The rise of automation and the fall of the retail business model...

The rise of automation and the fall of the retail business model...

Published on April 10,

By Ben Silver Co-Founder + COO at ivee / Managing Director, BeamBox Ventures

Sentient machines, neural laces, AI that can beat the worlds best poker players. Wave after wave of developments and news about automation, artificial intelligence, robots and the dawn of another industrial revolution where "30% of human jobs in the next 15 years" will be lost to inexorable developments within computing, on the apparent march towards singularity.

It's easy to believe (and widely acknowledged) that the first roles that'll be superseded by automation will be those at the unskilled and lower skilled level; menial labour and simple jobs. With this in mind it's inevitable that much of the forecast unemployment will occur within retail: checkout, store replenishment, customer service agents, warehouse, amongst others.

Many retailers employ vast labor forces, Walmart for example, the largest private employer in the world employing 2.3 million people and supporting millions of families. But what happens when these jobs can be automated, the roles of 6 people can be carried out at the same cost as 1 person, do retailers jettison their workers and bring in software, machines and artificial intelligence? What happens to all the people that are upended, will they even be able to afford the products retailers are selling? Will the cost reductions and operational efficiencies gained be translated into weaker revenue?

I'm a firm believer in technologies that push society from A to B, and I believe that automation is ineluctable and unemployment is predestined. These are contentious issues and deserve another article in their own right, but economies have always and will continue to solve complex problems, including those posed by automation. To that end, I firmly believe retailers should be pushing heavily into automation.

I'll start at store level where Amazon has seemingly pioneered the first checkout-less store with Amazon Go, and other firms such as Panasonic have demoed smart baskets where no humans are needed. Checkout is a low hanging fruit where costs can be reduced for retailers, and time saved by customers.

Retailers should be implementing ways that shoppers can get in and out of the store without having to queue, or having to deal with dysfunctional self-checkout machines. Autonomous checkout may be some ways away from being perfect, but it's clear a centralised point of checkout does not make for the smoothest shopping experience. Automated checkout is the end goal, but by creating several checkout nodes around the store, the checkout process could immediately be streamlined. Technologies, such as Oak Labs smart mirror, enable the consumer to checkout in a changing room, for instance, creating a quick and efficient experience.

It's 2017, and prices and product information in nearly all stores are still displayed on printable paper as opposed to e-ink wireless displays connected to systems that can regulate the price of products on the fly. One of the reasons that brick and mortar is currently unsustainable is because of the inability to quickly change product prices to compete with the likes of Amazon. If prices were digitally merchandised, and to a greater effect, automatically dynamically priced, causing retailers to become consistently price competitive, consumers will enter the store knowing that they are getting the best deal. This is one of the simpler, logical and inexpensive changes that can have a profound effect on the ways products are merchandised.

One of the major areas where automation can drive efficiencies and cost reduction is within the supply chain. Human bias touches every part of the supply chain in areas such as buying, merchandising, logistics, planning etc. Humans are not infallible, and more often that not, outside factors; relationships, risk aversion, outside environmental factors amongst others, have an impact on the decision making processes in the supply chain. This is an area where automation can drive huge efficiencies and cost savings.

Forecasting comes to mind as a mission critical tool for stores. Too often this is done manually, by merchandise planners or forecasters, and without the use of machines and algorithms. With the huge amounts of data that retailers have on consumers' historical purchasing behaviours, they should be able to generate models that accurately predict the required quantities of product. More accurate forecasting, reduces the immense costs associated with holding inventory and downside risk when a forecast is incorrect.

One of the main areas of frustration for many people in the retail world, is the process of product selection (for retailers selling third party goods). Which product gets selected, why do they get picked, what are the parameters? More often than not, it's a relationship play, with existing suppliers and "halo" products getting picked over more suitable products, smaller suppliers and products that may offer better margins and/or a superior product. Once again, data is the game changer here, and retailers should adopt software that allows them to granularly understand what the consumer wants in a particular region and pick products based on quantifiable metrics not a buyer's opinion. No more guessing games.

Automation will streamline the brick and mortar process, allow them to cut costs and become more competitive, and enhance their product selections, but there is a more pressing area that needs to be addressed for retailers to have a chance at surviving the seismic shifts happening.

The Business Model

If we dissect a traditional brick and mortar P&L it looks something like this:

You see revenue, followed by the cost of sales (goods), closely followed by SG&A (Selling, General & Administration) expenses, which covers things like employees, store costs etc. and then lastly a tiny slither of profit (if any at all). The model I put together is primitive and obviously there are other expenses to take into account, but the gist is that a margin driven business model is not sustainable for both retailer and supplier.

The margin model relies on the concept that a supplier is able to offer up margin in order for a retailer to cover it's expenses, and then hopefully make money. It's a fairly reliable model, but it means retailers have to push back to a supplier if they a) want to make more money or b) their costs go up. It also relies on the assumption that a product will actually sell, that there will consumer demand for it. Additionally, retailers consistently charge for store space, a further cost to a supplier. Take Best Buy, for example, who will charge 100's of thousands of dollars in order for a supplier to be rolled out across all of their stores.

In addition, the brick and mortar model relies (mainly) on the retailer buying inventory to stock their stores and paying for these goods anywhere from 30-120 days after receipt. Huge cost outlays for a retailer, something which requires precision forecasting and reliance on product sell through.

When retailers miscalculate, mainly because their forecasting is not good enough, or the price is no longer competitive, or an overzealous purchasing decision has caused an excess inventory situation, the system breaks down fairly quickly. In the short term, retailers move to discount inventory, reducing their margins and in the long term suppliers will normally bear the brunt of miscalculation, with retailers having watertight overstock return clauses and the ability to withhold payment should discounting not suffice.

My point: the margin model is fundamentally flawed and needs to be adapted.

When price wars occur and the consumer habits change, how can retailers reduce prices, whilst maintaining margin, whilst not driving their suppliers into the ground? It doesn't work. The vast cost structures of retailers put them at a severe disadvantage to the online world that are able to run leaner enterprises.

Walmart recently held a summit with some of their largest suppliers, mandating that as a business they want to be cheaper on 80% of products than Amazon and therefore require 15% additional margin from a supplier. Instead of innovating, cutting costs, implanting automation into their ecosystem, they're pushing back even harder on the supplier. I feel this will rapidly reach a breaking point, which will leave retailers with little manoeuvrability and will continue to exacerbate the current situation.

Conversely, Amazon is hosting a conference in May with the worlds leading CPG brands in a bid to cajole brands to reshape their business models and to innovate with the current consumer trends. This would involve shipping directly to consumers from their own warehouses, a world apart from the current hub and spoke business model.

Retailers should be thinking outside of the box in search of a new business model that is sustainable and can withstand these socio-economic shifts. How can retailers create a model that's less sensitive to shifts, generates more profit and returns margin back to the suppliers? Subscriptions? Consignment? Stores within stores?

So, what should be the business model?

(I have my own ideas, but this ties into a project I'm working on, and that would be a premature give away!)

I wanted to add an additional few observational paragraphs on the effects the current market has had on the retail/supplier relationship.

For onlookers, it's implied that there's a deep symbiosis between retailers and their suppliers, one where both would look out for each other to ensure the success of one another's business and work in harmony.

A utopian dream, right?

Unfortunately the supplier/retailer relationship has been continuously degraded over the years, with retailers using power plays and desperation in order to force suppliers into margin concessions, unfair business terms and disproportionate demands, in order to prop up their ailing businesses.

Payment terms have been increased to absurd amounts of time, some as long as 6 months. Business terms such as the ability to withhold payment if a product is not selling, or being able to return inventory at any time, are crippling to small business.

Retailers act without recourse as they know that suppliers need their channels to sell products, but as the tide turns and the market shifts, there's a hope that the balance of these relationships can be reset.

In 2017, in the US alone there are expected to be close to 10,000 store closures. Nearly 3000 stores already this year, from the likes of Macy's, Sears, RadioShack, Sports Authority et al. Unprecedented, even compared to the storm of 2008.

Retail is changing, and the volatility we're seeing now is a result of the emergence and growth of Amazon and consumer behaviour shifts, all of which incumbents have not been able to keep up with. I feel we are only at the beginning of a purge where the weak will vanish and even the strong will have more than a few battle scars. As has been demonstrated by retailers, it's incredibly arduous to retrofit an old school solution with new school philosophies and it's with this that I feel after the dust settles, we will see an emergence of new players in the coming years. Ones that have been built from the ground up with the centralised platforms, full automation and a more robust business model.


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