The new equations of retail

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The new equations of retail

The new equations of retail

Michael Ross Chief Scientist and Co-founder, eCommera

A common complaint of the retail CEO confronted with the tsunami of online data is now what?
Retail is about thousands of small decisions so the question should be: what new or different decisions should we make given this data? Three things make this difcult: New activities Google, site sort orders, CRM, delivery to customers are all generally new disciplines for retailers, and require new skills New data each of these activities generates its own torrent of data which needs to be collected and understood New costs the cost per click of Google, the variable costs of picking/packing/shipping, cost of communicating with customers. New costs change the economics of retail. New activities mean new decisions. And new costs mean different decisions. These decisions require rules. And the new data allows rules to be codied what we (somewhat) grandly call the new equations of retail. This article gives ve examples (out of the hundreds of possible examples) of the sorts of scenarios where new and different decisions need to be made and where its easy to get it wrong. How much is it worth investing in the service experience? What prot per order maximises your overall prot? How much should you spend on a keyword on Google that hasnt generated any sales? What combination of markdown and product views maximises prot? When should you target a customer who has stopped purchasing?

This article sheds some light on these questions.

OPERATIONS: Whats the value of service?

In physical retail, operations is back of house, focused on getting product to store. In the online world, operations is the last touch point with the customer, and is fundamental to success, but it is often handled by exactly the same people, and in exactly the same way. For most retailers, this is not the exciting part of eCommerce. Theres no whizzy new technology to play with and no social opportunity yet operational excellence is critical for success. Imagine a typical situation: you get a 600 order at 2.30pm from a rst time customer who has selected a different billing and shipping address, with next day delivery. Do you: (i) Do everything possible to ship it same day (ii) Do a standard fraud check but insist that the rst order is delivered to the billing address (iii) Do a rigorous fraud check and probably miss the delivery promise. Figure 1: Delivery on promise
More Prot

The likes of Amazon and Net-a-Porter can simply decide to make service a focus and have a messianic belief that its the right thing to do. For the majority of retailers, their CEOs and boards require convincing that this is the right place to invest. A key operational question therefore is how can you make the trade-off of between cost vs. service?

The Maths
Intuitively it is obvious that better service drives customer retention, but how do you quantify the value of service? Whats the equation that tells you when to stop investing? The key is to understand the relationship between service and customer retention, and then to quantify the value of retaining customers. A typical analysis is below:

INPUTS Impact of delivery on promise on customer satisfaction Impact of customer satisfaction on repeat purchase rate Impact of repeat purchase rate on customer lifetime value (LTV)

Optimisation opportunity

Incremental customer lifetime value

TODAY

Incremental prot
Less Prot

Cost of improvement to delivery of promise

-3% Worse service

-2%

-1%

TODAY

+1%

+2%

+3%

+4%

Better service

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The new equations of retail

Once the relationship between cost and service has been established new processes need to be put in place. Of particular importance are automated fraud processing, order prioritisation/routing, order cut-off times, carrier pick up time, shift patterns, weekend working (to avoid a Monday backlog), etc. For example, Figleaves had a focus that all instock orders placed by 4pm should be shipped same day and the warehouse managers daily report showed orders placed by 4pm not shipped. It is vital to develop processes that make failing on promise unacceptable. In the early days of Net-a-Porter, orders from VIP customers were printed on pink paper so they stood out in the warehouse, with a mandate that all VIP orders had to ship same day. Operational magic!

MARKETING: Whats the right prot per order?

In physical retail, marketing is either non-existent (high street rent obviates the need for marketing) or is a xed annual spend. As one retailer told me recently, our marketing strategy is deciding how much we will spend on TV at the beginning of the year. In addition, the variable costs of sale in store are negligible typically a carrier bag and credit card charge. In physical retail, all transactions (outside of sale and clearance) make money. The prot model online is different. Its very easy to lose money on an online order. Firstly, most marketing is a variable cost whether per order, per click, or per impression. Add to this variability a delivery charge (which could be greater, equal or less than the directly associated costs) and promotion costs. Tough-minded retailers often announce that they want to make money on every order they ship. This statement sounds sensible but is Figure 2 Understanding prot per order

(i) not what it seems and (ii) is denitely not the way to optimise prots. Firstly, aspiring to make money on every order is primarily a statement about the granularity of marketing allocation. Why? Look at the marketing cost of an example order, the visitor clicked on Google and that visit cost 27 pence, so the individual order looks very protable. However, you then note that this protable order is accompanied by 300 visits that didnt convert. So the order is protable but the marketing activity directly associated with the order isnt. Secondly, ensuring that all orders are protable is clearly a different statement to ensuring that the overall prot is maximised. Imagine a retailer with a 10 delivery charge this may guarantee that every order shipped makes money; unfortunately, a high delivery charge has a negative impact on

Gross prot per order Trading prot per order Delivery revenue/ cost per order Promotion cost per order Marketing cost per order Number of orders x Online visitors

Average order value x Gross margin

Marketing cost per visit Conversion rate

Gross trading prot

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The new equations of retail

conversion rate, and will depress the volume of orders. So, a core marketing question to ask is what prot per order maximises overall prot?

order I placed for an earring multipack, but the overall business is extremely protable. Online retailers need to recognise that monitoring and managing the distribution of order protability is a new discipline. They should monitor competitors delivery charges, free delivery thresholds and the availability of widely available discount codes. Offering free/reduced delivery by stealth (i.e., without marketing) is a great way to understand the latent elasticity without creating a call to action. There are creative ways to manage order protability: for example, Zappos treats promotions, marketing and delivery as a single pot so that free delivery becomes a promotional activity funded by marketing.

The Maths
Maximising overall prot requires the right balance of marketing spend, delivery charge and promotion cost. To give a simple example, a retailer makes more money from 5,000 orders at 5 prot per order, than 2,000 orders at 10 prot per order. The critical equation to understand is what distribution of order protability maximises total prot (and the optimal prot will typically come with some loss making orders). For example, ASOS offer free delivery and free returns in the UK. It is unlikely they made any money on the 3
Figure 3: Prot per order
CURRENT DISTRIBUTION OF ORDER PROFITABILITY
Number of orders

ILLUSTRATIVE
OVERALL PROFIT
More prot

AVERAGE 18.20
TODAY

Optimisation opportunity

<0

0-10

10-20

20-40 >40 Prot per order

Less prot

Average prot per order

5
More promotional

10

15
TODAY

20

25
Less promotional

MERCHANDISING Lower price or more trafc?

In physical retail products either sell or dont sell. For those that dont sell, the action is blunt reduce their price. Whether buyer or merchandiser, the ownership of the performance is clear. This combination of the physical cost of marking down and the well understood price elasticity means that most retailers typically have a mature discount schedule. For example, most fashion retailers have a 30-50-70 percentage point discount approach. Online the product economics are different. Product views have a cost and you can for example drive trafc from Google to specic products. For merchandising therefore, a key question is Do you get a better return from 100 more visits or a 10 percent discount?

protability (do you give money to Google or customers?). The maths requires understanding the relative elasticity of price versus trafc. A typical analysis is below. Once this relationship is understood the next challenge is one of cultural change. Merchandising teams must learn to make discounting decisions using analytics data. Buyers incentivised purely on achieved product margin have little interest in worrying about end-to-end product economics. Similarly, marketing teams incentivised on a cost per order dont worry about gross margin. I asked the CEO of a US department store how he got his buyers and merchandisers to engage in this sort of analytically driven markdown approach. He replied: If buyers/merchandisers come to me to approve a markdown and dont have any analytics data, its a short meeting.

The Maths
Online retailers need to understand the optimal price/views mix that maximises product Figure 4: Price/views to optimise product prot
Total product contribution, 000 (Margin direct marketing)

ILLUSTRATIVE

60 50 40 30 20 10

Optimal strategy to reduce price and views Optimisation opportunity

20% off

Full retail price

100

200

300

400

TODAY

600

700

800

PRODUCT VIEWS

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The new equations of retail

MARKETING: How much to spend on a keyword with no sales?

Most retailers are spending between 10-30 per cent of their paid search budget on keywords that have never generated a sale. Often retailers simply look at their blended overall Google performance and accept (either implicitly or explicitly) that the efcient spend can subsidise the inefcient spend. Its a dangerous game equivalent to accepting that protable stores can subsidise unprotable stores and is simply a waste of money. Optimising Google requires optimising on a keyword by keyword basis. For example, imagine you start bidding on a new keyword Canon Ixus 230hs which hasnt generated any sales (on any attribution window) after 5 visits, 10 visits, 100 visits, 1000 visits when do you stop? Stop too soon and you will miss sales, stop too late and only Google wins. A critical marketing question then is How do you determine the optimal stopping point for a new keyword?

The Maths
The maths of paid search is horribly complex. Google has created a deceptively simple model you pay per click. How hard can it be? In reality it is an enormous mathematical puzzle.

Figure 5: Optimal stopping point for example keyword

Expected prot

INPUTS: Example for Canon Ixus 230hs Cost per click W pence Product gross margin X Expected customer lifetime value Y Target customer acquistion cost for this keyword Z Informed prior distribution assumption

Optimal stopping point Lifetime value

50

40

30

Optimal stopping point 1st order prot

20

10

0 5 -10 10 15 20 25 30 35 40

Number of visits with no sale

-20

The maths requires understanding after how many clicks to stop spending. The analysis above shows the relationship between the expected prot versus the number of visits without a sale. There are a wide range of new activities and processes that are required to manage thousands of long tail keywords. If a keyword isnt working, its easy to simply switch it off, however that may not be the best action to take. The new processes include: Checking price/availability (dont blame Google if youre out of stock or overpriced) Checking match type its easy for broad match keywords to pollute performance Checking landing pages/copy (looking at bounce, engagement, quality score its easy for landing pages to become out of date) More targeted bidding by geography or time of day for example, we found at Figleaves that bidding on the keyword lingerie was less economic late at night. Google are the virtual landlords of the high street. And as on the high street, no one likes to over pay on rent!

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The new equations of retail

CUSTOMER NEXT BEST ACTION: When is a customer lapsed?

In physical retail customers are typically anonymous. By contrast the online world affords untold information about your customers. It is clearly a retailers prerogative to decide (i) whether to look at this data, and (ii) what action to take. Doing nothing is a strategy and there are many very successful retailers today who succeed without tapping into any deep customer insight. For those that do look, the question is what to actually do. Take a customer (John) who has spent 1200 over the last 3 years, making 12 purchases. Johns last purchase was 6 months

ago. Do you: (i) do nothing, (ii) send an email promotion, (iii) retarget John with a banner advert, or (iv) call John? Common wisdom is that a customer who hasnt purchased for 6 months is lapsing and after 12 months is lapsed. These are clearly broad generalisations. Every category has its own purchasing rhythm. So a key question on customer next best action to ask yourself is: When is the optimal time to target a customer who hasnt purchased?

Figure 6: Optimal intervention point

Incremental lifetime value

ILLUSTRATIVE
Optimal intervention point

Optimisation opportunity

20% promotion

10% promotion

TODAY

10

Weeks since purchase

10

The Maths
It is critical to analyse and understand the impact on customer lifetime value of different promotions at different times post purchase. Offering a discount on the next order immediately may be too soon, after 12 months may be too late. The optimum time will be different for each business. For example the Economist designed a renewal at birth campaign after recognising that the best time to renew a subscription was just after it had been taken out. Moving from broadcast to targeted communications requires building a customercentric marketing capability with a culture of disciplined testing. Many organisations claim to be customer-centric with a test and learn culture. Few act like this in practice true customer centricity is difcult and most retailers like the concept of test and learn, but dont like to make mistakes.

*** As Richard Feynmann who won the Nobel Prize for Physics often remarked, If anyone tells me they understand quantum mechanics, they dont. I feel the same is true of most aspects of eCommerce. eCommerce is still in its infancy and many of the new equations are simply unsolved. The best ecommerce practitioners know what they dont know.

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