A retail business model follows a direct-to-consumer approach, also called B2C, where the company sells directly to final customers a processed/finished product. This implies a business model that is mostly local-based, it carries higher margins, but also higher costs and distribution risks.
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Introducing the Retail Business Model
As a classic example of a retail business model, think of the local coffee shop or restaurant. The coffee shop owner buys a set of products in bulk by wholesalers (coffee beans, foods, drinks, etc.) thus paying these products at a low price and it sells them back in its store with a high markup.
For instance, as a trivial example, the coffee shop might buy a coffee bag at $100, and with that make 100 coffees, which it will sell at $3 each, thus turning the $100 into $300. That all seem simple, yet there are a few things to take into account when it comes to retail business models.
In fact, while the retail business model runs with higher margins than wholesale, there are a few critical differences. And a few things to take into account:
- Local and direct access to customers: the retailer distribution is mostly local. Therefore, just like in the case of the coffee shop, the retailer can build a strong tie with the local community, so that it can enjoy repeat customers who help the local shop bottom line.
- Higher margins: the local shop enjoys higher margins, given the fact it can sell directly to customers. Therefore, transform a simple product (perhaps a bag of coffee) into a product served to customers and therefore with an incredible markup.
- Distribution risks: while the local shop might enjoy high gross margins, in reality, its net margins might be pretty tight (that’s because the local shop needs to pay for expenses like a rental in a central area, personnel costs, and so on) which makes it hard for it to survive in the long run. Therefore, the retailer does take on its shoulders the distribution risks, associated with the costs of running the overall business and making sure that a continuous stream of customers and repeat customers feed the business.
- Local competition: in some cases, local competition can also be very strong. Take the case of the ice cream shop, which is a retailer that enjoys very tight margins, as you might find in the same neighborhood many others selling the same product, thus leading to saturation of the local market and a price competition which erodes the bottom line. The same applies to local shops like gas stations, where margins on the main product (the oil) are extremely low. And instead, the real money will be made by selling ancillary products, at much higher margins (like candies, drinks, snacks, and so on).
- Wholesale prices fluctuations: since the retailer usually does not control the supply chain it might also be exposed to price fluctuations which it can’t control. Take the case of the increased price of coffee beans for coffee shops, which can’t be easily translated into the final product (the cup of coffee) as this would disappoint local customers, thus threatening the survival of the business.
Vertical integration
To have more control over prices and on the overall supply chain, retailers might expand upward. Take the case of a coffee shop that buys coffee plants, and the machinery to make that coffee. While much more expensive to control the supply chain, this might give more stability to the retail business in the long term.
While direct to consumer wasn’t much common decades ago. With the rise of the Internet and the access of millions of consumers, many companies, in various industries have converted to this model. One example is Tesla which by opening local showrooms across large cities (similar to the Apple store) can sell directly its cars to consumers. Therefore, enjoying higher margins (as it doesn’t have to pay middlemen and car dealers) and access to customer feedback.
How can retail business models survive and thrive long-term?
As we saw the retail business model has the advantage of having direct access to local consumers, therefore, it can build a strong tie with the local community to build a profitable business. Yet, we also saw that the local retailer also carries the distribution risks and that local competition can also be fierce.
In addition, since the retailer does not control the supply chain, it might be subsect to prices swings for the raw products, which it can’t pass to local consumers so easily as this would lead to a loss of its customer base.
How do deal with these?
- Strong local community: a retailer should focus in understanding the local community, as primary focus. In fact, by building ties with the neighborhood, it can develop a product, offering tied with that. This is a long-lasting advantage.
- Hard to copy product and experience: while many retail shops sell products that can be easily copied. It can also offer an experience around the product, which is hard to copy. As an example, the same coffee shop, can become the second home for many of the neighborhood, which go there to work, hang out and organize local events.
- Go upstream and innovate the product: the retailer can also over time try to control more steps of the supply chain upward, so to have more control over prices swings. Pherhaps thinking of an ice cream shop, instead of selling the same ice cream, it can open its own lab, to make its own ice cream, and experiment with new tastes.
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