Insights > Retail Viewpoint: Balancing Supply Chain, Labor, and Inflation

Retail Viewpoint: Balancing Supply Chain, Labor, and Inflation

A version of this article first appeared in the Journal of Corporate Renewal, examining retail’s next wave of challenges across inflation, labor, and the supply chain.

In recent months, retailers seem to be on a stronger footing but continue to face challenges spurred by the impacts of the pandemic. These impacts—labor shortages, supply chain issues, unpredictable inventory levels, and inflation—have created a rocky terrain for the retail landscape. By proactively understanding and addressing these issues, retailers can increase their chances of success through 2021 and into 2022.

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A major sticking point for retailers today is the lack of workers available to mind the store and keep distribution centers running efficiently. Wage levels, employee turnover, and labor productivity have all been impacted through the pandemic. Retailers need to contend with the short- and long-term impacts of all of these factors.

Businesses need to look past stimulus packages that may have buffered top lines and begin to contend with hourly worker wages. Federal and state unemployment benefits have deterred many people from returning to work, forcing retailers to increase wages to attract new hires. Also, many businesses have had to adjust current workers’ wage rates in line with newer workers, compounding the impact. This adjustment can have a meaningful impact on profitability, often causing higher costs in retail stores and distribution centers. To manage this new reality, companies will have to find creative solutions to reduce other costs or increase prices to prevent margin erosion.

At distribution centers, there have been losses in productivity due to furloughs that happened early in the pandemic. When facilities reopened, many employers realized that only about half of their staff readily returned to work, and many top performers had secured alternate employment. Understaffing of distribution centers resulted in difficulties keeping up with e-commerce orders and store replenishments. When ramping labor back up, a company should understand the financial impact of understaffing, which includes putting a price on slower fulfillment. Doing so helps businesses frame how much to invest in incentives, overtime pay, recruiting, or other one-time expenditures to accelerate hiring in this difficult labor market.

Over the last year, onboarding new staff has also become costly and complex because training requires new safety protocols, such as social distancing. While social distancing protocols continue to be relaxed, whenever worker turnover occurs, there will be inefficiencies. Retailers can address these concerns by understanding historic productivity levels per employee, monitoring current levels, and targeting specific time frames to reach or exceed those levels when new workers are hired.

Labor productivity is critical for distribution centers and retail stores alike. Many retailers started to see high labor efficiency levels in stores in the middle of the pandemic; however, they should be mindful this is likely a short-term phenomenon. In stores, hours are down partly because of increased conversion rates where customers limit time spent in stores to minimize pandemic-related risks. When customer behavior again favors browsing, conversions will trend down, and the ratio of hours to units sold will revert to pre-pandemic levels. Ahead of that reversion, the average cost per hour is increasing, effectively acting as a multiplier to future labor costs when hours once again increase. Retailers should make sure they are planning for these labor cost increases over the next year.

At the height of the pandemic, some opportunistic retailers started shipping from stores to leverage in-store labor and inventory. While the pandemic necessitated this creativity, for many it accelerated the development of an omnichannel fulfillment skillset. The next stage of development will be to turn this opportunistic tactic into the holistic strategy to thoughtfully unlock slower moving in-store inventories and leverage under-absorbed labor. Retailers must understand the strengths and weaknesses in their inventory systems and labor management to fulfill orders from stores on an accretive basis.

Supply chain challenges

In 2019 and 2020, supply chain discussions were very focused on optimizing the last mile of delivery. While this remains a critical issue, many other challenges have presented themselves through the pandemic, including reverse supply chain logistics (also known as e-commerce returns) and the cost or availability of transportation.

The pandemic drove a 32% increase in retailers’ e-commerce revenues in 2020, a $185 billion lift over 2019, to $763 billion, according to the US Census Bureau Report published in May by the Department of Commerce. Higher sales drive substantially more returns, which totaled $102 billion in 2020, according to the National Retail Federation’s 2020 Returns Survey. Online purchases are also more than three times more likely to be returned compared to in-store purchases, and returns also present dramatically higher processing costs than in-store returns.

This data, coupled with the fact that almost half of online retailers offer free shipping and free returns, can only mean this shift had a big impact on retailers’ bottom line. Between the logistical challenges, labor, costs, and inefficiency of repositioning inventory returned online, the reality is that the cost of reverse supply chain logistics will likely increase before it can be controlled. In the interim, it is important for retailers to anticipate these costs and plan for these logistical challenges.

For most supply chain experts, the last 15 to 20 years of retail supply chain efforts were focused largely on driving efficiency and squeezing out margin wherever possible. However, with this efficiency came inherent inflexibility.

The ripple effect leading to today started in early 2020 when COVID-19 was thought by many to be a problem only in Asia, and retailers fought aggressively to complete productions and accelerate shipments ahead of shutdowns during the Chinese New Year. Within a few weeks, as the pandemic spread globally, buyers frantically worked to cancel orders.

These movements—combined with the historic level of retail bankruptcy filings in 2020—put tremendous pressure on retail supply chains. Vendors no longer planned their productions months in advance, with thoughtful procurement of raw material scheduled in advance. Shipping schedules fluctuated greatly, with capacity opportunistically absorbed and redirected to other industries. In the United States, domestic freight also became further challenged as pandemic concerns prevented the training of incremental truck drivers, despite pressing demand. Simultaneously, demand did not drop as expected, and many retailers found themselves short on inventory.

Now, with stronger balance sheets and better borrowing capacity than in recent memory, retailers have placed large orders for back-to-school and holiday seasons. This is a big gamble, with many retailers concerned that orders may arrive late, which could lead to hefty costs to expedite goods or heavy markdowns if seasonal goods are delivered late.

The disruption is coming from a number of places, including shortages in the supply of shipping containers, sea freight, and trucking supply, which manifests itself in longer wait times and higher prices. In some cases, businesses are seeing up to quadruple the freight rates compared to a year ago, an official at the Journal of Commerce told an ABC News outlet in May.

Shipping container transit times are also significantly longer. For example, Costco reported in its third quarter earnings call that the turnaround times doubled—from approximately 25 days to 50 days—for shipping containers arriving to the United States, delivering contents, and going to the port to return overseas. Transporting goods via truck also involves capacity issues, with data showing more than 102 flatbed loads for every available truck on DAT load boards in early May—more than six and a half times the levels recorded in 2020.

As retailers emerge from pandemic difficulties and seek reliable transportation, the medium term will require flexibility, which in turn will carry a premium. Business will need to evaluate when it makes sense to absorb these premiums, such as paying air freight to get desirable inventories back on shelves quickly, or when a business can accommodate lower stock levels or try to move last season’s styles.

Minding inflation

While an ever-changing landscape of issues impact retailers’ success, the winners of this next cycle will clearly have to navigate inflation, at rates likely not seen since the early 1980s. Retailers should approach this inflationary period with both excitement and trepidation.

The positive benefit is that inflation will have a deleveraging effect on balance sheets. The end-state benefit of high inflation is that the nominal value of companies’ debt obligations will remain unchanged; in reality, these obligations will simply become more affordable for borrowers as each dollar becomes less valuable. The major concern for retailers is the path to that end state. They will need to balance pressures on their cost structures with price increase to customers. This requires maintaining margin percentages and volumes while navigating increases to costs of goods sold, overhead, labor, and retail prices—and each of these inputs have their own complex competitive and market pressures.

If done correctly, earnings and margins should expand. However, companies that move too fast could overpay for labor or ostracize customers with higher prices. By contrast, reacting too slowly could cause companies to lose top talent while giving up valuable margin.

Ultimately it is likely that retailers will coalesce around a few paths through inflation, all of which involve a focus on enterprise-wide profit margins. Some retailers will convince customers to simply absorb price increases. Others will hold price while quietly decreasing package size. A third strategy will be to hold price and package size to be seen as a value leader to drive volume and traffic.

Whatever path is chosen will require navigating increasing pressures on costs and prices during this inflationary period, and retailers who win will be those that stay focused on this inflationary balancing act.

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