The use of dark stores in a scenario of growing e-commerce demand

With the growth of e-commerce and the increase in customer service expectations, the last mile challenge has gained urgency on the agenda of retail executives: how to reduce delivery time without compromising logistical costs? Companies are moving around thinking about this equation and new initiatives are emerging all the time, such as the implementation of CDUs (Urban Distribution Centers), previously discussed here at ILOS insights

With the outbreak of the Covid-19 epidemic in the world and the consequent need for social isolation, what we saw was an even more vertiginous growth in e-commerce. According to the Impact of the Pandemic on Brazilian Consumption Behavior survey, carried out by the Locomotiva Institute, 10% of people did not buy online and started to buy during the quarantine; 45% already bought online and started to buy even more in that period; 24% already bought and continued buying the same volume; 11% already bought, but started to buy less; and 10% do not shop online.

Even with the easing of restrictions in cities and the gradual return of the economy, the expectation is that online sales will remain at a significantly higher level than that observed in the last year. And, to absorb this sudden increase in e-commerce, large retail companies are adopting the dark store model in their chains.

Dark stores are stores that are closed to the public and serve as distribution points for products in a given region. With the restrictions on opening hours and the capacity limit imposed by several governments during the quarantine period, many companies ended up taking the opportunity to close some of their stores to the public and increase the capacity to process orders online. This installation model was already being implemented by some networks before the pandemic, mainly in Europe, Asia and the United States, but there has been greater adherence in recent months.

In the United States, Amazon closed some Whole Foods stores in Los Angeles and New York to the public and turned them into online fulfillment centers. Other supermarket chains such as Walmart, Kroger and Giant Eagle have also temporarily converted some establishments into dark stores, but have plans for some locations to remain dark stores permanently.

In New Zealand, the Countdown supermarket chain opened two dark stores in the country and has already announced its intention to open a third unit. The stores look like a traditional market (Figure 1), but have a layout that considers what the company's customers buy most frequently over the internet. This strategy was adopted in order to be able to increase the capacity to fulfill online orders, since visits to the network's website increased by 300% during the lockdown period imposed in the country.

In Brazil, the Hortifruti Natural da Terra group has already implemented this trend, which saw its digital operation jump from representing 1% to 2% to 20% of monthly sales. With that in mind, the chain opened in May the first dark store unit in the country, in the north of São Paulo, with the Natural da Terra brand. The second dark store was opened in June, in Rio de Janeiro, under the Hortifruti banner. By the beginning of 2021, it is expected that there will be three 'dark stores' in São Paulo and three in Rio.

Although there are also examples of other retail segments that are adopting this strategy, such as the home products chain Bed Bath & Beyond and the jewelry store Kendra Scott, most of the companies that are following this direction are from the supermarket segment. This segment, mainly the market for fresh items, depends a lot on the level of service and product quality, and the dark store model benefits from this.

The main objective of dark stores is to provide faster deliveries for those who buy online, in addition to being a more practical possibility of pick-up, since these stores are usually located in the areas of greatest demand in cities. In addition, dark stores provide greater order picking capacity, as they are closed to customers. For stores that receive up to 100 orders per day, it is believed to be possible to maintain distribution from stock, in a ship-from-store model. However, for a demand greater than this, the flow of separation intersects with the flow of customers, which can harm the customer's experience in the store. Thus, having a dark store is more recommended for stores that receive a volume of orders greater than this per day.

Despite these advantages and the fact that a store like this requires a much smaller investment than a traditional store, this is an expensive model that is still not profitable for most companies that adopt it. Supermarkets already have notoriously low margins. With purchases being made online, they become even smaller as the task of sorting, packing and transporting items passes from the customer to the employee and many chains are reluctant to charge for these activities. According to a study carried out by the consultancy Bain (Figure 2), sales made in physical stores generate an operating margin of 2% to 4% for supermarkets. In cases of online orders to a physical store, where the customer is responsible for collection, the margin reduces to -5% and, when the order is delivered to the customer's home, it drops to -15%.

Figure 1: Study on the profitability of online orders for supermarkets. Source: Bain study released by CNBC

Factors such as high labor and rent costs for brick-and-mortar stores used to fulfill online orders are the main drivers of eroding retailers' profits. To allow for an increase in the level of online order fulfillment service without causing a loss to the store, supermarkets should not be afraid of applying convenience fees, they should adopt automation and look for new sources of revenue. According to the Bain study, good solutions include investing in large automated fulfillment centers, developing micro-fulfillment centers at the back of stores, and converting unprofitable physical stores into dark stores. In addition, companies should pursue new revenue streams such as selling advertising space on their website/app to companies wanting to promote a grocery item, allowing brands to pay to add a free sample to customers' online shopping baskets, and charge to make virtual sales data available.

The global pandemic has shaken the retail world and created huge unknowns for the future. Dark stores can help improve the customer experience and facilitate access to essential items, but it is important that there is a strategy behind their creation and that they are one more possibility in the chain and not a substitute for physical stores. It is also essential that retailers find more efficient ways to fulfill orders, under the risk of seeing all their profits collapse and the business being compromised.

This and other retail trends will be discussed in depth in the track 'E-commerce and the New Retail' of 26th International Supply Chain Forum, which will take place between October 13th and 15th, 2020. For the first time, the ILOS Forum will be 100% online and an opportunity for anyone who wants to keep up to date on these and other topics that are in vogue when it comes to logistics and supplychain.

References:

- E-commerce Brazil – Interest in online shopping should continue after pandemic
– E-commerce Brazil – Dark store: how this phenomenon will impact the “new retail”
– The Motley Fool – Amazon Is Turning Some Whole Foods Markets Into 'Dark Stores'
– Forbes – Dark Stores Are The Future Of Post-Pandemic Retail
– Stuff – Supermarket without customers opens in Auckland
– Stuff – Countdown to open 'dark store' in Wellington as online demand booms
– Valor Econômico – Hortifruti Natural da Terra opens 'dark stores'
– Época Negócios – What are the 'dark stores' of the retail giants and why they proliferate around the world
– CNBC – Grocers urgently need to fix broken online business model, as pandemic shifts more to web, report says