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 / Spring 2006 / Issue 42(originally published by Booz & Company)


The Hidden Costs of Clicks

For each combination of customer and merchandise, there is an optimal cost-to-serve option among the different delivery choices: store inventory, store delivery, in-store pickup, and direct delivery. For customers living far from a store, for example, even for bulky products like the HDTV, the benefits of routing the goods through a regional distribution center (such as that maintained by Circuit City) may be offset by the extra costs of a two-step distribution cycle, compared to the simplicity of direct home delivery. Finding the optimal cost-to-serve at the levels of customer and item may be challenging, but it will be rewarding.

Even pure-play online retailers should consider the cost-to-serve in their pricing. Despite having the ability to customize Web pages to each individual, few companies fully leverage the potential to price products to reflect the different underlying costs. For example, eBags offers special pricing for bulk purchases for corporate sales, but it does not attempt to adjust shipping costs on the basis of a customer’s geographic location. Such fine-tuned pricing could potentially increase the company’s profitability. That’s the kind of detail that retailers will have to consider as they grow their online businesses.

Accounting for Intangibles
Cost-to-serve in online retailing includes such factors as the expenses associated with inventory, transportation, and replication of the existing offerings of traditional retailers. But to get a truer sense of cost-to-serve, it should also take into account intangible costs to the customer. Consider the current approach to furniture retailing, one of the least customer-friendly supply chains in retailing.

Because there are so many manufacturers offering so many styles in so many woods, finishes, and fabrics, most furniture retailers display a limited selection of goods. Customers place their orders and then wait for the couch, table, or chair to be manufactured, shipped to the retailer, and finally delivered to their homes. The whole process regularly takes 12 or more weeks — a cost in “pain and suffering” that falls squarely on the customers.

Early attempts to improve on the furniture retailing process via the Internet proved daunting. and, two failed Web retailers, focused on the “consumer experience” by investing in technology to allow shoppers to visualize the furniture in virtual mockups of their home. These companies’ supply chains — which, like Amazon’s, depended on outside delivery services — proved untenable. The challenge of scheduling precisely timed home deliveries, something Amazon’s products typically do not demand, proved to be beyond the ability of these nascent furniture retailers. Moreover, products often arrived damaged or unacceptable for some other reason, resulting in return rates of up to 35 percent of sales. Despite good efforts, the “virtual” model failed in the furniture category.

The Amazon online model doesn’t work for furniture sellers. It would be better for them to emulate the automotive industry. The big opportunity online for furniture retailers may lie not in eliminating storefronts, but in dramatically reducing the lead times in the order-to-delivery cycle. Car dealers resolve the choice challenge by sharing inventory information among dealerships and exchanging vehicles to better meet a particular customer’s desires. Roughly half of the vehicles sold by a typical dealership come from such an exchange; the other half come from the dealer’s own inventory on the lot. Similarly, with furniture, customers could check the “look and feel” of a display model, and the retailer would then locate the desired inventory at another store or at a centralized stock pool with delivery in days, not weeks. Such a business model would leverage the Internet’s information-sharing power to lower the “cost” of long lead times without incurring an undue level of inventory investment.

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