Retail discounts and the illusion of success

I came across a blog post for a retail software product (which I will not name here), which said the following: "We have achieved great success with our product implementation at a European online auto parts retailer. Our product was able to deliver a 15% sales lift with an effective discounting of only 2.17%..."

I thought that sounded very good.

But then I indulged myself in a thought experiment: 'What sales lift does a retailer need to breakeven on an initiative which discounts the price by 2.17% below the regular price?'. Stop for a moment and answer that question within 5 seconds without pen and paper....

Now let's look at the math behind a 'successful' promotion

If you are an online retailer with gross margins of 20%, average CPA commission of 1% and net shipping costs (shipping costs less shipping charges to customers) of 6% of revenue, then your 'effective' margin is 13% of revenue.

To breakeven on a 2.17% discount, you would require a sales lift of 20% (!!!).

Here is a What-if scenario table which calculates breakeven sales lift for various levels of effective margin and discount:

Said in another way, to breakeven on a 2.17% discount with a sales lift of 15%, the European retailer would need an 'effective' margin of 16.7%. With 1% average CPA commissions and 6% net shipping costs, they would need a gross margin higher than 23.7%.

I doubt whether the European retailer broke even on the discount, because my thought experiment doesn't even include the cost of the software (which claimed 'great success').

The thought experiment is an eye-opener for eCommerce and retail companies who are willing to spend a lot on discount programs. Remember that even a harmless looking 5% discount requires a sales lift of 63% if your 'effective' margin is 13% (refer to the table above).

So that set off another thought in my mind: "What long-term strategic reasons would merit making an apparent loss on a discount program?"

Here's what I think are potentially valid strategic reasons for any retailer:

1) It is a short life-cycle/ shelf-life product (clothes, shoes, books, mobile phones, cameras, laptops, perishables) which is approaching the end of its season/life-cycle/ shelf life. As a retailer you are taking a strategic call that the cost and the risk of carrying inventory beyond the end of the season/life-cycle/ shelf life would be too high. However it is critical to distinguish long life-cycle products in short-life cycle categories (e.g., plain blue jeans, basic dress shoes, text books, reference books, etc) and ensure that you are not discounting those as much as the short-life cycle products.


2) Competition is discounting the same product heavily and you assess that you will not be able to sell the product at a 'regular price' later. This reason may often play along with reason 1. However it makes sense to use price comparison frequently (at least daily) to ensure that you are not pricing well below competition.

3) By discounting the product and taking a short-term loss, you estimate that you will be able to acquire new customers who will be loyal beyond the short-term. Many eCommerce companies seem to be thinking this way. My good wishes for pulling this strategy off :-)

Would love to hear your thoughts. If you need a copy of the spreadsheet behind the breakeven table (which has a more detailed working based on gross margin, CPA commissions, and shipping costs), please email me at raj AT knowledgefoundry.net

Layaway: Sound recession strategy or outdated retail gimmick?

The Washington Post reported this weekend that layaway programs are back at retailers like KMart and Sears (click here for article) . Click here to get the KMart layaway program details.

In a layaway, shoppers put a small down payment on merchandise and pay a service charge of roughly $5 to $10. Shoppers must return every few weeks for 2-3 months to make payments until the merchandise is paid off. Only then can they take their prized possession home.

Such programs were popular during the Great recession but have been discontinued by most retailers in the past few decades.

I can't help but ask: Is the layaway program a sound recession marketing strategy or is it an outdated retail gimmick?

Here's what's working for layaway this season:

1. As is pointed out in the article, the fees for the layaway program are much lower than credit card late payment fees.
   
2. It forces people to budget for items they truly want to buy. Even Oprah Winfrey mentioned it on her TV show.
   

However here's what works against it:

1. It requires people to have the financial and mental discipline to buy what they can afford and wait for a few months to get it. This would be especially difficult for people who have not maxed out their credit limits.
2. Customers who lose merchandise because they could not make a payment in time will be disillusioned and may not use it next year.
3. Customers who make layaway payments using credit cards could be pushed further into debt.

In balance, I think that layaway programs will definitely increase in popularity compared to last year (partly because of wider availability and promotion of the program). However the discipline dilemma may not allow these programs to be as popular as they should :-( . Of course I'd love to see the US consumer prove me wrong.

Store chains should be careful not to use layaway as a technique to make easy money from cash-strapped customers (e.g., They should offer extensions to customers who are late on their last payment). They will likely lose customers who lose their holiday presents to a missed payment.

How can brick-and-mortar book stores compete?: Part 1

Last week, Borders and Barnes & Noble declared their third quarter results. Both companies reported a net loss at an operating level. Both companies are shutting some unprofitable book stores and trying to rein in costs to become profitable.

I am a big fan of both Borders and Barnes & Noble, and cannot help thinking: How can these companies use analytics to survive the onslaught of Amazon.com?

I analyzed the Q3 numbers of B&N, Borders and Amazon, and here's what I found:

• Online sales account for less than 10% of Barnes & Noble sales and less than 2% of Borders' sales. Of course they account for 100% of Amazon.com's sales.
  
• Amazon is growing much faster than B&N and Borders. In Q3, these companies had comparable sales growth of 19%, -6% and -12% respectively. Note that Amazon numbers are for Media sales (Books, DVD, music). Amazon Media sales for international markets grew faster at 24% compared to US sales at 15%.
  
• Amazon runs an operating profit whereas its competitors run a loss. The key difference is in SG&A cost and depreciation. Surprisingly B&N has a lower COGS (cost of goods sold) than Amazon. Amazon has a higher operating margin in its international operations. Borders has a higher operating loss margin in small-format Walden US stores (-14.4%) and a lower operating loss margin in international stores (-5.3%).
• A large format book retail store requires sales of $20 per sq.ft per month to turn an operational profit. B&N is currently registering $18 per sq.ft per month and Borders US is selling only $14 per sq ft per month in its large stores. A Walden's (small format) store requires sales of more than $30 per sq. ft per month to have an operational profit. Currently Walden's US has sales of $17 per sq ft per month only. Thus there is an urgent need to increase sales per sq ft
• Amazon has much lower inventory than B&N and Borders (as shown below). Borders is carrying more than 5 months of inventory whereas B&N is carrying more than 4 months of inventory. I feel that book stores need to better align inventory with demand.

Here are my suggestions (which I will detail in subsequent posts):

• B&N and Borders need to create a more credible online option to compete against Amazon.
  

1. I recommend usage of collaborative filtering to offer instant book recommendations to online buyers. Also bn.com and borders.com can improve in terms of linking past browsing behavior to book recommendations online
2. Barnes & Noble needs to consider matching amazon.com on pricing (given it's lower Cost of Goods). E.g., I recently found that the Buffett biography : The Snowball is priced at least 5% lower on Amazon.com
3. Many customers feel that Amazon has a wider selection of technical and children's books titles than other online book stores. Catering to the long tail may be essential to competing with Amazon.
   

• Use brick-and-mortar as a competitive advantage:

1. Offer the option to buy online and pickup at a store within a few hours
2. Let loyal book buyers work for you by organizing 'low-cost' book discussions/reading sessions especially for children, niche interest segments
3. Offer bundled offers in the store, based on basket analysis of previous purchases
4. Consider installing digital displays in the store showing reader reviews and suggesting complementary reading recommendations (based on collaborative filtering).

• Align inventory to demand

1. Use statistical models based on demographic profiles of localities and historical title sales to better allocate inventory to stores.
2. Dynamically trans-ship best-seller inventory between stores based on matching with demand patterns (since most demand for best-sellers occurs in the first week after release)
   

More later...

Black Friday deals: Do they work for the retailer?

The US holiday retail season this year is expected to be the worst in the past few decades. Many retailers have started offering Black Friday discounts in advance.

The website Black Friday Ads tracks some of the hottest discount deals being offered by retailers. They have a page which tracks the scanned advertisements of most big US retailers. Some retailers are offering online deals at prices below Black Friday prices.

I couldn't help wondering how retailers can use analytics to maximize their Black Friday sales and gross margins. Here are some suggestions :

• Designing the black friday deals:
  

1. Analyze market surveys to understand what products people want to buy during Black friday (computers, HD TVs, iPods, hard disk drives, digital cameras, GPS devices, clothes, toys) this year
2. Benchmark prices against competition based on information available daily to ensure that you have enough traffic-pullers...these get the people into the stores.
3. Ensure that your deals are spread across the aisles/ departments. This ensures that customers are exposed to more categories whil picking up the doorbuster items and that all doorbuster products are not picked up just by the first few customers. An analysis of previous years' transaction data will yield numbers on how many customers got a doorbuster product (typically a few hundred per store) and how each of these customers moved through the aisles.
   

• After Black Friday: Analyze the baskets of transactions during Black Friday:

1. Customers who buy doorbuster products often pick up other items that may not have significant discount. Calculate the sales and gross margin on baskets that have a doorbuster product. Retailers often lose money on the first customers in line.
   
2. Customers often come in after the doorbuster products are sold (Each store usually stocks 5-15 units of each doorbuster). They often pick up products with lower discounts. To calculate the halo effect of the discount, calculate the sales and gross margin lift for Black Friday baskets without a doorbuster product
3. So long as the total of the above has positive sales and margin impact, the retailer made money on the Black Friday deals.
4. The learning from Black Friday can be used to better structure deals for the rest of the holiday season.

This season, retailers may have to resort to a long period of discounting with dynamic moves based on competition and sales performance on a daily basis. Getting the process of discount pricing will be very critical.

About this blog

This is my first blog post. So I wanted to write about what this blog is going to be about. Hopefully this helps you decide whether to subscribe to this blog or not.

This blog will attempt to highlight how companies can make smarter business decisions using analytics (which I define as the 'collation, summarization, mining and analysis of data').


Why this blog?

Most companies generate and collect a lot of data in their business...but don't use this data enough while making business decisions. (This may sound cliched but it is true!). My hypotheses on why this happens are:

• Data is stored across functional and divisional silos across the company. E.g., Surveys done by the marketing team may not be available to the customer service team

• It requires a lot of effort to clean and update data required for analysis. Corporate IT is often short of resources for maintaining analytical databases. E.g., Many B2B companies don't have a single view of a customer across all their internal and third-party databases

• Analysis often requires ad-hoc queries of complex databases. Companies don't have enough skilled resources to query these databases

• Some advanced analysis techniques require significant expertise (statistics, operations research, etc), computing power and time. Some managers believe it is important to take half-correct decisions quickly rather than better decisions with more time.

What industries will this blog cover?

This blog will initially focus on business problems in the retail, consumer goods, telecoms, banking and insurance industries (because I am most interested in these industries). Of course, I will include business issues from other industries if I find them interesting and if I feel I am competent enough to write about them.



What kind of business problems will this blog discuss?

I plan to write about a wide variety of business problems ranging from marketing, merchandising to operations (supply chain, logistics) to fraud detection.



Of course, I welcome comments on what topics readers would like to discuss in the blog.