Ecommerce businesses are struggling against ratcheting borrowing costs, as interest rates rise and capital grows more expensive. We explore how they can rework their business models and weather the storm
Generations of consumers have never experienced a world of high prices, with business models, value propositions and retail relationships built on the assumption of low inflation. This is no longer the case, posing serious challenges for ecommerce businesses.
The cost-of-living crisis, fuelled by rocketing energy prices and soaring inflation – forecast to reach double digits for many European countries over the coming months – combined with the rising cost of raw materials, packaging, transport and labour, is putting insurmountable pressure on retailers and increasingly price-conscious consumers.
“The era of being rewarded for hyper growth at any cost is quickly coming to an end,” US venture capital firm, Sequoia Capital, warned in an advisory note to its portfolio companies in May.
Ecommerce businesses were set up on high-growth, low-profit models after more than a decade of cheap lending. They’re struggling against ratcheting borrowing costs, as interest rates creep up and capital becomes more expensive.
“We’ve been in an era of cheap money since the global financial crisis,” says J. Walker Smith, knowledge lead at global data and insights firm Kantar. This featured “a cheap money cycle supported by the kind of focus on running a start-up with the purpose of valuation, as opposed to creating bottom line value and profitability”, he says.
During this period, investors, venture capital and private equity firms could afford to underwrite growth-orientated business models. “But the investor climate has changed, and this is a wake-up call,” he warns.
What, then, can high-growth ecommerce businesses do to rework their models and weather the storm?
Erin Brookes is head of retail at Alvarez & Marsal, a global consultancy. For Brookes, “taking a razor-sharp look through their entire operating model and every single cost within the business will be essential for survival”.
This is about asking and understanding what really works at the core of the business “that we can back and that customers are really engaging with”, she explains. “What’s got to be the focus for this business to be healthy? And are there parts of the business, in adjacent categories or different geographics, that aren’t giving the return and that are distracting from the core of the business?”
There needs to be a shift in the kind of metrics used to drive these businesses, says Smith. The most immediate focus should be less about driving novelty in the offering to get attention and users and less about building an overall user base. It should instead be more about driving value per customer. He advises retailers to focus on value-orientated strategies which look at the value they can drive per customer, then evaluating success against a metric of profitable customers.
Alex Charlton is senior vice-president technology, media and telecoms at international research and insights agency Verve, which works with brands such as H&M, Samsung and No7 (Boots). He says part of the shift is understanding what ‘value’ means to different customer groups, then using this information to shape what you’re offering and how you communicate it.
“For retailers, granular understanding of their customer base could mean the difference between survival and liquidation over the coming months,” he explains. “Factors such as market segmentation, targeting and positioning will be key, such as allowing them to target and tailor products and messaging to different customer groups accordingly.”
Charlton says retailers should become an authentic ally to their customers, especially those who are struggling financially. The thought process should shift from focusing on how they can sell more to asking how they can help, he says.
“Customers will remember, and it will be an opportunity to create lasting brand loyalty,” he adds.
Tony Preedy, managing director of global marketplace Fruugo, says it’s crucial that online retailers measure, understand and manage unit economics to overcome rising inflationary pressures.
“Ultimately, businesses are going to have to make trade-offs between profit now and growth later, so it’s important for them to analyse their data closely,” he says. “Inevitably, rising costs are likely to cause retailers to put up their prices in the short to medium term. But online retailers can be highly agile in how they price to optimise how they sell through their inventory, and they can also be cute about how they target discounts to prompt a purchase.”
However, he warns about a strategy of indiscriminate discounting to drive volume. “Very few businesses properly calculate the impact on gross margin of reduced prices and the massive growth in units required to keep income stable, never mind growing,” he says.
With a myriad of data at their fingertips and agility in their pricing and marketing, ecommerce businesses have some strong advantages over their bricks and mortar counterparts.
However, the overarching issue for online retailers, compared to physical retail, is the cost of distribution and the impact this has on margins, “a weakness in the business model which is only exacerbated in the current trading environment,” says James Hankins, founder of strategy consultancy Vizer Consulting and co-chair of the IPA Share of Search ThinkTank.
With bricks and mortar, the cost of fulfilment is held by the consumer. But with ecommerce this relationship is inverted, with the retailer having to sink the cost. “This is a huge cost base that ecommerce players have to shoulder, and it’s very difficult to optimise,” says Hankins. In today’s market of soaring costs, it’s becoming untenable.
To mitigate these fulfilment challenges, retailers such as Zara and Boohoo have started charging customers for delivery and returns. Returns are a costly element of the distribution model for online fashion businesses, with Asos saying in June that a “significant increase” in returns contributed to its latest profit warning.
Some retailers are supplementing their core ecommerce channel with other revenue streams. In March, fashion retailer H&M started trailing the sale of third-party brands on its website in Sweden and Germany, opening its distribution network to other brands and effectively renting it out.
Meanwhile, German ecommerce giant Zalando has bought a majority stake in retail media business Highsnobiety, “which offers the opportunity for high margins and relatively low effort” says Hankins, allowing it to sell advertising and helping cross-subsidise the weakness in the ecommerce business model.
Online furniture retailer Made.com, which has made little profit comparative to revenue in its 12 years of trading, bought online marketplace, Trouva, in May. “If consumers are buying more than Made products by shopping across the marketplace, you are opening up the potential demand,” says Hankins. “This means your marginal costs should hopefully reduce because you’re getting more brands to use your distribution network.”
Pressure is growing as interest rates rise and banks start to call in loans. High-growth retailers must think long-term and strategically about building operations that support their core business, while bolting on multi-revenue generating arms that have been tested, scaled and managed appropriately to cross-subsidise the cost challenges in their distribution model and the wider economic climate.