by Michael Ross
Success in retail is almost entirely predicated on growth, but while the route to it in physical retail is well understood, growth in online retail is not. This has resulted in big winners and losers online. Some, such as ASOS, John Lewis and Amazon, have sustained exponential growth, but many online retailers or divisions of multichannel retailers have quietly stopped growing, leaving customers for their competitors. This has not necessarily been a problem where online represents a small percentage of overall sales, as excess stock bought for online can be managed. But as online comes to represent an increasing share of sales, the impact on stock turn, margin and cashflow may be disastrous if retailers fail to understand the underlying drivers of growth. Many retailers enjoyed ‘easy’ growth in the first decade of online retail; it was hard NOT to grow at exponential rates as customers moved purchases online. In particular, high street retailers saw rapid growth when they went online driven by:
• Channel shifting (with some cannibalisation of store sales)
• Increased sales to loyal customers
• Access to latent demand beyond a store catchment area.
For many, the real challenge now is how to retain this early momentum which requires a real understanding of the growth model of online retail.
• Traditional growth models: How do physical retailers and brand owners grow?
• The online growth model: What drives growth in online retail?
• The challenge: Why do most online retailers stop growing?
Traditional growth models
The growth models for physical retailers and brand owners are tried and tested and there are many successful players to emulate and learn from. However, the tactics and reasons for success for a physical retailer are completely different to those of a brand owner.
Surprisingly the growth dynamic of an online business is more similar to that of brand owners, than a physical retailer.
How physical retailers grow
Retailers’ growth is driven by like-for-likes and new stores. This is a growth model honed over the last 150 years – and the largest retailers in the world have a lot of stores The ability of these stores to succeed is based on consumer insight around range, price, convenience and service – the core elements of a store format. Each store then gives access to new customers.
How brand owners grow
The growth of brand owner (consumer goods) businesses, selling products such as baked beans, toothpaste and shampoo, is based on building a loyal customer base. Brand owners carefully manage the transition of consumers from trialists to repeaters to loyalists. Lots of people can be encouraged to try something based on promotions, marketing and shelf positioning. Some percentage go on to repeat and some of those then become loyal. Only if the ‘percentages’ work does the brand owner roll-out.
The mathematics of this transition was worked out in the 1960s/70s by the likes of Eskin, Kalwani and Silk. It was fuelled by the roll-out of barcode scanning which, for the first time, allowed the large-scale tracking of individual consumers’ behaviour. They discovered that the transition from trialist to loyalist is predictable. This enabled the successful FMCG companies to get very large.
The online growth model: what drives growth?
Online retail growth – at its most fundamental – is similarly driven by customers. Customers do or do not purchase for a first time, and then do or do not come back. This rhythm of customer acquisition and retention is the starting point, and everything a retailer does will affect the rate of acquisition or retention.
While growing retailers will have achieved some combination of an increase in traffic, conversion and average order value, it is important to recognise that these are outcomes rather than business inputs. Similarly, increasing stock (whether breadth or depth) can be a critical driver of growth but will not necessarily drive growth in and of itself.
Adding new products or increasing cover can simply lead to cannibalisation or a reduction in stock turn. Improving delivery on promise is never a bad thing but it many be uneconomic if it doesn’t drive customer retention.
It is important to note that whilst customer loyalty is an outcome (of great products and service), the challenge for retailers online is to understand the relationship between inputs and customers. In the offline world, this requires experience and instinct; in the online world, it requires good analysis. Only by understanding the impact on customers can the right decisions be made.
Cohort analysis explains this growth dynamic. It is probably the single most important analysis an online retailer can do, and is is the heartbeat of their business. There are four elements of a cohort analysis:
• How customers transition from new to loyal
• How long it takes to make this transition
• How it gets better/worse over time
• The spend pattern of a loyal customer.
This data is what’s needed to predict – it tells you what growth rate is achievable given a marketing spend, or what marketing spend is required to deliver a target growth rate. And it is the baseline against which all other initiatives can be evaluated and one of the reasons for the development of our Intelligent Trader online decision making tool.
So why do most online retailers stop growing?
This is down principally to customer churn; they buy once or even twice and never return, in the same way as people who try out a new consumer goods brand. Proof that you can’t just look at customer acquisition, because once it is equal to the churn of your customer base, you will stop growing.
The solution of course is simple: get more new customers or reduce churn. Many multichannel retailers (who don’t break out online) have been satisfied with their growth because they have increased like-for-like sales, so if their web store is growing faster than the physical stores, they’re happy. However, the comparison is not helpful given the huge opportunities that global eCommerce offer and the relatively small number of constraints to taking part. If you do not take advantage of the opportunities, then someone else will.
Possibly the majority of online plans today are based on modelling marketing channels, categories or simple extrapolations of traffic, conversion and average order value. Some plans are simply based on what the chief executive says. This is very dangerous – the impact on stock/margin from a growth rate that is off by 10 to 20 percentage points is always going to be more expensive than building a better model.
However, understanding customer data and acting on insight is a challenge, particularly to those retailers that do not have a customer database, or who are doing customer analysis sporadically or not at all. It’s all about understanding individual customers and the reasons behind their purchases, and this is a new way of working for retailers who have built successful businesses on inference and gut feel.
Michael Ross is co-founder and director of eCommera