Online retailers feel the pinch of accelerated consumer returns

Accelerated returns of goods purchased online, supply chain pressures, and soaring freight costs continue to squeeze profit margins in the fast fashion sector.

Online retail was initially one of the pandemic-era industry winners, as periodic lockdowns accelerated e-commerce sales. But time seems to have caught up with the sector’s meteoric growth. Rising prices, from input costs to labour, wage and fuel inflation, the impact of China’s Covid Zero policy on exports, supply chain bottlenecks on inventory levels and surging transport costs have all cramped revenues and profitability.

Ironically, consumer behaviour change – which for much of the past decade was a tailwind supporting online retailers’ high street disruption – is now a significant headwind. Two decades ago, when online shopping was not popular, online retailers offered free delivery and returns to convince people to shop online and ‘buy before trying’. Online retailers have successfully overcome this psychological barrier, so much so that “buying five and keeping one” is not uncommon.

According to the Centre of Retail Research, UK e-commerce represented 28.9% of all domestic retail in 2021, with retailers still burdened by the legacy promise of free delivery and returns. But the cost implications are soaring. Two and a half years of pandemic disruptions, the impact of a land war in Europe on energy costs, labour shortages and wage inflation, have caused freight costs to spiral.

ASOS issued a profit warning last month, citing “uncertain consumer purchasing behaviour and the potential continuation of higher returns”, while Boohoo also warned of slowing revenue growth and elevated operating costs due to higher product returns. In May, Missguided, the online fashion retailer, collapsed into administration and was later acquired by Mike Ashley’s Frasers Group for £20m in cash.

Shopping behaviours are changing as the impact of inflationary pressures has weighed on discretionary spend. UK inflation hit a new 40-year high in June at 9.4%, according to the Office for National Statistics, and is forecast to peak in October at somewhere north of 11%, according to the Bank of England. The cost of living squeeze has severely depressed consumer sentiment, which reached a 48-year low in June, according to GfK’s Consumer Confidence Index, amid acute concerns for the general economic situation. Lower consumer confidence may well be a cause of higher return rates across the UK and Europe, creating a negative feedback loop between inflation, consumer sentiment and returns. The shift in market dynamics for the online retail sector also marks a milestone for operators, which now must pivot from the growth phase of the past decade to ensuring sustainable profitability.

The recent higher rate of returns exposes a weakness in the online retailer business model. Returns cost retailers more than original delivery costs and by the time returned products make it back to stores, they are often out of season and sold at a discount. Over the course of this year, online retailers reached a threshold where prices had to increase across the board or start charging for returned items, reflecting underlying cost base increases. Both outcomes will impact demand. There is now consensus in the sector on which outcome is the lesser of two evils: charging for returns. Uniqlo, Next, Zara and Boohoo have all introduced charges at under £2. However, online purchases can be returned for free to retailers with a bricks-and-mortar footprint, pushing consumers back to physical stores and accelerating product resales. It is a pragmatic solution. However, for pure online retailers, customers are directed to drop-off points, reinforcing the need for investment in reverse logistics. Amazon has increased its prices in the UK and across Europe for its prime membership; rising 20% in the UK, while costs in Germany jumped 30% and by 43% in France. The online retailer cited inflation and higher operating costs.

In the event of a recession, the rate of returns may well resoften and consumer behaviour may evolve to a broad-based reduction in sales, darkening the outlook for the sector already experiencing severe price competition, inventory challenges and EU red tape. In this context, online retailers would be minded to assess the outlook for demand in their sector and the implications for margins, debt serviceability costs and profitability.

Similarly, suppliers to online retailers may also wish to review their trade credit insurance. In any distressed business, maintaining credit insurance confidence is crucial to avoid the perception of liquidity constraints creating and deepening the reality.  For example, suppliers tend to secure trade credit insurance to safeguard against the financial distress of their clients. As a business starts to feel the pinch of financial stress, insurers often respond by reducing the level of credit insurance protection offered to suppliers, which can cause suppliers to accelerate payment terms, exacerbating and existing liquidity problems.

The outlook for UK base rates is for continued higher borrowing costs. Andrew Bailey, Governor of the Bank of England, has intimated that a 50 basis points increase is “on the table” at next week’s Monetary Policy Committee (MPC). For online retailers, and their suppliers, who want to understand their options, the quicker that advice is sought is always the best first step – early intervention equates to increased options.

For those businesses who may wish to refinance or extend existing debt – from trade finance facilities, to overdrafts, revolving credit facilities, to long-term fixed rate loans – BTG Advisory has a wide network of lenders, from high street clearers to specialist funders in the sector. We are well placed to help with regular finance requirements to assess worst-case options if your company is near insolvency risk. Please do get in touch with our team today, if you need help.