other retail executives who have also highlighted the impact online operations have had on their business.

According to the CEO of Michael Kors CEO John Idol,  “Unfortunately today, e-commerce generates a lower operating profit for us than four-wall brick-and-mortar. We think over time that will reverse itself, but, as you know, when the consumer requires free delivery, free return, wonderful packaging, plus there’s a new trend that people are buying multiple sizes of things to try them out at home and then return them, that all is a negative headwind for us.” he said during his company’s quarterly earnings call.

Anticipate and shaping the needs of today’s and tomorrow’s customer is extremely hard. Situation @ Nordstrom is similar to what is going on at every retailer’s boardroom (e.g., Macy’s, Kors,  Saks etc.).  This is a major industry challenge as millennials, who have become the dominant force in retail sales, do much of their shopping online, forcing brick-and-mortar retailers to bulk up their online presence.

In summary, retail is a tough business. Retail has high fixed costs, high working capital intensity, fickle customers, and low barriers to entry. And for an industry that already has its share of “profit” problems, the need to build out an online presence adds expenses, logistical complications, and additional pressure on the business.

The strategic challenge is how to stay relevant and interesting.  At the same time, not do crazy things like Sears, J.C.P that made the brand irrelevant quickly by alienating customers.  But evolution of retail is inevitable as shown below.

Evolution of USA Retail

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I would love to hear from you about strategies that actually work.  I also would like to hear about world-class firms or upstarts that have successfully made the shift to digital.

Additional Resources:

  1. Digital 101
  2. Digital Architecture 101
  3. Digital Integrator Model – How to Execute Transformation
  4. Digital Personas and “A Day in the Life Of” — disruptivedigital.wordpress.com
  5. Mobile Marketing Engagement – Path to Purchase – disruptivedigital.wordpress.com
  6. Digital Transformation
  7. Big Data Use Cases
  8. See Mobile Marketing Automation for more insights into Mobile Geo-Fencing and Targeting. Mobile ads are rapidly overtaking desktop ad spending in all categories—display ads, search, social media and video
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