In ‘No stores necessary’, 22seven Insights showed how spending in the apparel sector is shifting towards online-only retailers like Shein and Superbalist, threatening the investable, mostly store-based part of the market. The customers leading the online-only change are young and they’ll carry their preferences forward as their spending power increases, and they’re high-value customers. After controlling for differences in income, we showed how customers who shop online spend more on clothing than their contemporaries who only shop in-store.
But what does this mean for profitability? After all, don’t online shoppers just return everything they order?
We’re going to attempt to answer this question by contrasting the transaction economics of in-store and online purchases, to quantify which channel is more profitable for retailers.
One of the truisms in retail is that every year a retailer must start from scratch. Sales – the revenue kind – are not guaranteed to recur in the next period. The base unit of sales is the transaction. Gross profit is earned on each transaction. Aggregated over many transactions, gross profit is used to pay for the cost of operations, people and taxes. Anything left over is available to the providers of capital.
Analysing profitability at the transaction level therefore seems like a good approach to contrast overall profitability between online and in-store sales. In most cases, the data to do this comparison simply doesn’t exist, but with the 22seven user base at our disposal, we were able to aggregate 280,000 actual transactions from real consumers to provide a quantitative assessment.
For anyone concerned about the future earnings of clothing retailers, this analysis provides a robust foundation to evaluate the assumptions in your forecasts. For a retailer, this note might give you an idea of how you stack up against your competitors.
Let’s explore the data…
Profit per transaction
This analysis seeks to contrast the gross profit of the marginal transaction. That is, when the store’s doors or website ‘open’ at the start of the year, what is the profit earned from the first online or in-store purchase.
In South Africa, most store-based clothing retailers distribute items that are purchased online from a store that is close to the customer. Similarly, sales from online-only retailers are fulfilled by staffed distribution centres.
Therefore, for the marginal order, the cost of the store or distribution infrastructure, and any personnel to fulfil the order, is fixed.
The key difference between the marginal gross profit of an online purchase versus an in-store purchase comes down to the transaction value, the gross profit margin, any delivery costs and the cost of returns. We’ll unpack each of these.
Transaction values and return frequencies
The value of online purchases is generally higher than in-store purchases because customers buy additional items and return clothes that don’t fit or clothes that aren’t as flattering in real life as they are worn by the model on the website.
We wanted to find out how much more people are spending online than in-store, and how often online orders are returned. To do so, we identified purchases and returns from 15 retailers:
- Five omnichannel retailers where Insights could distinguish online and in-store purchases: Mr Price, CottonOn, PnP Clothing, Sportsmans Warehouse and Cape Union Mart.
- Six retailers where Insights was not able to separate store purchases from online purchases, either because online transactions are channelled through a central payment gateway (Markhams and Sportscene) or because online is not available or is too small to be representative (Ackermans, Edgars, Zara and H&M). Although there may be a small contribution from online purchases in this group, we think it’s minor, so we refer to this category as in-store only.
- Three online-only retailers: Superbalist, Shein and Zando.
- For the sake of comparison, we also included the largest general merchandise online retailer, Takealot.
To estimate returns for each retailer, we compared the number and the value of returns (credits) to the number and value of purchases (debits) over six months.
Returns for omnichannel retailers are more difficult because items ordered online are often returned in-store. For these retailers, we identified all online purchases and restricted credits to the users who had previously purchased online. We used a similar method for in-store purchases: excluding users who had recently ordered online.
The average purchase and return value for each retailer is shown in the charts below. As an example, the average order value for Mr Price online is R584, and the average return value is R428. The average order value for Shein is R1,566, with a return value of R979.
Average transaction values
- The average online transaction value across all retailers (R1,107) is 55% higher than the average in-store transaction value (R713).
- It follows that the return value is also higher for orders that originate online (22%).
- For omnichannel retailers, online transaction values are 20-30% higher than in-store transaction values.
- The online order and return values for Cape Union Mart and Sportsmans Warehouse are significantly higher than their in-store values. This may be because they sell a wider range of goods, such as sports watches and technical equipment, than their peers.
- The average transaction values at online-only apparel retailers comfortably exceed the transaction values of their store-based competitors. Shein has the highest transaction value, on average.
Next question: How often are items returned?
Frequency of returns
- On average, 15% of orders that originate online are returned, compared to only 3% of in-store purchases.
- 26% of Superbalist orders were returned during the six months ending August 2022. Since returns are typically of a lower value than the original purchase, returns accounted for 19% of total purchase values. Similarly, 24% of Zando orders were returned, with an overall value of 17% of all purchases.
- The frequency of returns for online orders at Cape Union Mart and Sportsmans Warehouse are higher than at other store-based retailers. We think this may be attributed to a variation in products ordered online via these retailers. See the comment above regarding transaction values.
- Albeit not as high as Sportsmans Warehouse and Cape Union Mart, online return frequencies are significantly higher for Mr Price and CottonOn compared to in-store return frequencies.
- Takealot is not a clothing retailer, but it’s the largest online retailer among 22seven users. c5% of Takealot purchases are returned.
- The frequency of Shein returns is low – only 3%. This is arguably because of the challenge of returning items. Although refunds are offered within a 30-day period, customers must package and ship their returns at their own expense.
Free delivery: common but not standard
To estimate the delivery cost for the average online order, we compared the fees that retailers charge for delivery. In nearly all instances, delivery is free if the value of the order exceeds a certain threshold.
For most retailers, the cost of delivery is within a narrow range of R50-60 per order for orders less than R500-600. Shein has the highest delivery fee and the highest minimum order value, which most likely reflects the higher cost of distributing each order from China via air freight. (Note that this delivery fee excludes duties and other fees paid separately to third-party couriers on Shein orders because these do not impact the retailer’s profitability.)
We find it interesting that Mr Price is the only retailer that Insights could identify that does not offer free delivery. Customers are charged at least R50 for any online purchase, irrespective of the purchase value. As we show below, the recovery of this delivery cost from the customer is crucial to the economics of Mr Price’s online offer.
A further observation: In most examples, the average transaction value is 50%+ above the minimum required to qualify for free delivery. The outlier in our sample is PnP Clothing, where the average transaction value is only slightly higher (2%) than the R700 threshold to qualify for free delivery. This suggests that for most retailers, the free delivery threshold is not a meaningful barrier for most orders.
Delivery fees and minimum order thresholds
Rands or margins?
Combining these findings, we are nearly able to estimate the gross profit (in rands) and the gross margin (in percent) for orders through each channel for each retailer.
The only assumption we make in this analysis is the average gross margin earned on the merchandise sold. Gross margin is influenced by the type of merchandise sold (branded vs in-house, footwear vs clothing, fitness watches vs accessories etc.) and it will vary for each retailer. To enable our comparison, we assumed a standard gross margin of 42% for all retailers. This level is informed by the last reported gross margins for Mr Price (42.1%) and TFG Africa (43.1%). Readers are welcome to request the spreadsheet to express their own views in the calculations.
In some cases, we have good reason to expect gross margins to be higher. For instance, H&M and Zara (parent company: Inditex) report significantly higher gross margins internationally, but high import duties in South Africa may mean these margins are lower locally. For this reason, we show a range for H&M and Zara.
In addition, although it’s a private company, some argue that the gross margin on Shein’s products could be even higher than other fast fashion retailers. For the purpose of this analysis, we show a range for Shein based on a low estimate (42% like Mr Price) and a high estimate (55% like H&M and Inditex).
The gross profit on an online order is calculated as follows:
(Purchase value * GP% - delivery cost) – %purchased returned*(Return value*GP% - delivery cost)
Gross margin = gross profit / transaction value
Let’s start with gross margin. For the five omnichannel retailers where we can compare in-store and online purchases, the cost of delivery and returns reduces gross margin by 10% percentage points on average.
For the three online-only retailers, the impact of delivery costs and returns is a reduction of c14% on the assumed gross margin of 42%.
Gross profit, shown in the chart below, is a different story. The three most striking observations are as follows:
The gross profit earned (in rands) on online purchases at the four omnichannel retailers is not meaningfully lower than the gross profit earned on the average in-store purchase.
Superbalist earns more gross profit per transaction than store-based clothing retailers like Edgars, Mr Price, CottonOn and Ackermans.
Shein generates the highest profit per transaction – as much as 2.8-3.7 times the average gross profit of competitors like Ackermans, Mr Price, CottonOn, Edgars and PnP Clothing.
Gross profit
Why is this important?
Executives in charge of store-based retail chains often talk about getting the economics of online to ‘work’. Our findings across hundreds of thousands of transactions show that the gross profit earned for an online transaction is comparable to that earned for an in-store transaction. However, the margin is typically lower, sometimes significantly.
For that reason, online doesn’t complement the income statement of an established store-based retailer because a growing online contribution will dilute the group’s overall gross margin. (Here’s a tip for analysts assessing these businesses: If you expect online revenue share to grow, account for the diluting impact on gross margins.)
We have previously shown that Superbalist is a large retailer by South African standards. We estimate cR2.5bn in annual GMV. In this analysis, we’ve provided quantitative evidence that its gross profit is higher, on average, than many mainstream store-based clothing retailers. Since Superbalist is part of the Takealot group, it’s impossible to definitively assess whether the business is profitable. Takealot itself is not (yet) but when you compare Superbalist to its clothing competitors – many of them highly profitable listed businesses – the evidence suggests that it might well be.
Insights has alerted readers to the rapid gains that Shein has made in South Africa since its launch two years ago. We have shown that these gains are a function of enormous growth in the number of users experimenting with the service, multiplied by outsized transaction baskets – as much as 4x the average transaction value than store-based competitors. Put another way, users shopping at Shein are effectively shopping once, whereas they might have shopped at four other local retailers. In this note, we’ve provided additional evidence that Shein earns 2.5-3.8 times more per transaction than many large, listed retailers. Shein’s impact on the South African market’s revenue share has been sudden and disruptive, and its impact on profit share may be even more so…
Please get in touch if you would like any further info.
