Why profit margins are so thin online

Certain segments of retail, such as groceries, were already operating on thin margins long before e-commerce came along. But selling goods online can also bring its own challenges.

For one thing, the visibility of e-commerce makes it easy for consumers to compare prices across retailers, creating intense competition to offer the best deals possible. In the US, prices across Amazon and other online retailers ticked downward for so long it prompted one economist to pose e-commerce as a reason for low inflation in the country.

The costs of fulfilling orders and handling returns—what retailers call reverse logistics—can also be high. Shoppers have come to expect fast, inexpensive shipping, placing the financial burdens of delivery largely on the shoulders of retailers. Target has said it’s about 90% cheaper on average when a customer picks up an online order in one of its stores versus Target shipping the item to their home.

Returns compound the costs, and they occur more frequently with online purchases. Return rates vary by category, but in the case of clothing, shoppers may even buy multiple items with the intent of returning most. Every return carries expenses such as shipping, customer care, inspecting and sorting goods, sometimes repackaging and repairing them, storage, and sometimes liquidation. As e-commerce grows, the volume of returns keeps rising.

The study found that purely online retailers tend to run on much slimmer margins than the industry average: 1.4%, versus 5.4% for the total industry. They generally have a different cost structure, and may also make up in growing sales volume and market share what they lack in profits.

Some categories, such as jewelry and furniture, are more insulated from the pandemic-accelerated shift online, according to the study. But retailers of items such as clothing, home goods, and electronics whose businesses are weighted toward store networks will likely need to make invest in building out their digital operations and improving their efficiency, putting even more pressure on their profitability in the near term.

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