By Suzanne Kapner
The Internet appears to be the main winner at the start of the
holiday shopping blitz, and the loser could be the retail
industry's profits.
An early reading of "Cyber Monday" shows that e-commerce sales
increased 15.6% compared with a year ago, according to Channel
Advisor, which tracked transaction data for more than 2,700
retailers selling online between midnight and noon Monday.
The results, after a weak Black Friday, underscore the extent to
which the Internet has become the main source of growth in the
industry. The online operations of traditional retailers like
department stores and apparel chains are catching up--each posting
big gains online this year, according to data from International
Business Machines Corp.--but that isn't entirely good news.
While conventional wisdom holds that online sales should be more
profitable, because websites don't need the pricey real estate and
labor necessary to maintain a store network, many retailers
actually earn less or even lose money online after factoring in the
cost of shipping, handling and higher rates of returns.
For retailers that outsource their Web and fulfillment
operations, costs can run as high as 25% of sales, industry
analysts said.
Kohl's Corp. says its profitability online is less than half
what it reaps in its store. Wal-Mart Stores Inc. says it expects to
lose money online at least through early 2016 as it invests to
build its technology, infrastructure and fulfillment networks.
Target Corp. says its margins will shrink as its online sales grow.
Best Buy Co. said faster growth on its website will weigh on its
profitability at the end of the year.
And Primark, the European discount retailer that plans to open
eight U.S. stores, has shunned online retailing altogether because
it deems it unprofitable.
"We are not in the business of doing something and not making
any money on it," said John Bason, the chief financial officer of
Primark's parent, Associated British Foods PLC.
The comments reflect the challenge facing retailers as U.S.
shoppers move online and the Internet puts pressure on the
economics that have long underpinned the industry.
Thinner margins aren't just something that brick-and-mortar
retailers are grappling with. Amazon.com Inc. operates on
razor-thin margins, as do many other pure e-commerce retailers. An
Amazon spokesman declined to comment.
"If the e-commerce business was inherently so much more
profitable, pure e-commerce companies would have higher margins,"
said Simeon Siegel, an analyst with Nomura.
Online sales are growing much faster than brick-and-mortar
sales. They are expected to hit $414 billion, or 11% of all U.S.
retail sales, by 2018, according to Forrester Research. That is up
from an estimated $294 billion, or 9% of retail sales, in 2014.
"If you don't play online, you are making a pretty big mistake,
because that is where the market is moving," said Kohl's Chief
Executive Kevin Mansell.
Mr. Mansell said Kohl's is willing to sacrifice some profit to
capture more sales. Like most retailers, Kohl's discloses little
about its online operations in its financial reports. Mr. Mansell
said online operating margins at Kohl's are about 4%, less than
half the 10% operating margins of its nearly 1,200 physical
stores.
"I don't care if customers buy online or in store," he said.
"We're focused on sales."
Kohl's profit fell 20% in the three months through Nov. 1,
compared with a year earlier, as its quarterly sales excluding
newly opened or closed stores sank for the third time this year.
Kohl's expects sales on that basis to rise during the holiday
quarter. Online sales account for about $2 billion of the company's
$19 billion fiscal-year total.
One reason for lower online margins at Kohl's is its low prices.
Retailers that sell inexpensive goods are at a particular
disadvantage on the Web, because it costs roughly the same to
warehouse and distribute lower-priced items as it does
higher-priced items of the same size.
The company's e-commerce margins should get a lift as more
Kohl's customers shop online and spread the cost of building its
website and distribution centers across a larger sales base, and
services such as buy online for in-store pickup cut shipping
expenses. But Kohl's Chief Financial Officer Wesley McDonald said
he doesn't expect the profits made online to ever match those of
the company's stores.
Abercrombie & Fitch Co. and Lululemon Athletica Inc. are
among the few retailers that break out online profits, and both
show e-commerce margins that exceed those of their stores.
Analysts point out, however, that companies have a lot of leeway
in how they allocate costs, so results can vary widely. Abercrombie
and Lululemon declined to comment.
Online margins are largely a mystery, because the vast majority
of retailers don't disclose much hard data about their Web
operations. There is evidence that online margins are narrower,
however.
Paul Lejuez, an analyst with Wells Fargo Securities, tracked the
online penetration and margin performance of 15 retailers from 2011
to 2013. At nine of the retailers--including Abercrombie, Lululemon
and Kohl's--margins fell as e-commerce grew as a percentage of
overall sales.
There can be a lot of reasons for declining margins, including
less foot traffic and heavier discounting at brick-and-mortar
stores. But Mr. Lejuez argues that the challenges facing physical
stores are at least partly the result of the rise of e-commerce,
which has pressured prices by making it easier for customers to
ferret out the best deals online.
Another factor weighing on e-commerce margins is that online
sales have a higher degree of variable costs. A brick-and-mortar
retailer incurs roughly the same costs whether 10 or 50 people
purchase a pair of pants from a store. The lights are already on,
the rent is paid and the employees are in place. That means when
sales go up, profit goes up faster.
But online, there are costs associated with each additional
order. Employees must locate those pants in a warehouse, pack and
ship them, and then deal with return shipping and restocking when
goods come back, often at two or three times the rate at which
store-bought goods are returned.
Add free shipping to the equation, and those costs eat into
margins well beyond the fixed expenses of running the distribution
centers and the computer networks.
Primark ran up against the prohibitive costs of e-commerce in
2013, when it sold some goods through Asos.com Ltd., an online
British retailer, in a test that lasted a few months. Asos handled
the warehousing, shipping and other related costs for an
undisclosed fee. Asos didn't respond to requests for comment.
"The demand was there, but we weren't able to turn a profit,"
said Mr. Bason, the finance chief of Primark's parent. Mr. Bason
concluded that Primark would be better off spending its money on
physical stores, where sales average $800 a square foot.
"We don't need to resort to dilutive online tactics," he
said.
Write to Suzanne Kapner at Suzanne.Kapner@wsj.com
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