Every retailer keeps a watchful eye on their profit margins. Yet net profit can feel like the hardest metric to maintain.
2022 was a tough time for many retailers. In the US, net margins dipped by 2.6%, year-on-year. As we enter the final part of 2023, there is little sign yet of their recovery. In Q2 2023, margins for consumer discretionary and consumer staples companies in the S&P 500 underperformed projections, both sitting some way below their 2021 peaks.
The picture is much the same across the Atlantic. In the UK, margins for the biggest supermarkets declined in 2022 by up to 1.2% off their pre-pandemic peaks.
But why are retailers being spread so thin? And is there anything they can do to stop their profitability being whittled away further?
Let’s dive in.
Reasons for the margin squeeze
The decline in retail profitability in the last few years has been multicausal. Some factors are acute and circumstantial, while others have been longer acting.
1. Inflation
We don’t need to tell you that the last two years have seen costs balloon. This has caused a major strategic headache for retailers. Passing on rising costs to customers in the form of higher prices would close the margin gap. But customers don’t like sticker shock.
Inflation motivates customers to become less loyal and shop around more, and creating new custom is much more expensive than retaining it. Any short-term margin restitution gained by price increases may well be outweighed by the added costs of customer churn.
This leaves many retailers with little choice but to swallow rising input costs for fear of losing a competitive edge.
2. Price wars
During inflationary periods, some bigger retailers will prioritise volume over margin and engage in price wars. We’ve already observed this happening in the UK and US among the major grocers in 2023.
This hit to profitability might be deemed worthwhile to keep customers in the fold through a difficult time. But it can disadvantage retailers who don’t have the means to temporarily slash their profitability.
3. The rise of D2C
Retailers don’t just have to compete with each other anymore. They must also vie with a new breed of packaged goods businesses who use the internet to sell directly to their customers, skipping the retail stage altogether.
Successful direct-to-consumer (D2C) businesses typically achieve higher margins, even with lower prices. This has allowed them to snatch a growing market share from spread-thin retailers.
4. Product returns
Insider Intelligence predicts that the value of products returned to retailers in 2023 will exceed $620 billion.
Processing the average return will cost a retailer 59% of its sale price. With so many millions of products winging their way back each year, unwanted items are a major margin dilution for the retail sector.
5. Supply chain and inventory woes
Two years on from 2021’s supply chain crisis, trading conditions have still not recovered. This has left its mark in the runaway inflation that we’re all bitterly familiar with. But it has also caused a lot of unexpected stockouts or overstocks.
Both a lack and a surplus of inventory are perilous for retailers’ profit margins. Too little stock and you'll miss sales opportunities. Too much stock and you need to mark it down and clear it. Either way, a lot of value disappears down the drain.
Supply chain disruption can send lead times shooting up. But renegotiating relationships with suppliers and distributors – or finding new ones who can work faster – can be expensive and time-consuming.
How to safeguard your margins
None of the factors we’ve explored are truly in any single retailer’s control. There isn’t any neat trick by which businesses can insulate themselves from huge market shocks. But there are measures they can take to stop themselves from becoming hostages to fortune.
As inflation eases, margins may rebound. Until that happens, retailers’ best route to consolidating their profits lies in their logistics. Specifically, it means finding efficiencies in procurement, inventory and distribution. So, what do retailers need to deploy here?
1. Panoramic data
It all starts with data. Retailers need to know everything that’s going on at all stages of their operations. Every blind spot in the stock management and fulfilment journey is a hole through which cash leaks out.
A robust data collection system should span warehouses, in-store, the point of sale and the full path of inbound and outbound deliveries. Just as important is the software that makes sense of all this information. From identifying underperforming suppliers to homing in on links between stock placement and sales, data analytics technology makes holistic cost control possible.
2. Predictive analytics
What could be better than knowing exactly what’s going on right now?
Knowing what’s most likely to be coming down the line.
By training predictive analytics algorithms on your sales data to create models of future demand, you can optimise your inventory management in advance.
The same goes for the returns problem. By assessing which types of items get returned more than others, models can forecast the viability of new products before you put them on shelves. Automated insight generation is your best safeguard against waste and scarcity alike.
3. Order management
Running an integrated, data-driven retail strategy calls for some way to tie together all the strands of information you’re collecting from across your operations. That’s what order management systems (OMS) do.
An OMS is a software application that lets retailers track each order they receive on any channel, from start to finish, in real time. By integrating with your data collection systems, an OMS can regulate your inventory levels by automatically placing orders when stock falls below a certain level. The efficiency gains buttress your margin, while the benefits to the customer experience can help feed into retention levels.
By themselves, these tools can’t get more people through your door. But they can create efficiencies that widen the gap between what you’re making and what you’re spending.
If you’d like to learn more about how the new breed of order management tools is driving a quiet revolution in retail, download our new whitepaper.