We have witnessed the problems and tribulations of traditional “bricks and mortar” retailers over the past couple of years. In previous blogs I have discussed how increasing costs; revolving around rentals and business rates, have stymied their growth prospects. By contrast online retailers have forged ahead, unencumbered by such restrictions. It appears as though their nimble business models are likely to win out in the longer-term.

You can imagine my surprise when in mid-December (2018) I woke up to read about the profit warning pushed out by ASOS. This was the first time in my recollection, that a pure-play online retailer has expressed problems and concerns about its performance. Has the “worm turned”? Is this the first sign that the travails of “bricks and mortar” retailing has extended to online operations?

Let us consider some of the underlying background and key issues.

ASOS has been one of successful pioneers of online retailing. Founded by two brothers in North London in 2000, it has consistently posted impressive sales and profit statements over the past fifteen years or so. It claims to have over 18 million customers world-wide, operates in over 240 countries, employs around 4,400 people and operates state-of-the-art distribution centres in Barnsley (UK) and Berlin (Germany). It is working on a similar operation in Georgia (USA). In recent years it has invested heavily in its back-office operations such as distribution and warehousing along with its digital marketing. Approximately forty per cent of its sales comes from its domestic UK market. In truth it is a major player globally in the pure-play e-tail business space.

Thus the profit warning sent out in December has caused some significant ripples across the retail sector and beyond. Retail commentators are beginning to express some doubts about the efficacy of the respective business models of e-tailers.

Specifically ASOS announced that its sales for the three months to end November 2018 had increased by 14 per cent. On the face of it, not too bad you might say. However this represented some significant deterioration in the month of November and forced the retailer to revise downwards its anticipated sales of between 20 – 25 per cent full year growth to in and around 15 per cent.

This had the effect of wiping over 38 per cent off its share price.

More worryingly it predicted a decline in profit margin from 4 per cent to 2 per cent.

In another alarming disclosure similar problems in terms of sales were experienced in two of its main European markets: Germany and France (both markets representing 60 per cent of its European sales).

Was this an isolated event only featuring ASOS? Not really. One of its main online competitors in the fashion business: German e-tailer Zalando also had nearly £1 billion wiped off its shares. H&M, the Swedish fashion retailer also encountered a fall of 8.5 per cent.

Shares in Boohoo – a retailer that we have highlighted as one of the success stories of online, also recorded a drop in share price of 18.5 per cent. We can conclude that this is not necessarily an isolated case from the perspective of ASOS. Something is happening that we should not just acknowledge but assess, as it may have implications for online retailing going forward.

Let us look more closely for potential clues as to this decline.

The possible answer in my view lies in the predicted decline in profit margin from 4 per cent to 2 per cent in the case of ASOS. These figures reveal the dangers of operating on very low profit margins.

This has been exacerbated by the unrelenting heavy discounting applied by many fast-fashion retailers in an attempt to drum up business. Retail analysts also reveal that approximately two –thirds of the 4 per cent margin comes from ASOS charging shoppers for deliveries. If the margin continues to decline, as predicted by ASOS senior management, then we can expect even worse performance in the coming couple of years.

It highlights the dangers of discounting in a very clear way. The reality is that over the past couple of years, fashion retailers have survived by consistently offering promotions and discounts. The “Black Friday” phenomenon, established a few years ago, had bred an expectation among shoppers that they will get discounts if they are prepared to wait.

Heavy and sustained discounting erodes the value of the brand.

The 2018 Black Friday campaigns totally focused on discounting. In the case of ASOS, it offered a blanket 20 per cent discount on all items, on top of already heavy discounting in the previous months. Even so, many customers globally appear to have gone off the initial enthusiasm captured in previous “Black Friday” campaigns. Why? Because they expect discounts all year round now.

This has led to the effect of shoppers becoming discount-loyal at the expense of becoming store-loyal. Quite simply they will shop where they can get the best deal. If a retailer is already working with very tight, nebulous margins, the pressure to make money becomes even more acute.

We also need to factor in the typical demographic profile of fast-fashion shoppers who do business with the likes of ASOS and BooHoo. They are typically in their twenties and operating with lower disposable incomes than was the case ten years or so ago (due to a decline in real incomes). Although wages are showing tentative indications of increasing in the UK in 2018, such shoppers have cut back on their expenditure on fashion and are seeking better value and deals on the internet.

While footfall has declined in physical stores in the UK, we are perhaps witnessing the same effect in the e-tailing space as well.

Some e-tailers offer free delivery to shoppers. This in my view is no longer sustainable in markets where the margin is so low. ASOS charges different categories of shoppers for different delivery patterns such as standard next-day, same-day and Saturday deliveries. This is difficult to justify if some of its competitors are offering free delivery.

Shoppers will need to recognise that they will have to pay in the future, possibly more than they pay presently.

It is difficult to assess whether the problems encountered by ASOS and some if its competitors is temporary and a blip. Uncertainties surrounding BREXIT and economic performance in many European countries suggest that it may last for a longer period of time than is acceptable to retailers.

Pure-play retailers will need to revisit the basic dynamics of their business models – particularly with respect to discounting practices and management of their supply chains. Operating on such low margins works well in times where there is significant demand. In periods where demand declines, this affects the quantity of the items sold and places enormous pressure on the sustainability of such a model.

Trend-setters such as Amazon have set the pace in terms of retail innovation – particularly in the context of supply chain management.

Retailers such as ASOS would be well advised to study carefully the Amazon model and effect, and learn.

Let us see what happens over the next year or so!