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Comment: Measuring cost to serve crucial in modern retailing

Until recently, it was widely acknowledged among the retail community that omnichannel customers are more profitable than traditional ones. Countless thought leadership pieces proclaim the value of the omnichannel customer, who shops on average three times more frequently and generates three times more sales than a store only customer.

But, recent research paints a slightly different picture. Keeping with the rule of three, IBM has released research claiming the cost to serve the omnichannel customer is up to three times more than traditional store customers.

So which expert is right? Thought leadership aside, if we look at the results published in the market, they reinforce the theory that omnichannel customers may not be as profitable as we first believed. According to analysis from OC&C Strategy Consultants, average operating profits for the UK's top ten omnichannel retailers have more than halved since 2011. In addition to discounts and rising wages, margins are being impacted by the higher costs required to fulfil the omnichannel service proposition.

From one channel to many, according to Barclays Chain Reaction report, the average retailer now offers 7.2 delivery and collection options. But this increase in channels and fulfilment methods has not necessarily been matched with a corresponding increase in sales. This impacts the ability of retailers to maximise economies of scale by driving volume through any one channel or fulfilment option. The last mile service proposition also represents a cost challenge – with Amazon raising the bar on the service offer – the pressure to offer free, fast and flexible delivery to the customer increases.

And let's not forget the sunk costs of returns! According to industry averages the omnichannel customer coincidentally returns three times more than the traditional store customer.

So how do we manage the cost impact of omnichannel? If higher operational costs are eating retailers' margins, businesses need to evaluate how they measure and manage the cost to serve the omnichannel shopper. But unfortunately, this is only the tip of an iceberg of issues.

By cost to serve I'm referring to the operational costs that build-up as a product moves through the supply chain to get to the customer. Cost-to-serve is not a new concept but it's a fairly important one. Most retailers will be familiar with activity based costing methods and be using a version of this approach somewhere in their business. But before online, things were far more straightforward. We had a linear, more localised supply chain. As the end point for the majority of sales, stores largely held a channel monopoly. Sales staff rather than strange acronyms like PUDO put items into shoppers' hands. And, we measured uncomplicated KPIs like intake margin and physical store sales.

So why is this a challenge now? Well, research suggests it's something that isn't even being evaluated by many businesses! According to IGD, 56% of retailers don't know their cost to serve. And, of those who are tracking this vital KPI, traditional channels are more likely to have a cost-to-serve measure in place with only 27% of online channels measuring their cost to serve.

Further to this, by complicating the journey a product takes to market, omnichannel challenges the ways retailers should approach their cost to serve. In the linear supply chain, retailers could rely on average based activity costing to inform business decisions. But, when you lay this onto a complex network rather than a chain, the greater variations require more granular cost insight and visibility into new processes and third party activity.

Cost to serve for omnichannel involves being able to assess the operational costs from serving a particular customer, that product, through a set channel and at the designated service level. By having insight into the specific activities and inputs that generate the least value, retailers can then make the changes necessary to make omnichannel growth profitable.

As food for thought, consider how your business performs against the following questions:

1.) If your channel mix changes, do you know how this will impact your profits?

2.) Do you have visibility of the number of times a product is returned before it lands with a customer?

3.) Which promotions generate the highest value for your business?

4.) Do the KPIs of different departments lead to common and harmonious goals?

So, do you believe that your business really measures your cost to serve?

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