Insight

Retail viewpoint: Are services the newest winning tactic in the playbook?

February 2019

Preliminary reports from the U.S. Census Bureau suggest that retail sales in the 2018 holiday season were up 3.1% on 2017. While there is still a possibility that this data may be revised, we're expecting the final numbers to fall within our predicted range of 3.1% to 4.1%, giving us good reason to declare ourselves champions of this holiday's prediction race.

Speaking of winning, athletes today are faster, stronger, more talented, and finding new, creative ways to play and score. The world of retail is no different. Companies that are willing to be creative find more ways to win – in turn getting more attention and making more money. Look no further than the three most valuable companies in the world: Apple, Amazon, and Microsoft. While we generally think of these companies as makers or sellers of products, they have each created a more diversified approach for themselves by also generating significant revenue from the services they provide (see Figure 1). Growth in services revenue has significantly outpaced product revenues in the last two years for all three companies.

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The retail industry is headed in the same direction. Services have always been an important part of most omnichannel retailers' playbooks, especially in the Amazon era. This included everything from enhanced customer service activities, such as beauty demonstrations, to multiple fulfillment and pickup options. But now, some of the most successful retailers have expanded their services into discrete revenue-driving activities such as electronics installation and support (like Geek Squad), interior design services (like the RH Members Program), or group cooking classes (like by Sur la Table).

Newer variations have included apparel rental services (such as Rent the Runway or Le Tote) and monthly subscription boxes for all kinds of goods (for example, Kidbox or Barkbox). These new models have generally been generated by digital-first, direct-to-consumer companies, but traditional players are increasingly getting into the game as well. With 88.7% of consumers in our recent survey preferring to become a subscribing member of a brand they already shop at as opposed to of an Internet startup service, the playing field seems to be wide open for legacy retailers (see Figure 2).

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There seems to be room for retailers to increase their subscription revenue; customers do not appear to mind paying more for subscription services and memberships. Netflix recently raised its membership prices (again). In another consumer survey, 53% of consumers told us that 2018's Amazon Prime price increase had not impacted their membership status, with almost a quarter of the surveyed not even aware of the change (see Figure 3).

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Setting up a services-based revenue stream can create opportunities for higher valuations. However, going a step beyond – into what is essentially a retail-as-a-service model – can lead to several added operational benefits. Membership programs enable a more enriched customer relationship, allowing for a longer retention lifecycle than traditional product-driven approaches, while providing more opportunities for customer touchpoints as well as an increased flow of relevant data. Memberships can also generate steadier demand patterns and more consistent revenue and allow retailers to retrain customers away from promotional activity spikes. Consistent revenue can, in turn, dramatically simplify sales forecasting, which can create efficiencies in product development, inventory management, and store operations. Finally, a membership model can be a powerful competitive play, as customers who are locked into a model have higher switching costs and, so, are less likely to shop at a competitor.

Following the playbook

Experience has been the buzzword in retail over the last couple of years. However, the next few years may indeed turn out to be all about services and memberships. Following the lead of Amazon Prime, Costco, and Sam's Club, fee-based membership programs may start making their way into specialty retail next. Restoration Hardware moved to a fee-based program in 2016, and Lululemon is reportedly testing a membership plan with a wider launch imminent, as just two examples. Restoration Hardware's stock has more than tripled since the launch of its program in March 2016, with reports crediting at least some of the bounce to its move into providing services. And Lululemon's membership program test in Edmonton, Canada, generated so much demand that the athletic apparel retailer is reportedly considering raising its prices as it looks to expand into newer regions.

Even if you don't have a full membership program in the works, there are a few ways to get started:

Huddle up: A successful service offering will require coordination between finance, merchandising, and the marketing organization. Are these groups willing to potentially sacrifice product sales in the short term to achieve longer-term services growth? If teams are not aligned, a new operating model or organizational structure may be required.

Understand the game: Customers don't necessarily just want your product. They want the way it makes them feel, as well as the benefits the product provides. Truly understanding why your customers shop with you and effectively communicating that message to prospective customers is the first step in evolving from a product to a service orientation — or at least adding services onto your offerings.

Get the stats: Nearly all retailers know how many items of a certain product are sold in a year. But are you aware how many products each customer purchased, at what price, and for what reason? Understanding your customers' shopping habits at an individual level is key to designing effective membership programs. If your data isn't ready for the bright lights just yet, invest in advanced tracking and reporting now.

In retail, as in sports, winning isn't everything; it's the only thing.

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