The peak holiday delivery season often challenges shippers and carriers, but it can also surprise them.

Capacity limitations were commonplace in 2020, leading carriers to become more selective about the types of packages they accept into their networks. In 2021, earlier ordering activity and upstream supply chain challenges kept holiday volumes lower than expected.

As the 2022 peak season approaches, some of the challenges stakeholders faced the previous two years have eased, while others remain front and center. The pandemic-induced home delivery spike is fizzling out and carriers' labor challenges are abating. At the same time, shipping costs remain elevated and companies like FedEx and UPS are laser-focused on prioritizing the most profitable shipments.

To get a sense of what's in store this year, we asked five experts for their takes on the parcel delivery sector's busiest (and most panic-inducing) stretch: How effectively will last mile carriers deliver during the 2022 peak season, and what can shippers do to be successful during this time? Some answers have been edited for length and clarity.

If you know anyone who works in demand forecasting or inventory management for a retailer, they could maybe use a hug.

These were always difficult jobs, based in no small part on the vagaries of consumers tastes, trends and various intersecting markets and economies. The pandemic era has thrown several new layers of difficulty in planning and purchasing inventory. From panic buying to supply shortfalls to historic inflation spikes, the intensity by which the environment can change is matched only by the speed of that change.

Target’s shocker earlier in June highlighted how quickly the world changes. Just weeks after cutting its profit expectations for the second quarter, the retailer cut them again, dramatically. Just as importantly, the retailer signaled it was moving to clear inventory through markdowns and other measures, and would be canceling orders.

It was a sign of the speed and severity of consumer changes and cost inflation. It also portended rocky days ahead for the industry as it prepares for the all-important holiday season. Retailers, brands, wholesalers and other industry players are trying to match inventory with consumer demand — whatever that will be for the season.

“They're guessing. They're all guessing. And any one of them that tells you they're not guessing, they're lying, because they don’t know,” John McQuiston, managing director and global head of originations, receivables and trade finance with Wells Fargo, told Retail Dive in an interview. “The demand levels are entirely unpredictable. Consumer behavior is unpredictable. … This is a bit of a crystal ball Christmas.”

‘Rapid revisions’ at Target

While some analysts called out Target for the planning miss, the announcement was illustrative of several things going on in this particular moment in retail.

Baked into Target’s description of what it was doing and why was a kind of whiplash. Customers changed their purchasing behaviors much more quickly than the company anticipated, whether through bad luck, poor planning or some combination of the two.

From Target’s past earnings call, as well as those of Walmart and other retailers, it’s clear that consumers are reacting to price inflation, particularly in food and fuel, the latter of which has skyrocketed since Russia (a major oil producer) invaded Ukraine and has exacerbated already elevated supply chain costs.

Target’s post-earnings announcement was a sign of just how quickly consumers were changing. The retailer said at the time that it was making “rapid revisions to sales forecasts, promotional plans and cost expectations by category.” Specifically, the company cut its forecasts for discretionary categories — calling out home goods by name — while expecting strength in food, household essentials and beauty.

Following Target’s announcement, Bill Kirk, managing director with MKM Partners, said in a research note that the analyst team observed “strong discounting” in a store visit to Target in discretionary sections of the store.

And while Target said it is clearing inventory to help foster top-line growth — by pivoting to better-selling (if lower-margin) products — the move is not without risks beyond the profit hit.

“We worry that large discounts could damage Target's brand image: 1) part of the apparel department looked like a Ross ... store; 2) the electronics department looked like Black Friday; and 3) outdoor goods looked like it was Winter,” Kirk said in the note. “We worry that even after inventory clears, some impact could remain.”

Mismatches in supply and demand, and sales and inventory levels, extend far beyond Target and cover many if not most discretionary categories. As one example, HSBC analysts said in a mid-June note they were “[b]racing for another lap of complexity” in the sporting goods sector.

The “[b]iggest risk in our view is the sector moving from inventory shortages last year to a glut as early as H2 this year,” the analysts said. “With tight inventories, the sector enjoyed some gross margin support (more full-price sales); with supply chains functioning a lot more efficiently now and possibly some over-ordering, we could soon be in a situation in which inventories are larger than what the market can absorb.”

BTIG analysts Camilo Lyon and Mackenzie Boydston said in a research note that they heard from retail contacts that Nike was “surprising” wholesale partners with more “at-once” orders potentially due to slowing DTC sales, thus “creating a need to place late-arriving inventory.”

The analysts said the move “is surprising to us since at-once orders have been relatively rare in this supply-constrained, COVID environment as [Nike] has struggled to get back into a normalized delivery cadence.” But they also noted that “not all is dire, as retailers that have been starved for inventory are getting it, and seemingly selling through it.”

‘Cancellations, delays and markdowns’

All of this shows how an adaptation to one extreme circumstance suddenly became a disadvantage. “What happened is that the retailers started to buy a lot more in anticipation of the issues of getting goods and bringing them on shore,” Joel Wolitzer, senior vice president and business development officer with Rosenthal & Rosenthal, said in an interview with Retail Dive. “And so they were trying to backfill to compensate for the supply chain issues at the height of the pandemic. Now they have a lot of inventory that’s not moving as quickly as they would have liked.”

Importers that Rosenthal & Rosenthal works with “are seeing cancellations, delays and markdowns and deductions that the retailers seem to be taking, because of this backlog,” Wolitzer said.

Prediction hiccups have become endemic with the pandemic. “Retailers, right at the start of the pandemic, marked everything down because they all thought they'd be fighting off bankruptcy,” Wells Fargo’s McQuiston said. “The government then sends multi-$1,000 checks to the entire American population unexpectedly. And everybody goes out and shops and finds the stores are empty because all the merchandise has been either sent off to consolidators, or marked down and sold.”

That was early in the pandemic. Today, McQuiston noted, billions of dollars in merchandise is sitting on boats waiting to be unloaded into warehouses and go on to shelves, while at the same time “the consumer has been tapped.” Again, prices for daily life needs — food and gasoline — are putting pressure on the vast majority of consumers who aren’t wealthy. (The wealthy, as always, have a buffer against economic travails, as does the luxury sector.)

There’s another factor affecting discretionary spending along with inflation, again related to the pandemic. David Silverman, senior director at Fitch Ratings, said in emailed comments following the May retail sales figures that they showed “consumers are less interested in buying more things and instead are focusing their attention on travel, entertainment, and other services.”

Some have called out retailers for not being ready for any of these various factors. “[R]etailers seemed to have taken an approach of full-bore for pandemic habits until they saw real evidence that the behavior was shifting — and, for inventory management, that’s way too late,” Nikki Baird, vice president of strategy for retail technology company Aptos, said in emailed comments. “You can’t stop a supply chain on a dime, as we already learned during the pandemic.”

All that said, the attention to inventories may be overstating the issue. Jason Miller, associate professor of logistics at Michigan State University, analyzed Q1 data for six major retailers who are also major importers: Walmart, Target, Home Depot, Lowe’s, Dollar Tree and Costco. With the exception of Costco, the days to turn inventory in Q1 this year increased over 2021 and 2019 by varying degrees. But, Miller said by email that the increases “aren't suggesting that these retailers will need to suddenly curtail a large percentage of their orders.”

Miller added, “My conclusion looking at this is that while we will see retailers be more deliberate in their ordering over the coming months, we are unlikely to see a sudden sharp drop in imports.”

But how big is the inventory decline, really?

With all that in mind, the holidays are going to be complicated, to say the least.

Asked how retailers are planning for holiday inventory, McQuiston said they were doing so “with a great deal of emotion.” Once again, the retail world is headed into a holiday season defined by — to use a word that has been overused but unavoidable since the pandemic began — uncertainty. A safe bet, with the understanding that everything could quickly turn, is that consumer momentum won’t be what it was last holiday cycle.

Fitch expects heightened promotions through the summer as retailers clear excess inventory. Silverman noted that “reduced inventory orders for the back half of the year could help overall industry health while easing some supply chain concerns.”

For now, retail products are still shipping, Target’s cancelations notwithstanding. Imports in April remained at near record high volumes, according to tracking by the National Retail Federation and Hackett Associates.

“We’re in for a busy summer at the ports,” Jonathan Gold, NRF’s vice president for supply chain and customs policy, said in a June press release. “Back-to-school supplies are already arriving, and holiday merchandise will be right behind them.”

Government data pulled by Michigan State’s Miller also shows import levels well above 2019 levels in April (by 37%, according to Miller’s analysis). “What I want to emphasize is that there is no precedence beyond a monumental economic calamity (e.g., the original COVID shutdowns, the Great Recession) for sharp drops in volumes,” Miller said.

But whether retailers will be able to sell all the goods coming in today is the big question. And with freight, fuel and labor costs elevated for retailers, the pressure is on those doing the purchasing and inventory planning in a market that continues to defy prediction.

“There’s a lot of noise out there with inflation and rising [interest] rates,” Wolitzer said. “If retailers are able to flush out some of the non-performing goods, they’ll make room for strong purchases for the holiday season. But there’s only so much room on the floor and in their warehouses to take merchandise in. Which is why importers are facing delays or cancellations.”

Thousands of FedEx Ground contractors are forming an alliance to press for higher per-stop pay to hedge against inflationary pressures ahead of Black Friday, one of the company's largest contractors wrote in a letter to FedEx executives Wednesday.

A 10-person committee will act as “a unified voice” for thousands of contractors within FedEx’s ground shipping arm, wrote Spencer Patton, founder and president of Ground contractor Patton Logistics. Patton, who is also head of contractor broker and consultancy Route Consultant, said the committee will be formed at an Aug. 20-21 event in Las Vegas for contractors.

"Know that my desired outcome here is not to unionize, it is instead to unify both FedEx Ground back with their contractors," Patton said in a video accompanying the letter.

The committee's initial focus will be on negotiating what Patton calls urgently needed changes for contractors by Nov. 25 — right as the peak holiday shipping season heats up. Patton called for pay increases for both pickup and delivery contractors ($0.50 more per stop) and linehaul contractors ($0.20 more per mile), with a reassessment after 12 months. The average rate for contractors is unclear, as it varies based on the routes they run.

If FedEx Ground were to reject the contractors’ requests, the committee will have the authority to make a recommended course of action to contractors, Patton said in an email Thursday. Patton didn’t specify what a potential action could entail.

“Let's hope to goodness that FedEx Ground does not push it to that point,” Patton said. “We've made a strong business case for compensation adjustments — let's focus on validating that.”

In a statement, FedEx said it has found "the most effective solutions are identified through direct engagement" with each contractor due to their unique characteristics.

"We recognize the shifting market dynamics and current economic conditions may pose new challenges for service provider businesses, and we remain committed to working with these businesses to create opportunities for continued success," the company said.

Among FedEx's different subsidiaries, Ground makes day-definite deliveries via contracted service providers, as opposed to in-house employees like at FedEx Express and rival UPS. More than 6,000 of these providers move volume for Ground using their respective fleets, and they earned an average revenue of $2.3 million last year, FedEx said.

Pay increases for Ground contractors are necessary to counter declining service levels and higher default rates that are placing the Ground network "in a significant state of unreported distress," Patton said in his letter.

"Not a single day passes without my phone ringing with the story of yet another contractor who is financially collapsing under the weight of these dramatic cost changes that have gone unaddressed by FedEx Ground in 2022," Patton said.

Contractors are buckling under the weight of inflation for fuel, wages and trucks, according to Patton — three categories critical to their day-to-day operations. Contractors have had to spend more in these areas to keep up with the surge in home delivery volumes since the pandemic. Ground's average daily package volume grew 10.6% from fiscal year 2019 to 2022.

FedEx Ground offered a six-month contractor compensation increase in 2020 to help them adjust to the COVID-19 pandemic, according to Patton. The economic turmoil in the past 12 months, however, is much greater than what occurred that year and no financial adjustment has been made by the company, he said.

A new alliance between Ground contractors could help cushion the blow of inflation. In addition to the committee, contractors will use their combined purchasing power to acquire goods and services at lower costs. The group, known as the Route Consultant Purchasing Alliance, will also be announced at the August event, Patton said.

In a June investors meeting, FedEx Ground President and CEO John Smith said Ground is making sure financial agreements between the company and its contractors "appropriately reflect market dynamics."

Ground will reduce contractor costs "wherever we can" by leveraging the company's buying power, according to Smith. This includes introducing a third-party option for group healthcare to reduce service providers' out-of-pocket costs.

The investors meeting highlighted Ground's plans to boost profit margins and operational efficiencies under its parent company's Network 2.0 initiative, in which FedEx Express, Ground and Freight will collaborate on shipments more frequently. Part of the plan is to cut pickup and delivery routes in which companies overlap.

Warehouse labor constraints continue to plague many companies, impacting production levels and causing delivery delays. With a 49% turnover rate in the sector last year, businesses are straining to attract and retain talent.

Those looking to secure talent should expand their hiring pools and offer potential workers opportunities to learn new skills or advance in their careers, experts say. 

“Competition for talent at the entry level is significant right now,” said Abe Eshkenazi, CEO of the Association for Supply Chain Management. “I’m not sure there’s one silver bullet. You’ve got to give [workers] something more than just pay.”

Part of the problem in securing warehouse workers is that the jobs often suffer a reputation as boring, dirty and physically taxing. But that’s often not the case — many warehouses are far more technologically advanced than most people think, said Susan Boylan, senior director analyst at Gartner. 

“They have very smart infrastructure that rely on a lot of technology, but the prevailing image is a dusty old warehouse,” she said.

Showcasing how smart technology enables warehouses can spur more interest from potential employees, particularly if companies can show clear upward career mobility for people that work with the technology, Eshkenazi said.

The technology itself can provide more opportunities for those who may not initially believe they’re qualified for warehouse work, he added. Tools like remote operated forklifts and exoskeleton co-bots could make warehouse jobs possible for older and disabled workers.

“If you think of the population we’re currently working with, we need to open up the aperture in terms of diversity and inclusion and what different people with different competencies can contribute to the organization,” said Eshkenazi.

Advance Auto, for example, has hired more than 360 workers who have autism or are hearing impaired for its warehouses, distribution centers and other supply chain roles through a disability inclusion program.

“This is a great, largely untapped resource for talent out there, and with everybody needing that talent, it just makes sense,” said James Emmitt, owner of consulting firm James Emmett & Company, which helps employers launch disability inclusion programs. “It makes sense for your company, it makes sense for your community, to really lean in and find that talent wherever you can right now. … We’re nowhere close to done.”

Companies can combat the notion that warehouse jobs are terminal careers by providing clear opportunities for workers to advance. A February 2022 Gartner report found that 81% of workers want to find opportunities to learn skills that will be useful to their jobs, but only 42% said they were easy to find. 

“No one wants a dead end job anywhere they work, so offering skills upgrades and training” can go a long way, said Elissa Jessup, HR knowledge advisor at the Society for Human Resource Management.

Entry level workers should be given opportunities to explore other opportunities within the organization, according to Boylan. That could be interacting with tools like robots or wearables, as well as learning about augmented reality and digital twins. Employees can also be offered the chance to learn back office skills, should they find they want to transition into other roles, she added.

Companies should keep close tabs on their workers to know both why employees leave a role as well as why they choose to join the organization, Jessup said. While exit interviews are helpful, businesses can also conduct surveys of new hires to learn why they wanted a particular job. They can also do “stay interviews” to find out why employees remain in their post and what could keep them in the future.

By doing so, managers can “be engaged with their employees and help to provide them a meaningful work environment,” she said.

Overall, companies should understand that retention is not always about money. When Boylan was working for a perishable food market in Ireland, she found that she couldn’t convince workers to take on added overtime during peak seasons because additional pay pushed them into a higher tax bracket.

She surveyed employees and found that they most highly valued time at home with their families. So instead of higher pay, the company offered additional time off around employee holidays. 

“Obviously you can’t be everything to everyone all of the time,” Boylan said. “But you can deliver that to the best of your ability.”

Packaging constraints are the latest supply chain wrinkle for companies as the pandemic, weather events and increased demand for sustainable materials stress supply. 

“It’s almost like the perfect storm,” said John Blake, senior director analyst with the Gartner Supply Chain practice, with the latest round of thunder coming from the recent COVID-19 lockdowns in Shanghai. 

Packaging supply is expected to remain tight through the 2022 holiday season, Blake said. Procurement managers have options to alleviate the pressure by working more closely with suppliers, adding supply chain resilience and sourcing months instead of weeks ahead.

Forest-related products —such as corrugated boxes, non-corrugated boxes and folding boxes — present differing challenges for supply chains, said Derek Mahlburg, director of North American paper and packaging at Fastmarkets RISI.

Whereas corrugated boxes have been hard to source given the surge in e-commerce since the start of the pandemic, Mahlburg noted that they should be easier to get in the next six months as production finally catches up to demand. In the meantime, “buyers will probably have to continue to explore all the ways they can to source paper and packaging products,” he said.

Mahlburg suggested that managers speak directly with mills to find out what they are already producing, “instead of calling around to see who can actually fit in an order of this special grade.” Doing so can help procurement teams find a sourcing solution, even if it’s not as custom-made as they’d like, he said.

Coordinating with suppliers can also help procurement managers adjust their packaging order designs based on what a vendor can realistically provide. For example, eliminating multi-color graphics can make production less complex for a vendor, and help the order receive higher priority, Blake said. 

If packaging requires multiple color stations and therefore extra work and downtime for packaging converters, it can make the process more labor intensive for suppliers. “Just understanding what we can do to make it easier for our suppliers to provide our orders for us” can be the difference between less colorful but still effective packaging, or no packaging at all, Blake said.

While just in time delivery worked when supply chains were "normal," they don’t work in the face of continued volatility, said Tom Egan, vice president of industry services at PMMI, the Association for Packaging and Processing Technologies. Building resilience in a supply chain can help.

“If you’re going to have a factory shut down in one spot, you still have the material you need to source both the product and the packaging materials,” Egan said. “That change toward a resilient supply chain is something that’s here to stay for quite a while.”

Segmentation can give companies a strategic view of their supply needs and help reinforce that resilience.  

“We lose sight of the implications of our total portfolio. By segmenting, we can look at how we utilize a certain material or format across our entire portfolio to see where we can consolidate, harmonize or standardize specifications,” Blake said. 

While some segments, like corrugated boxes, could improve in the next six months, lead times are still long, and Blake said he doesn’t anticipate any kind of normalcy in the packaging supply chain until at least 2023, if not later.

“Currently we’re seeing six months [lead time] where it used to be four to six weeks,” he said. “Things like labels have 12 to 16-week lead times, where it used to be four to six.”

While Egan suggests working with suppliers to build in longer lead times, delays can persist, especially for sustainable packaging. For example, companies that want to move from a multi layered bottle to a monolayered one that can be more easily recycled are having a difficult time sourcing the right product, Egan said.

“That is leading to difficulties in being able to get almost any type of material that we use as primary packaging materials," he said. 

Companies should talk to their suppliers now about their forecasts for the next four to six months, so that organizations can know where they can fit in the production schedule.

“It’s a very specific and clear example of where that communication can alleviate some of those [issues] and help the supply chain work a little bit better," Egan said.

It's official: The International Longshore and Warehouse Union will begin its long-anticipated contract negotiations with the Pacific Maritime Association on May 10.

Many shippers were nervously awaiting this moment. After all, the two parties involved represent many of the companies and workers that keep West Coast ports running. If, like in the past, contract disagreements were to cause disruptions — supply chains could slow down further, too.

Leaders from both the ILWU and PMA have so far downplayed those fears.

"Talks are scheduled to continue on a daily basis until an agreement is reached," the two parties said in a joint press release Monday. "Both sides say they expect cargo to keep moving until an agreement is reached."

The message of mutual cooperation is one the two groups have consistently emphasized as they set the stage for contract negotiations. During subsequent appearances at the Port of Los Angeles’ monthly media briefings in April and May, officials from both the ILWU and PMA emphasized their optimism in the negotiations, noting the trials of the COVID-19 pandemic had helped cement a cooperative relationship. And while each side expressed confidence in reaching a deal, they also came short of guaranteeing the talks would conclude before the current contract expires at 5 p.m. on July 1, 2022.

“I expect the contract negotiation to go past July 1, they always do,” PMA CEO Jim McKenna said during the May media briefing. The ILWU confirmed similar expectations in an email.

‘We need to stay at the table’

For McKenna, how long the talks last is not the issue. “It’s just, we need to stay at the table and get an agreement without causing any further disruptions.”

The time and disruptions involved in previous contract negotiations have widely varied. In 2002, talks were extended for almost three months past the July 1 contract expiry date and an impasse led ports to shut down before a deal was reached. The 2008 talks, meanwhile, caused “little to no disruption” and lasted for three weeks past expiry, McKenna said.

During the most recent round of bargaining in 2014, negotiations prolonged for eight months beyond expiry and featured work slowdowns.

"Each contract is different. [You can't] decide them on the front end," McKenna said. "Again, I think everybody is optimistic going into this one that we're gonna get to where we need."

During the April media briefing, ILWU leaders struck a similar tone, highlighting the two parties’ recent record of contract revisions as an example of their ability to negotiate details without disruption to supply chains.

“If people just look [at] what we’ve done over the last past few years, we sat down and collectively bargained agreements to get through COVID,” said Frank Ponce De Leon, ILWU Coast Committeeman. “We didn’t close any of our ports up and down the whole West Coast.”

What will the parties discuss?

Days away from the first official meeting between the two sides, reports, open letters and public comments laid out a list of topics the ILWU and PMA need to address.

The PMA website indicates the employers' association is entering the negotiation with five goals: avoiding work disruptions; continuing to offer "world-class benefits"; prioritizing safety and training; "modernizing" terminals through densification and automation; and preparing to meet "stringent" environmental regulations.

On Friday, ILWU International President Willie Adams made parts of the union's negotiating position clear through an open letter, which was emailed to Supply Chain Dive. In it, Adams cited the need for a deal that protects both workers and the economy, but decried efforts to automate marine terminals.

"To strengthen America's economy, it's not enough for ports to hold the best economic cards," Adams wrote. "They have to play them in ways that help the American workers who make, grow, and move the things we need for our lives."

Of the five principles outlined for negotiation by the PMA, automation drew particular attention late last week.

On Thursday, the employers' association released a report outlining the benefits of marine terminal automation. The report cites two terminals at the Los Angeles and Long Beach ports as case studies of how the technology could affect volume and jobs. The terminals' use of automation starting in 2015 helped the ports stay competitive and drew in cargo volumes. And as cargo volumes rose, so did labor hours.

The ILWU did not delay in countering the report. By Friday, the union had emailed out a statement arguing automation had cost jobs and efficiency at the overall San Pedro Bay port complex.

"We've seen more container volume, not more speed at the automated ports," Ponce De Leon said. "This shift is due to shipping alliances diverting more cargo to automated terminals, leaving unused capacity at other terminals during a time when the ports have been congested and need every terminal to be as productive as possible."

At the Port of Los Angeles media briefing Friday, McKenna stood by the push for automation, saying it helps terminals achieve higher throughput, stay competitive and meet emissions standards. 

But he also noted it's not the first time the two parties have discussed automation. And though such topics are always tough to discuss, hours, wages and working conditions would remain at the forefront of negotiations.

“I think we're going in with that spirit of cooperation," McKenna said. "But until you get to the table, until you see the demands that come across and the proposals that go across … you're really at a wait and see moment in time.”

For most of the industry's life, retail had a plentiful supply of labor for critical tasks that was absolutely free. The source of that unpaid labor? Customers.

Shoppers drove the last mile to and from their house to the nearest distribution hub (in this case, a store). They paced the aisles and picked the merchandise from the shelf. They walked products from shelf to point of sale and then to their car before driving off, perhaps to another store.

It was a sweet deal for the retailer, which also drew a major marketing benefit from the perpetual billboard of a storefront. Among all the other things that COVID-19 has upended, that operating model, too, now might have changed to a large degree, forever.

"Everything that should be happening over a five-, 10-year period is happening now," said Pete Madden, a director with AlixPartners. "It's a rethink, it's expensive and it's on top of expense that has already happened."

Digital shopping reached new heights last year, pulling forward years of growth and packing it into a matter of months. Under that umbrella of online shopping, consumers flocked to curbside and delivery fulfillment options as they sought to avoid stores.

Buy online, pick up in store — which allows customers to reduce their time in stores — also went through massive growth across the industry during the pandemic. In all of those options, consumers shifted labor they used to do back to the retailer.

What all of these changes mean for retailers depends on numerous factors. What's profitable for one retailer might be a drain on another. All of the primary fulfillment channels have their own cost profiles, upfront investments and bugaboos that add expense.

The omnichannel 'imperative'

On a list of "imperatives" for retail as the industry prepares for 2021 and beyond, the Retail Industry Leaders Association listed as No. 1 the need to "become omnipotent on omnichannel."

Those imperatives grew out of a survey from RILA and McKinsey & Company that found two-thirds of retail executives citing the growth of omnichannel and digital shopping as the most significant trend affecting the industry, and its greatest challenge.

"Online sales are remarkably less profitable than a store sale," Sajal Kohli, senior partner with McKinsey and one of the report's authors, said in an interview. "You have to invest in capability to have better margin structure."

In the U.S., the proportion of online sales supported by physical stores rose to 37% during the 2020 holiday season, up from 32% in 2019, according to GlobalData. Pickup of online orders from stores grew by 103% last year, while retailers shipping orders from stores grew by 80%.

Curbside, which retailers were starting to experiment with in prior years, grew in importance last year. For some chains forced to close temporarily, curbside was put in place basically overnight and became a crucial revenue lifeline that continued growing well after stores reopened. Many retailers saw their curbside sales grow by triple digits over the year.

At Dick's Sporting Goods, for example, curbside and BOPIS sales grew by 250% YoY, driving a 57% increase in e-commerce for the year. Dick's CEO Lauren Hobart said that during Q4, the company's stores accounted for 90% of all sales and fulfilled 70% of online sales via the retailer's curbside, pickup and ship-from-store channels.

Hobart also noted that curbside pickup, launched in March 2020, helped improve the profitability of Dick's online channel overall, and the company expected it to be a big part of its offer, going forward.

Breaking down the costs per channel

Whether curbside and BOPIS boost profits on digital sales depends on a variety of factors. In many cases, those channels might not lift profits at all.

First and foremost are some of the labor costs involved. "One component [to cost] that matters most is time," said Vishwa Chandra, a partner with McKinsey.

In-store shopping, according to that premise, incurs the least amount of time for the retailer, because the customer is going and grabbing products off the shelf and driving them home. With curbside, on the other hand, retailers do the picking, staging and walk it out to a car, Chandra noted.

According to AlixPartners estimates, the profit margin on a $100 sweater, as an example, is significantly less for curbside and BOPIS than either an in-store sale or an online sale that ships from a distribution center. That factors in costs, including running a distribution center, shipping, store costs and channel-specific overhead.

In a vacuum, the most-costly, least-profitable fulfillment channel is ship from store, which, in Madden's formulation, combines the worst of all worlds. It also illustrates the costs of ship-to-home and omnichannel fulfillment methods.

"You're shipping the product from the distribution center to the store. I have to process it in the backroom and put it on the shelf," Madden said. "Then the online order comes in. I'm adding incremental payroll at this point. I have to do the picking, I have to take it to an area and I have to do the packing. Then I have to incur the incremental costs of shipping."

As it plays out in the real world, labor costs for picking online orders depend on the retailer and maybe even the day.

"To some degree, depending on how many orders that you're picking in the store, that's free labor," said Christa Hart, senior managing director with FTI Consulting. "It's time that people had, that they weren't busy servicing customers, or servicing the store — putting out stock or cleaning up. In that instance, the picking and the shipping from a labor perspective is free."

Hart went on to note that, as retailers grow in omnichannel sales and devote more resources to in-store picking and fulfillment — a pivot that giants such as Walmart and Target are making — then the labor ceases to be free. That is, the fulfillment tasks are not something to do during downtime and slow traffic periods, but rather they become the primary tasks of many staff members.

The changes to retail workers' jobs have not come without tension. As major retailers have redefined what their stores are, employees have reported to media that extra tasks have been dumped on them without additional resources or time to help manage them.

Others are redefining roles at the same time as they pare down staffing. Best Buy, for example, is reducing full-time employees in stores in favor of part timers. At the same time, the electronics retailer, whose digital sales have skyrocketed since the pandemic, is expanding the range of tasks that employees are responsible for.

A single Best Buy worker might fulfill curbside orders, take customer support calls from a national hotline, be a virtual expert through the retailer's app, or take on a supply chain role that can be done remotely, Best Buy's CEO told analysts this year.

'Returns are absolutely a killer'

In the early days of e-commerce, it seemed to many observers a straightforward proposition that it could be a more profitable way to sell products: Cut out hundreds of store leases, thousands of store employees and heaps of other costs, and instead ship products all over the country from a single distribution center or several.

"Think of the [direct-to-consumer] retailer that never had a physical store network to begin with, and think about the cost that they've avoided by not having it and the low barriers to entry of just having a single point of distribution," Madden said. "As long as you have that single path … with never a return, it's a beautiful business model."

Plenty of factors complicate that equation, including the steep expenses of digital marketing, last-mile costs and returns. The product itself matters, too. "There's a very wide range in terms of what it costs to pick an e-commerce order," said Matt Garfield, managing director with FTI.

Varying rates of returns by category also complicate e-commerce costs. Garfield noted apparel and footwear as having the higher distribution costs, "just because returns tend to be so high." He pointed to one large footwear retailer whose online returns amounted to two or three pairs of shoes per every pair kept by customers.

Returns, as wary retailers know well by now, confound the entire cost picture through all channels. "Returns are absolutely a killer," Madden said. "It's a give-back on the sale; it's a give-back on the margin; you're just absorbing the cost."

On that hypothetical $100 sweater, the hit on margin is $8 for a return via shipping back to a distribution center, versus $2 for returning to a store, according to AlixPartners estimates.

In other words, the channel matters all the more when returns enter the picture.

"That's where the omnichannel idea really has favored the people with stores, because stores can be a good place to take returns," Hart said. "It's very economical to take a return in the store. They are able to reprice it, chances are they have a sale section, so ... they can clear it out in a in a reasonable way. And they don't have to repackage."

Spending money to save money

Along with variable costs for labor, there is also intense outlay for omnichannel capabilities — technology, processes, automation, all that eat into profits but can boost them over the long run.

"Over the past year, that's only accelerated," Garfield said of investment expenses. "Massive growth in the e-commerce sector wasn't in anybody's five-year plan."

Many of the upfront technological investments go toward making omnichannel operations more efficient in the long run.

"Once those capabilities are enabled, it really has positive impacts on reducing costs, improving your inventory productivity," Garfield said. "Inventory is not productive in a warehouse. But in the store, it's very productive. I can sell it across multiple channels."

Order and inventory management are among the most important capabilities.

"Anytime you go online and do a pickup from store, it always says wait for the email to confirm we have your product — a lot of customers don't, and they just start driving to the stores," Garfield said. "And if there's any sort of an inventory mismatch, that leads to guest dissatisfaction."

For old-fashioned sales at the cash register, the point-of-sale and inventory systems are "very hard and very mature, so it's cheap," Madden said. "When you start doing buy online, pick up in store, all of a sudden now I have to get my associates handheld devices. And now they have to have scanning capability. And that scanning capability needs to have almost real-time inventory … that's where the costs come in."

Multitasking can save retailers money in multiple channels. Picking multiple baskets at the same time can save time, McKinsey's Chandra noted.

In shipping out of a distribution center, Garfield said that picking multiple items at once can improve profitability by reducing "idle walking."

In all channels, automation can also save money by reducing returns, pick times and labor hours. And, of course, anything a retailer can do to reduce returns helps the profit on a sale.

The calculus on store channels go beyond simple margin breakdown and cost of goods sold. Having multiple sales and fulfillment channels can drive customers to a retailer to begin with.

Target, whose curbside, BOPIS and same-day delivery sales skyrocketed last year, aims to be "America's easiest place to shop," based on its omnichannel capabilities. After making massive outlays in recent years, Target is planning another $4 billion investment in its business that includes beefing up its online fulfillment capabilities even more.

As pandemic concerns ease, getting customers inside stores to shop not only can reduce shipping and labor costs, it can trigger other sales. Perhaps more importantly in the long run, having a store can trigger sales online.

Madden and FTI's Hart brought up the potential hidden costs of closing stores while pivoting to digital.

"People who think they can close stores and exit geographies … are underestimating the halo effect of stores," Hart said.

Every holiday season there is an invisible deadline that drives procrastinating shoppers into stores in droves: the shipping cut-off. Order by this date for Christmas Eve delivery. Miss it, and you’re on your own.

In 2020, this same deadline came again, though perhaps a bit earlier than usual. But the shopper was different. In 2020, as consumers hesitated to leave home, the shoppers rushing to stores were paid by gig economy services to do so.

Throughout the pandemic, gig-economy-based logistics players such as Instacart, Postmates, Roadie and Shipt have moved into new roles — becoming more than simple speed plays.  In many cases, they have integrated into retailers' parcel portfolios as an alternative to traditional carriers.

Roadie CEO Marc Gorlin said one customer increased its deliveries through the app by 3,000% from January to April. The flexible “hiring” inherent within gig platforms make them ideally set up for volume fluctuations. “A distributed workforce carries fewer points of failure,” Gorlin said.

Gig-based delivery companies, mostly startups, have been slowly but steadily racking up retail partnerships for the last several years. Neither Instacart, Postmates, Roadie nor Shipt was founded before 2011. Many scaled through food of one stripe or another, grocery, or restaurant. But ask the CEOs, and they’ll say they always knew gig-backed services would make it into nonperishable retail.

“What was a surprise was not where the market is heading — that's why the company exists," Bringg CEO Guy Bloch said in an interview. Bringg software helps users orchestrate last-mile delivery through numerous gig-based, last-mile providers. "What changed was how fast we got to the point that the market realized that that's what they need to do, because suddenly it was no longer a nice-to-have. This is a must-have.”

A change in the math

Online integrations at checkout, offering a litany of possibilities for order fulfillment, are exhibit A that these companies have arrived. But the even stronger evidence are the conversations happening right now between major retailers and the gig-backed providers. After throwing together curbside pickup, buy online pickup in store and same-day-delivery programs in haste last year, permanently installing these services is first on the docket in 2021, according to Bloch.

“Those that were not prepared had to be reactive, and they just put many patches in one place. But now, when the volume starts coming, and they see the velocity of the demand is increasing, it doesn't scale, and it breaks, and it's not optimized .... So, the big initiative is, how do we create an ERP for the last mile?” Bloch said.

It’s not just closed stores that sent retailers clamoring for same-day services. The parcel carrier capacity crunch has launched the gig economy into the prime-time, small-parcel world to compensate. In 2020, traditional carriers made two simultaneous moves that fast-tracked the growth of these players. Carriers upped costs for shippers with surcharges and pricing changes without a clear end-date in sight. They also did not hesitate to say that the surcharging strategy would be a favorite in the future.

Carrier service also faltered. With demand for parcel services far ahead of supply, on-time deliveries dipped, and the cost-benefit analysis of traditional carrier versus gig carrier changed.

UPS even encouraged retailers to push consumers toward omnichannel services that wouldn't require UPS service, when capacity began to tighten heading into the 2020 holiday season.

“If Shipt and Instacart and Doordash and Uber are all doing last mile from stores, that's a pretty good hedge,” said Rick Watson, CEO of RMW Commerce Consulting. Pitney Bowes, with no physical stores from which to ship, has launched a same-day offering for its shippers, partnering with Roadie and Postmates on delivery. And Roadie has a similar deal with Shopify.

Home Depot invested in Roadie when current CEO of UPS, Carol Tomé, was chief financial officer for the home improvement retailer, and Gorlin for one, isn’t surprised by UPS’ change of tone since she took the helm.

“She knows that delivery ain't free,” Gorlin said.

Flexibility trumps speed

The pandemic exploded business for gig-economy carriers from all directions — restaurants, retail, grocery and more.

Optionality is what shippers need when disruptions are constant and hard to predict, Watson said. But the CEO suggested that ship-from-store, for most retailers, may eventually be a gig-economy-only affair. Without consolidation or significant volume, it may not make sense for traditional parcel carriers to support it, in most cases.

The volume uptick for gig carriers may also be simpler than an overnight craving for supply chain agility. “Retailers move slow,” he said, and the pandemic was the push they needed. Plus, the level of consumer adoption has gone up with pandemic restrictions, too.

“We see feedback from customers coming in, and it's super simple feedback … They're basically just saying, ‘Who knew you could get so many things delivered?’ They didn't know. They weren't aware that it was possible,” Gorlin said.