Long before the COVID-19 crisis, the retail industry was facing serious upheaval. Declining profitability, evolving consumer preferences, and the meteoric rise of e-commerce were threatening long-held ways of working and draining market share. The pandemic dramatically accelerated these trends, and the need to address them has become more urgent. Traditional retailers now have no choice but to transform their operating models.
Retailers have endured these trends for years, but most have responded by making incremental changes rather than by embracing them as an opportunity to fully rethink their operating models. This passivity has translated to painting around the edges to cut spending while underinvesting in foundational capabilities such as IT, digital, and talent. In the meantime, legacy structures and processes remain in place, even as the entire industry landscape has changed, making it difficult for retailers to keep pace.
To widen the narrow lens of cost cutting, retailers can focus on three “big ideas”: manage the skill shift, adopt a more agile and omnichannel operating model, and embrace automation across the organization. These foundational moves can help retailers adapt their operating models to match the unprecedented challenges that lie ahead.
A long time coming
The pandemic has monopolized headlines and boardroom focus for the past year, yet 2020 represented an acceleration of existing trends rather than the adoption of a completely new direction. The mounting challenges retailers are facing are demonstrated by trends in three areas. First, retailers have experienced a sharp drop in traffic to physical stores—about 5 percent a year from 2015 to 2018. The resulting series of store closures, which rose 59 percent in 2019 compared with the previous year, was an attempt to safeguard EBITDA1 margins, but these efforts likely won’t be sufficient. For instance, from 2015 to 2021, margins in apparel are predicted to decrease by five percentage points. Additionally, retail bankruptcies have increased in the past year: 49 companies with more than €50 million in annual revenue went bankrupt in the first half of 2020. In the United States alone, 30 retailers met this fate in 2020.
Consumers are also evolving. Expectations of what Generation Z and millennial shoppers want from retailers are markedly different than that of previous generations: these consumers are more connected, less loyal, more informed, and clearly channel agnostic. For example, 82 percent of these consumers regularly turn to their smartphones when making purchasing decisions.
Partly as a result, e-commerce is no longer a secondary channel to physical retail but an essential element of consumer engagement. Apparel, fashion, and luxury retailers saw online penetration rise to 26 percent in 2020, up from 16 percent, and this share is expected to total 30 percent in 2021. That’s equivalent to eight years of online growth compressed into just two years. Clearly, e-commerce can no longer be an afterthought.
Despite these dramatic shifts, many retailers did not mount a proportionate response. They instead fell back on superficial efforts to trim costs by 2 to 3 percent a year. This included reducing quantities of in-store sales staff and downsizing marketing teams, as well as limiting spending on IT. Sustained cost cutting put retailers well behind other industries. For example, in 2016, retailers on average were spending 2 percent of their revenues on IT—compared with 5 percent in business and professional services and 7 percent in banking. This focus on cost reductions led executives to avoid making more drastic adjustments to their operating models. Even as the pace of change has ramped up, retailers are still saddled with operating models characterized by underinvestment in the capabilities required to be competitive.
Three foundational pillars of an operating model transformation
For retailers to change the way they work, they must think differently, adopt a more agile and omnichannel operating model, and embrace the power of automation. Making this shift will require investments in three pillars.
1. Manage the skill shift: Invest in future growth areas by hiring the right talent and reskilling
Talent has become a differentiator in retail. In a recent survey, 80 percent of top executives assert that new capabilities are key for the growth of their companies. Yet 87 percent of respondents foresee a skill shortage, and just one-third think their training-and-recruitment plans are robust enough. Fully one-half even admit they don’t have any plan to manage the skill shift. With so much riding on talent, retailers should focus on several areas to ensure they have the horsepower to carry through their business strategy.
Plan ahead. The first step for retailers is to clearly map their capabilities now and across a ten-year horizon to understand the gaps that need to be bridged. Leaders can then identify the number of people and the capabilities needed to support the growth agenda. Part of this process involves determining which departments and geographies will create value, as well as identifying the people needed to support them.
As an example, a DIY retailer set an aspirational growth target that required a deep transformation of its business model (such as the integration of digital and new store formats). It complemented this strategy by developing a workforce demand-and-supply model across five levers: automation and digitization, working models, spans and layers, agile, and new roles and skills. The resulting three-year road map included a set of bottom-up initiatives that identified opportunities to boost productivity by 20 percent, as well as to create more than 20 new roles (for example, IoT engineer and enterprise architect). Such large transformations can succeed only with ambitious reskilling and recruiting plans.
Reskill the workforce. Although reskilling programs require significant resources, they typically have an ROI that is 1.5 to 3.0 times higher than recruitment. Once retailers have identified the capability gaps, they should develop learning journeys and devise ways to deliver training at scale.
One large retail conglomerate reskilled 40,000 employees in digital and analytics by partnering with a set of vendors to create an in-house school for continuous learning. All employees were required to go through a tailored learning journey based on their roles, tenure, and capabilities. Amazon, as part of its “Upskilling 2025” initiative, will invest $700 million to train 100,000 employees for higher-skilled jobs over the next six years. This effort will allow the company to address skills gaps in areas such as data mapping, data science, security engineering, and business analysis through a range of internal training options.
Walmart also invested $4 billion in a reskilling program over four years, with frontline hires required to begin with Pathways, a certificate program in basic retail and emotional skills. Tenured employees can take part in Walmart Academy—now with more than 500,000 alumni—and the “dollar-per-day college,” which allows associates to earn college degrees in retail management.
Recruit new talent. Reskilling programs are necessary but not sufficient to develop the talent needed and build capabilities. Some positions cannot be filled by internal employees, especially for retailers that are lagging behind in digital and analytics capabilities. Overall, 50 percent of top executives say that they will need to increase their capabilities in terms of technology (in back offices and warehouses, as well as for positions such as category management and precision pricing). In such cases, reskilling programs need to be complemented. Recruiting is an expensive undertaking that requires significant company resources. The competition for recruiting promising candidates requires companies to invest in brand building to attract the best talent, an undertaking made even trickier by social media, which provides greater transparency into an organization’s culture.
But attracting is not enough; retention is also key. Some iconic brick-and-mortar retailers can offer top digital executives a good challenge, but other talent might continue to prefer the opportunities and salary at start-ups. Retailers may need to rethink how they combine career paths and compensation into a more attractive package. For example, in 2020, Ocado raised £1 billion to develop technology projects and fill 500 high-skilled jobs that will support its omnichannel offerings.2
2. Adopt a more agile, omnichannel operating model
The appropriate operating model will differ based on a retailer’s archetype: pure digital player, omnichannel player, or legacy brick-and-mortar player. We often observe that low performers tend to change organizational structure less frequently, while fast-growing companies or start-ups continually evolve their organizations to adjust to the changing trends.
Become an omnichannel-first organization. A retailer’s starting point on digital maturity will determine its path forward. For instance, if online operations are almost nonexistent, executives often establish a dedicated digital team before combining it fully with offline operations. In such cases, having a C-suite position focused on digital or e-commerce can help increase the share of voice and rebalance the investments and decisions toward online (especially in striking the right balance between spending on store refurbishment and spending on online and IT capabilities to support omnichannel development).
Omnichannel players have usually accomplished some degree of integration; the next step is to push for the full mutualization of online and offline teams. Some players have merged the heads of retail and e-commerce into one position in charge of omnichannel. In 2018, Walmart added the chief customer officer role to ensure that its digital channels and stores coordinated their efforts.3 And in 2020, Under Armour created the role of chief experience officer, responsible for global retail and e-commerce business as part of the overall consumer experience and digital strategy.4 Similarly, J.Crew established a chief customer officer role in 2019 to oversee stores and e-commerce, marketing, and loyalty.5
Another trend is to mutualize purchasing teams (especially for wholesale players or retailers that span multiple categories or business units). This approach reduces the number of touchpoints with suppliers. Often, marketing teams are already fully blended so that communication and branding are seamless across channels.
Take a zero-based approach to resourcing. Incumbent retailers often have entrenched processes and are long overdue for a detailed reassessment of resource allocation. Questions could include: Is the business activity at the same level as three years ago? Do I have new tools and data to support the decision-making process? Are all the reports used? Are all the meetings and routines critical for the business? The answers could help optimize the cost base and suggest new ways of working and new habits without impeding the organization’s ability to function at a high level.
Our experience suggests 5 to 10 percent of costs could be saved by reassessing which activities are critical for the business. Some players have invested in building greater transparency on some key roles (such as buyer, controller, and accounting) and then used a series of iterative workshops to cut some activities. This move can generate some quick wins to finance the more structural shifts needed to capture the full value at stake.
Inject agile through cross-teams. Agile can take many forms—from the adoption of collaboration tools, such as Monday or Slack, to full enterprise agility. Some retailers are organizing selected teams around business units with clear missions to deliver cross-functional value by channel (for example, at some retailers, certain teams are in charge of revenue and operations for a set of stores), by journey (combining teams from various departments along a journey, such as high-net-worth individuals), or by category (for instance, full ownership of a specific category, from sourcing to assortment to marketing and communication).
As an example, an online fashion pure play incorporated agile into its operations in phases. After introducing agile methodologies into its engineering teams, leadership made agile a key component when scaling its IT function. They then rolled out these concepts to the entire organization, which accelerated decision making and enabled a more nimble response. Some legacy players have adapted their organizations to agile enterprises, with teams organized by squads along use cases. These moves have resulted in productivity gains of 10 to 20 percent.
Some legacy players have adapted their organizations to agile enterprises, with teams organized by squads along use cases.
Retailers usually experiment with agile by relying on small, cross-functional teams that hold end-to-end tech-product accountability (build and run) and encompass all the skills (such as product owner, designer, and full stack developer) required to develop solutions.
3. Disrupt ways of working through automation
Automation is expected to be one of the main sources of changes in capabilities required. McKinsey research found that 52 percent of retail activities could be automated, at least partially (exhibit). While nearly five million jobs could be at risk of displacement in retail, automation could also create new jobs that require new skills and increase the reliability of processes. Retailers could reinvest the savings from automation into their workforce through capability-building programs.
Simplify your processes. The first step in automating any process is to focus on what will be truly useful for the final customer. Usually, complex processes such as promotion management involve more than eight steps and more than four teams, and decision-making authority is not always clear from a RACI standpoint (who is responsible, accountable, consulted, and informed). In our experience, process-redesign efforts can typically help cut the number of steps by 20 to 30 percent and increase the speed of operations and decisions. Teams usually start by identifying the ten to 15 core macro processes that involve different teams, systems, tasks, and capabilities. After four to six weeks of iteration, key users suggest simple adjustments that streamline the process and lay the foundation for automation.
Go beyond legacy systems through smart automation technologies. Once processes are simplified, retailers could progressively automate them, particularly with robotic process automation (RPA). These solutions can be applied not only to back-office processes, such as accounts payable and receivable, but also to processes such as administrative purchasing or promotions that are largely manual (for example, in grocery retail). Workflow management tools also smooth decision processes and simplify validation steps. Retailers that implemented these technologies have reduced the time for some subprocesses by 50 to 70 percent while achieving nearly 100 percent accuracy. RPA has the benefit of being noninvasive, often with a payback of less than 12 months. Usually, the following conditions are ripe for automation: a large number of full-time equivalents (FTEs) working on the process, highly manual tasks, and legacy systems that are complex and costly to change.
Inject AI and automation into core value-adding processes. The next step is to incorporate artificial intelligence (AI) to improve the performance of processes. Beyond simply automating processes, this step requires “teaching” processes to learn and derive insights. As a result, it should be performed only on core and high-value-added processes to complement human intelligence. We see AI applied in areas such as assortment selection, promotion, and pricing, where advanced analytics algorithms are increasingly used to analyze large sets of data and improve the category-management function. The resulting insights will have a clear impact on team size, ways of working, and capabilities. In addition, category managers will need to understand the way the algorithms are functioning to be able to challenge and complement the recommendations. Retailers can gain a competitive advantage by harnessing AI, and we see more retailers recruiting expert revenue managers, because packaged goods companies are two to three years ahead of most retailers.
Over the past ten years, retailers have sought to become more resilient to emerging challenges by cutting costs. This concentration is no longer sufficient. We believe that reimagining the operating model could be a source of competitive advantage and a key success factor for the future: reskill and attract talent, fully implement omnichannel, and simplify processes and automate. These will be the building blocks of the next operating-model transformation for retailers.