Changing Cost Structure in the Retail Industry

The retail industry has undergone a lot of changes in the recent past. Each of these changes have been strategic in nature. As a result, their impact has been more or less permanent. This impact can be seen and felt in many ways across the entire retail organization. One of the ways in which this impact can be understood is by having a look at the changing cost structure in the retail industry.

In this article, we will have a closer look at the changing cost structure and understand how it impacts the retail business as a whole.

1. Introduction of Hybrid Models: It is important to note that the cost structure of any retail company is largely influenced by the format in which it operates. For instance, costs incurred by an online retail company are significantly different from the costs which are incurred by a brick-and-mortar retail store.

   Over the years, the adoption of online retailing has grown at a significant pace. As a result, even traditional brick and mortar retailers have started relying heavily on online retail. They have started adopting the hybrid model wherein brick and mortar stores are present in different locations. However, the number of these stores is limited. Most of the orders are fulfilled digitally. The introduction of this hybrid model has caused significant changes to the overall cost structure of the entire industry.

2. Low Expenses on Human Resources: Over the past few years, the retail industry has seen a large reduction in headcount. In the past decade, the retail industry was one of the main providers of lower end jobs. However, with the introduction of technologies such as artificial intelligence and machine learning, a lot of these low skilled jobs which were earlier done by humans can now be done automatically.

   The additional benefit of automation is that services can be provided in an uninterrupted manner which makes it more attractive to retail chains. Right now, human employees are only hired for essential jobs that cannot be done using technology.

   Over the years, it is likely that this trend will accelerate and the number of human beings working in the retail industry may come down significantly. This can already be seen with some stores launched by Amazon which operate without any human intervention!

3. Low Real Estate Costs: Apart from human resources, real estate was another significant contributor to the cost of any retail company. If we see the expenses incurred on real estate in the past decade, the trend of declining costs can be easily observed.

   Over the years, retailers have reduced the number of physical locations where they operate from. At first, retailers stopped opening new stores. Later, they shut down some of the non-performing stores and finally the size of existing stores was also reduced.

   Retailers across the world are trying to decouple their business model from real estate. This is because a business model that is heavily dependent upon physical presence makes it difficult to scale the business up and down as and when required.

   On the other hand, an internet-based retail model is more equipped to deal with the sudden increases and decreases in market demand. The sparse use of expensive real estate is a trend which is likely to continue in the real estate industry. Barring a few luxury brands, it is highly unlikely that any other brands will continue to extensively use real estate.

4. Pressure on Intermediary Margins: It is important to understand that intermediary margins have generally been a significant portion of the total cost of goods sold in the real estate sector.

   Traditionally, the retailers as well as wholesalers’ margins have accounted from about 50% of the total cost of goods sold. In products where extensive selling is required by the retailers, the margins are even higher.

   Now, with the advent of online retailing, the number of intermediaries as well as the transport costs have been drastically reduced. As a result, the role of several intermediaries such as distributors and wholesalers has been reduced or even eliminated.

   As a result, the margins earned by them have been under pressure in the past few years. On the other hand, the margins earned by retailers, particularly online retailers have seen an increase in the recent years. This trend is also likely to continue in the future as large retailers are further looking to optimize their supply chain.

5. High Expenditure on Information Technology: Last but not the least, the most significant trend impacting the real estate industry is the increased expenditure on technology.

   All the other trends such as reduction in headcount and real estate absorption are being driven by this one underlying trend. Retail companies are compelled to make higher investments in technology because of the environment in which they operate.

   As a result, expenses made on technology are increasing both in their profit and loss statements as well as their balance sheets. This trend is also likely to continue in the near future.

Hence it can be said that there are several trends which are currently evolving in the retail industry. These trends have already shaped the cost structure of the industry to a large extent and are likely to continue doing so in the future.