Retail and Consumer Packaged Goods

Bending the cost

curve in brick-and-
mortar retail
Retailers can achieve next-generation store efficiency by breaking
down silos and optimizing total cost across the value chain.
by Praveen Adhi, Vishwa Chandra, Karl-Hendrik Magnus, and Aneliya Valkova

© Noel Hendrickson/Getty Images

January 2020
 Making money in retail—particularly in physical for 40 percent of retail growth in the United States
stores—is becoming harder and more complex since 2016. A recent McKinsey survey found that
each year. Many retailers around the globe have 82 percent of US consumers reported spending
addressed many of the possible efficiencies in money online over the preceding three months,
labor productivity and process automation. It is and 42 percent of millennials report they prefer
time to consider the next generation of thinking to shopping online to shopping in store.² Still, the
make a meaningful difference in brick-and-mortar in-store experience is far from obsolete. McKinsey
economics and remain competitive in an ever- projects e-commerce will constitute just 21 percent
changing retail environment. of total retail sales and 5 percent of grocery sales
by 2023.
Our colleagues have discussed how an integrated
view on cost can help consumer-goods companies Second, brick-and-mortar stores are contending
optimize operations costs across the value chain.¹ with increasing SKU complexity; in a world of ever-
In this article, we take a closer look at how retailers shorter product cycles and rapid innovation, SKUs
can benefit from a similar end-to-end perspective. have proliferated rapidly.
The goal is to help traditionally siloed departments,
from store operations to supply chain to merchan- Third, stores are facing increased customer service
dising, understand the total cost of each SKU by and experience expectations, requiring both more
disaggregating the product’s journey from end to time dedicated to customers and better-trained
end. This understanding can enable retailers to make frontline staff to serve today’s highly digital, well-
better decisions about what products to purchase, informed customer. In addition, the proliferation
when to transport them, how to display them, whether of omnichannel experiences is changing the
to offer a sale—and, all along, how to make best use very purpose of a physical store.³ Stores are
of their employees’ time. increasingly expected to offer a variety of omni-
channel services, including in-store fulfillment and
While traditional store efficiency programs returns of online orders.
focused on in-store labor productivity can save
5 to 10 percent in overall costs, in our experience Finally, retailers’ traditional labor pool is dwindling
a more comprehensive cost approach can enable due to low unemployment and rising labor costs.
retailers to realize two to three times more savings, For example, the United States is experiencing
bending the cost curve more toward meaningful record-low unemployment.⁴ And to date, states
impact than the traditional incremental approach. that account for 30 percent of US workers have
committed to phasing in a minimum wage increase
that will ultimately reach $15 an hour—more than
Case for change: External environment double the federally mandated wage of $7.25.⁵
Even retailers with stable balance sheets face
mounting cost pressure due to several factors,
including decreased foot traffic, increased SKU What retailers can do
complexity, higher customer expectations, and To remain viable in this environment, retailers
rising labor costs. must constantly improve their store economics
by simplifying, eliminating, or automating routine
To start, consumers shop from the comfort of activities. Most retailers have implemented several
their couches rather than traveling to the nearest rounds of lean cost-improvement programs, such
shopping center; e-commerce has accounted as automating simple activities (reporting and

1
Philip Christiani, Sebastian Gatzer, Daniel Rexhausen, and Andreas Seyfert, “How to untap the full potential: An integrated—not isolated—view
on cost,” September 2019, McKinsey.com.
2
Praveen Adhi, Tiffany Burns, Andrew Davis, Shruti Lal, and Bill Mutell, “A transformation in store,” May 2019, McKinsey.com.
3
Raj Kumar, Tim Lange, and Patrik Silén, “Building omnichannel excellence,” April 2017, McKinsey.com.
4
“Employment situation summary,” Bureau of Labor Statistics, October 4, 2019, bls.gov.
5
Chris Marr, “States with $15 minimum wage laws doubled this year,” Bloomberg Law, May 23, 2019, bloomberglaw.com.

2 Bending the cost curve in brick-and-mortar retail

scheduling) and streamlining their inventory stocking discontinued. Further, a deeper understanding of
processes. However, most still take a narrow view net margin and labor implications in distribution
of what costs they can optimize, focusing on activities centers and stores can inform decisions about
the store can influence and accepting upstream whether to add or remove shelf space from a given
activities and decisions as constraints. SKU. The extra labor cost required to stock the
shelf between less frequent deliveries may be
To reach the next level of cost efficiency, retailers offset by transportation cost savings.
must expand their focus outside the four walls of the
store. Only the most advanced look for efficiency at A comprehensive view of cost can also inform
the intersection of store operations, merchandising, investments into enhanced capabilities such as
supply chain, and transportation to adopt a total-cost automation. For example, if a distribution center can
view—that is, the sum of cost components across be outfitted to build custom pallets that match a
the value chain (Exhibit 1). By considering underlying store’s layout, frontline staff would spend less time
costs, from how products are chosen to how they’re sorting products and moving between aisles.
stocked, in our experience retailers can expand the
scope beyond costs addressed in their brick-and- It is important to recognize that these efficiencies
mortar stores by 50 percent. These underlying costs will lower costs in some departments but
are also more likely to yield efficiency because they may be cost-neutral or increase costs in others;
have not been scrutinized as much as in-store costs. accounting for these cross-functional effects
will be critical to success.
A total cost approach can reveal a host of
unrealized efficiencies (Exhibit 2). For example,
with input from store operations, merchandising Success factors for bending the
can adjust the store’s promotional calendar by cost curve
category and product to incorporate both the Four primary factors are crucial to bending the cost
expected incremental margin as well as the curve through a total-cost approach: governance
store labor required to change price tags and and executive alignment, cost transparency, data and
build promotional displays. Given this more analytics capabilities, and key performance indicators
comprehensive view of cost, some promotional (KPIs) and incentive alignment.
activities will be seen as unprofitable and thus

To remain viable in this

environment, retailers must constantly
improve their store economics by
simplifying, eliminating, or automating
routine activities.

Bending the cost curve in brick-and-mortar retail 3

Exhibit 1

Cross-functional collaboration to understand total cost of handling can lead to a host of

unrealized efficiencies.
Cost decrease
SO Store operations SC Supply chain M Merchandising Neutral
Cost increase/
margin decrease

Category and product promotional Extra shelf space is added for fast-moving Product is purchased from vendors,
profitability is adjusted to account for SKU A to enable stocking all product at shipped, and stocked in shelf-ready
store labor costs to replace price tags and once. The store labor savings are greater packaging, which makes it easier for
build promo displays. This makes some than the lost margin from removing SKU stores to handle and outweighs the extra
promotions unprofitable, and they are B’s shelf space. vendor costs.
discontinued.

SO SC SO SC SO SC
M M M

The store receives less frequent deliveries The business case on whether to invest Promotional displays are built upstream in
to optimize transportation cost—the in distribution-center automation is the distribution center or at the vendor,
savings outweigh the extra labor needed amended to include store savings from reducing the time it takes store employees
to manage bigger shipments. stocking product that arrives in better- to set up.
organized pallets.

SO SC SO SC SO
M M SC M

4 Bending the cost curve in brick-and-mortar retail

Exhibit 2

The total cost of handling a product is determined by considering cost at each step of the
value chain.

Introduce to
Review category Create planogram Plan demand distribution center Receive and stock
and prepare to ship

Example New SKUs to Number of facings Safety stock Location in the Store processes
decisions introduce distribution center for stocking
Shelf depth Minimum for new SKU
Number of stores presentation
Space for category Placement of
for new SKU quantity Mode of shipping overstock (eg,
introduction to the store (case back room vs top
or individual) shelf vs elsewhere)
Frequency of
store delivery

Impacted cost Cost of goods sold, Store labor cost to Distribution center Store labor cost from Store labor cost
components write-offs, shrink replenish between picking cost based stocking full cases to stock product
shipments based on amount of vs individual units on shelves and
on shelf capacity product shipped return overstock
to back room
Inventory holding
cost of safety
stock and minimum
presentation

Governance and executive alignment Cost transparency

It starts from the top. Senior-level, cross-functional Retailers often struggle to calculate their total cost
alignment and sponsorship are required to of handling for two simple reasons: they either lack
communicate change and ensure it sticks. Given the a full understanding of cost components or don’t
sensitive nature of cross-functional savings—some have the data to quantify each. For example, many
departments will see a cost increase, while others will retailers do not have a clear sense of how much
see a disproportionate cost decrease—each function labor is used per unit of product in the store, starting
needs to be confident that senior leaders support with unloading it from a truck to placing it on the
them and that every function adheres to the same shelf, refilling the shelf between deliveries, checking
new standards. for out-dates, mounting promotions, and beyond.

In addition, the business owner of this new process Each SKU’s journey should be mapped and
should be selected with care. Ideally, they should broken down into cost-component steps. Each
reside outside of functions that own a meaningful step includes multiple iterations based on how it
number of cost components; finance is often a good is executed. For example, in–store labor cost is a
option because it lacks a direct stake in where costs component with at least two iterations based on
are incurred. Store operations is another viable how a product is stocked—as a full case or individual
option, as it is furthest downstream in the process. units. Identifying where a product goes and stocking

Bending the cost curve in brick-and-mortar retail 5

 a full case all at once requires much less labor per areas. However, many parts of the organization
unit compared with stocking individual units and have narrow P&Ls that don’t account for cross-
searching for the correct spot on the shelf after each functional effects. As such, end-to-end costs must
one. These cost estimates should be periodically be embedded in the reporting and KPIs of each
refined to reflect changes in cost structure. function. For example, a merchandising decision to
remove shelf space from the planogram of a fast-
Data and analytics capabilities moving SKU should consider more than the lost
Establishing cost transparency should result in the margin and vendor funding. The decision should
creation of a central data repository with access to also consider whether less shelf space may negate
multiple sources of data at the SKU and store levels, the benefit of shipping full cases to the store. In that
including all cost components across sales, cost, case, the SKU in that planogram will incur the extra
margin, safety stock and presentation requirements, cost from being shipped as individual units from the
promotional calendar, planogram versions, and distribution center and the additional cost of having
shipping quantities. Typically, these data sources are to be restocked between shipments if its shelf
not tied to each other, requiring additional work to capacity is decreased.
build a 360-degree view of each SKU.

Once the data are assembled, sophisticated data

and analytics capabilities are needed to simulate the Brick-and-mortar retail will continue being
different scenarios based on variable factors—such challenged to deliver on multiple fronts at once,
as how a product is shipped from the distribution including customer experience, omnichannel
center, in what quantity, and how often. An advanced services, and cost excellence. While initially impactful,
decision-engine algorithm needs to be put in place traditional lean levers employed by store operations
to determine the lowest-cost path through the limit the scope of opportunity by ignoring 50 percent
system and estimate the cost savings should all SKUs of cost controlled by other functions, including
follow the optimal path. Identifying the scenario that merchandising and supply chain. To bend the cost
matches the current state and comparing it to the curve and reach performance excellence, retailers
optimal state can illuminate the concrete savings should take an end-to-end view of cost. With a
gained by moving from the traditional to the proposed data–driven decision engine and senior leadership’s
approach. Savings can be realized both initially, when support, retailers can realize significant opportunity
the decision engine is put in place, and continuously across the organization and make better long-term
as the algorithm becomes embedded. operating decisions.

Key performance indicators and

incentive alignment
While advanced analytics can enable decisions that
optimize total cost across the organization, some
areas of the organization may experience relative
cost increases that permit bigger decreases in other

Praveen Adhi is a partner in McKinsey’s Chicago office, where Aneliya Valkova is an associate partner; Vishwa Chandra is a
partner in the San Francisco office; Karl-Hendrik Magnus is a partner in the Frankfurt office.

Copyright © 2020 McKinsey & Company. All rights reserved.

6 Bending the cost curve in brick-and-mortar retail