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E-Commerce Sales are Soaring! But are E-Commerce Operations Profitable?

Yes, if you take on risk.

We hear it everywhere and I have said it myself a number of times “e-commerce sales are soaring!” But more difficult to determine is the profitability of e-commerce operations. And even more difficult than profitability is the detailed cost-structure of e-commerce channels.  According to Digital Commerce 360, Amazon accounts for 42 percent of e-commerce. And the competitive pressures from Amazon (the “Amazon effect”) are largely responsible for the level of service e-commerce consumers receive, and the difficulties other retailers are having in turning a profit from e-commerce.

Revenue, Growth, and….Profit?

Let’s start with Amazon. Unfortunately the behemoth of e-commerce doesn’t provide a financial breakdown of its e-commerce business, exclusive of its other revenue streams and costs. However, Amazon North America is primarily retail sales of consumer products, but includes subscription services as well. So I consider it a reasonable point of reference. Amazon NA achieved an operating income margin of 2.6% for 2021. If you allocate income tax provisions to Amazon NA in proportion to its percentage of corporate revenues, you arrive at a 1.6 percent profit margin. Not a magnificent maring. Of course, Amazon is investing heavily in its infrastructure and working toward market share gains, likely in detriment to earnings. But that is exactly my point. This focus by Amazon is exerting similar pressures on competitors. Nike’s 2020 earnings are another example of costly e-commerce operations’ impact on the bottom line.  So what are the options available to competitors for achieving and maintaining e-commerce profitability?

The Old “Price plus shipping & handling”

E-Commerce costs are widely understood at a high-level. Inventory storage costs are lower than brick-and-mortar. Online order processing is also extremely cost-effective. The high costs of ecommerce relate to the fulfillment of orders – namely warehouse handling and transportation costs. However, the path to ecommerce profitability in more nuanced as today’s competitive pressures restrict cost containment options. Transportation costs account for a large percentage of costs. As does reverse logistics (returns). These costs can be charged to customers – at the risk of losing customers due to uncompetitive pricing. Or they can be absorbed by the seller – greatly diminishing profits. My colleagues Chris and Steve focus on last-mile transportation. I will leave that topic of discussion to them. Instead, let’s address the other big expense – warehousing and fulfillment costs.

Scalability and Capabilities

Warehouse automation investments provide increased throughput capabilities, operational stability, and the opportunity to reduce the variable costs of fulfillment. However, the higher fixed-costs come with risk. High volumes are necessary to pay down the fixed costs and achieve profitability. Even Amazon is subject to the two-sided effects of operational leverage. In fact, the following statement appeared in the Amazon Q4 2021 earnings transcript “Our results also include approximately $1 billion year-over-year negative impact from lower fixed cost leverage in our fulfillment network. Recall that we saw very high unit volumes for most of 2020 and the first half of 2021.” Large companies like Walmart, Amazon, and others have the financial resources to establish infrastructure and fixed assets to  create scale and lower variable costs of fulfillment. Warehouse automation investment is certainly a long-term strategic decision that can establish competitive position and deliver profitability. However, if your organization doesn’t have the risk tolerance or capital, many of these above mentioned companies also offer fulfillment outsourcing services that provide smaller retailers the opportunity to utilize this existing capacity (at the same time assisting these larger vendors pay back their capital investments). Examples include the Shopify Fulfillment Network, Amazon Multi-Channel Fulfillment, and Zalando Fulfillment Solutions (Europe). 3PLs are also investing in automation, allowing customers to benefit from their scalability. GXO Logistics is taking its investment to the next level. Of course, a certain amount of upside potential is lost when one decides to utilize a third-party fulfillment provider. But that must be balanced with the risk of investment misalignment with long-term requirements. This is where flexible automation in the form of mobile robotics or other technologies offer increased value. The ability to address a wide range of throughput requirements reduces the risk of investment and increases the probability that the investment will align with changing needs.

Ultimately, it’s a matter of aligning fulfillment capabilities with the specific circumstances and requirements of the organization. There are many paths to success. But evaluating the proper technology for adoption is certainly a good place to start.

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