The 3 Biggest Last-Mile Challenges the Retail Industry is Facing Today

While some trends that emerged during the pandemic were wholly new — sports stadiums full of cardboard fans, DIY haircuts, Tiger King — in many other ways, the pandemic only accelerated changes that were already underway.

This is especially true for the retail space. While American consumers had been steadily shifting their spending online for years, e-commerce made a quantum leap when the pandemic transformed life as we know it practically overnight.

This jaw-dropping growth in online shopping has presented businesses with unprecedented challenges. To get a clearer sense of where this rapidly shifting landscape stands today, we surveyed 500 consumers and 200 retailers and brands. What we learned may surprise you.

In this report, we explore:

• The extent to which retailers have reached their fulfillment capacity choke point and just how much that’s harming sales
• Which retail stakeholder is in the ultimate position of power (hint: it’s not Amazon.)
• Why retailers lose an entire week of online sales during the most lucrative time of the year
• How the definition of “fast” varies widely depending on who you’re asking

Read on to learn about the three biggest fulfillment challenges retailers are facing today — capacity, carriers, and consumer expectations — and how retailers can overcome these challenges to stay competitive and best serve their customers in an unpredictable and ever-evolving market.

E-commerce sales penetration more than doubled from around 16% in 2019 to 35% in 2020

While e-commerce had been growing at a steady clip of 11 percent year-over-year, in 2020, online sales penetration in the United States saw roughly ten years of growth within 90 days’ time. Lockdowns and shelter-in-place orders left consumers homebound practically overnight, forcing them to shop online not only for ordinary essentials such as groceries and clothes, but also for new needs such as outfitting home offices and entertaining stir-crazy kids. Consumers flocked to online shopping in droves and the online share of retail sales skyrocketed to 35 percent.

Since this initial spike in e-commerce penetration at the onset of the pandemic, American consumers have largely maintained their online shopping habits. While in-store sales saw 5 percent year-over-year growth in August 2021, e-commerce has held strong with 30 percent year-over-year growth.

Although the future of the pandemic remains hard to predict, one thing is certain: online shopping is here to stay and retailers and brands need to adapt to this shift more quickly than they might have originally planned.

99% of retailers have lost sales due to a lack of sufficient fulfillment capacity

Nearly every single retailer we surveyed reported that they lack the fulfillment capacity they need to keep up with the onslaught of online orders. The capacity problem is largely defined by real estate and labor woes.

Retailers lack sufficient real estate

• Retailers will need an additional one billion square feet of warehouse space for e-commerce by 2025, says JLL
• Traditional fulfillment methods are an intensive use of real estate, with most requiring three times the space as traditional throughput distribution
• Average industrial rents increased by a record 8.3 percent year-over-year in Q4 2020, says CBRE, while prices for costal markets near dense population centers grew by double-digit percentages
• Stores may soon dedicate as much as a third of their store space to online order fulfillment

Labor shortages are acute

• 1 in 3 retailers we surveyed identified labor shortages as a top threat to their entire e-commerce business
• The US labor force shrank in September — though there are 10 million open jobs, there are five million fewer people working than before the pandemic began
• The warehouse and transportation industry had a record 490,000 job openings in July

Not even the Goliaths are immune — after doubling the size of its fulfillment network in the past 18 months, Amazon has still “been playing catchup pretty much since the pandemic started,” reported its CFO in an earnings call. Its focus is “squarely on adding capacity to meet the current high customer demand.”

Retailers lost an average of 22% of sales last year due to insufficient fulfillment capacity and expect to lose nearly 30% this year

As a result of fulfillment capacity restraints, the retailers we surveyed estimate they lost, on average, more than 20% of sales in 2021, and more than 25% of retailers estimate they lost up to 50% of sales.

This year, retailers expect the capacity problem to only become more acute. 31% of retailers we surveyed expect to lose 25-50% of sales in 2022 due to lack of fulfillment capacity, and nearly 20% expect to lose more than 50% (!).

A major driver of these losses? Retailers are holding back on promoting and advertising inventory they already have in stock due to fulfillment capacity constraints.

Retailers say increasing fulfillment volume capacity is their #1 priority for the coming year

Although retailers have many headaches, the issue of fulfillment capacity single-handedly eclipses all other worries — more than reducing costs, improving change management abilities, or reducing out-of-stock inventory.

If retailers had the fulfillment capacity they needed to meet consumer demand, online sales penetration would already be as high as 40%

Since its hockey stick leap in March 2020, e-commerce penetration has largely leveled off. While many have attributed this flattening to a return to pre-Covid behavior amongst consumers, we assert that penetration has only stabilized because retailers’ fulfillment capacity has maxed out. It’s not that demand has ebbed; it’s that retailers have reached their fulfillment chokepoint and supply can’t keep up with the demand.

Our calculations project that if retailers had the fulfillment capacity they needed to earn the 22% of sales they estimate they lost this year, the online share of retail sales would have reached 40% by today. (Given the lockdowns and safety measures that prevented consumers from making in-store visits, this calculation assumes that the sale didn’t happen offline either and was entirely lost.)

The rise of e-commerce has put shipping carriers in a position of power, squeezing the retailers who rely on them

Even if retailers manage to successfully scale their fulfillment capacity to meet the surge in demand for online orders, they face daunting challenges in the next link of the supply chain: dispatching online orders and delivering them to consumers’ doorsteps. The meteoric rise of e-commerce has created a supply and demand imbalance that puts carriers in a position of power. UPS, FedEx, and USPS are said to control about 95% of last-mile deliveries of third-party parcels.

E-commerce order volume grew by an average of 30% in the last year, the vast majority of which was residential deliveries

The businesses we surveyed reported that their e-commerce order volume grew by an average of 30 percent last year, with 37 percent reporting that it grew by as much as 50 percent and another 11 percent reporting that it grew by more than 50 percent. The vast majority of these shipments have been residential deliveries, which are inefficient and barely profitable (if profitable at all) for shipping carriers.

1. Residential deliveries are inefficient, one-package stops

In residential deliveries, there is an average of 1.2 pieces per delivery,whereas in commercial deliveries, the pieces per delivery is about 2-3.

2. In residential deliveries, stops aren’t in close proximity to each other

Compared to business deliveries, where drop-offs are in dense urban centers usually in close proximity to each other, residential deliveries are widespread and far-flung. This makes B2C deliveries slow and expensive to execute.

3. Residential deliveries are besieged with problems and inaccuracies

Whereas most business deliveries require a signature and are largely headache-free, residential deliveries are prone to porch piracy and delivery to incorrect addresses.

Because of this unanticipated spike in residential delivery volume, delivery on-time performance (OTP) — considered to be a key indicator of shipping carrier capabilities — has suffered. Even prior to the holiday season, FedEx, UPS, and USPS hadn’t caught up to the Covid crush of demand and were struggling with their volume capabilities.

ShipMatrix estimates that in September 2021, 3 million parcels per day were being delivered late. These late deliveries are a costly and burdensome problem for shipping carriers, who have negotiated money-back guarantees with retailers in the event of such delays.

The rise of residential deliveries and the stress it’s placing on shipping carriers has led to an existential reckoning of the retailer and shipping carrier relationship, with shipping carriers actively culling accounts that are burdensome and unprofitable.

One Friday in June 2021, FedEx Freight announced that effective the coming Monday, it was immediately cutting service to 1,400 customers, giving the retailers virtually no time to make alternative shipping arrangements. This move impacted not only smaller businesses, but also larger brands such as Lowe’s and Costco. The backlash was so swift and instantaneous that FedEx immediately reinstated partial service to a portion of the affected customer base.

This aggressive culling of accounts is the main reason that on-time performance metrics were strong during the 2021 holiday season, with FedEx hitting 97.4%, UPS 99%, and USPS 98.6% for the week of November 28th to December 4th. Framed differently, performance only improved because fewer residential deliveries were made.

In a 2021 Q3 earnings call, UPS CEO Carol Tome said, “We’re controlling the volume that comes into our network because we are laser-focused on revenue quality. We used to think that every package was the same; we don’t think that anymore. For some shippers, we’re no longer delivering their packages and that’s OK with us.”

We asked businesses what the biggest threats to their e-commerce business are, and shipping carrier capacity limits looms as a top threat, rivaling supply chain delays and eclipsing labor shortages and shipping and fulfillment costs.

Carriers have also aggressively raised their residential delivery rates, with the price of delivering a package increasing by 71% in just 5 years

For high-volume brands and retailers, punitive surcharges incurred by FedEx and UPS have dramatically increased the cost of doing business. Due to peak residential surcharges imposed at the onset of the pandemic, shipping a 2-lb package via ground from Chicago to NYC skyrocketed from a little more than $10 in 2016 to more than $18 in 2021, based on our estimates.

That’s an increase of 71% in just five years, inviting the question: with free shipping now a given for most consumers, how long can merchants continue to eat these costs?

The rising residential delivery surcharges have become untenable amongst the retailers we surveyed. They report that reducing shipping costs is a top factor for success, rivaling increasing fulfillment volume capacity and overshadowing all other priorities, including reducing reliance on manual labor and reducing the amount of out-of-stock inventory.

With no obvious alternative to the large shipping carriers, retailers will need to take a fundamentally different approach to fulfillment to fix this power imbalance.

Retailers and consumers fail to see eye-to-eye about speed of delivery and when it will be critical to remaining competitive

Until recently, the traditional trifecta of customer satisfaction was always considered to be free shipping, price, and positive reviews; outside of food and groceries, speed of delivery wasn’t considered terribly emergent. When Amazon rolled out its next-day shipping push, retailers were warned to step slowly into one-day shipping themselves.

As recently as 2019, the Wall Street Journal warned, “A lot of ultrafast last-mile delivery solutions that consumers don’t even really ask for… ultimately are high-cost endeavors that don’t ultimately help a retailer’s bottom line.”

That’s simply no longer true. Whether they’re shopping online for rain boots, dog food, mascara, or a new Playstation, a growing number of consumers now consider fast delivery to be a critical offering.

61% of consumers define “fast delivery” as next-day or faster while 77% of retailers define it as two-day or slower

According to 61 percent of consumers we surveyed, “fast delivery” is next-day or faster — among them, 44 percent consider same-day to be “fast.” Yet only 23 percent of retailers define “fast delivery” as being next-day or faster, and among them, less than one percent define it as “same-day.” Instead, 41 percent of retailers define 2-3 day shipping as “fast,” while only 14 percent of consumers define it as such.

Nearly 1 in 4 shoppers consider free two-day shipping to be a make-or-break factor when purchasing, yet 40% of retailers don’t currently offer two-day shipping at all

92 percent of consumers we surveyed want retailers to provide free two-day shipping, with 23 percent considering it a “must-have” (if the retailer doesn’t offer it, they won’t buy), 35 percent considering it very important (if a retailer doesn’t have it, the consumer will purchase but only if they have no other option), and 34 percent considering it “nice to have” (they prefer to have it but it’s not a requirement). In other words, almost 1 in 4 consumers will shop elsewhere if a retailer doesn’t offer free two-day shipping.

While 60 percent of retailers currently offer two-day shipping, 4 out of 10 retailers do not and among them, nearly half have no plan in place to roll out the offering. This warrants a bell of alarm given that the majority of consumers already have demonstrated a clear expectation for retailers to provide the service — and for free to boot.

More concerning is that 68 percent of retailers do not believe that providing free two-day shipping is a requirement to stay competitive today. This number conflicts with the 58 percent of consumers who consider free two-day shipping to be very important or non-negotiable.

It’s one thing to not offer a service because it’s operationally and financially difficult to do so; it’s another thing entirely to hold the false perception that the service is unimportant.

Until recently, same-day delivery was considered a premium service that not even all grocery retailers managed to provide. That’s all changed now. Among the consumers we surveyed, more than 80 percent are more likely to purchase an item online if they can get it delivered the same day. According to Research and Markets, the same-day delivery market in the US is poised to grow by $9.82 billion over the next four years.

Consumers already value same-day delivery so much that the majority are willing to pay for it. Given that people have become overwhelmingly accustomed to free shipping, their willingness to pay a premium for the service reflects how much they value speed — and can reassure retailers and brands who are already stretched thin that consumers don’t necessarily expect them to eat the cost of the pricey proposition.

Yet once again, there’s a significant gap between the delivery speeds that consumers value and what retailers are currently offering. Despite almost 70 percent of consumers being willing to pay for same-day delivery, only 25 percent of retailers we surveyed currently offer it as a service.

While it’s understandable that retailers wouldn’t offer same-day shipping, which is operationally, strategically, and financially burdensome, it’s concerning that 64 percent of retailers do not consider it to be a requirement to stay competitive. Consumers have demonstrated that on-demand delivery is a service they want and are even willing to pay for; it’s a dangerous trap for retailers to hold the false perception that it’s unimportant overall.

It’s not that retailers are blind to consumers’ rapidly evolving preferences for speed; the majority believe that next-day and same-day delivery will be an absolute requirement to stay competitive within two years.

Retailers’ fundamental misunderstanding seems to be about when offering fast delivery will be of critical importance. For consumers, it’s not one or two years from now; it’s now. Their preferences have shifted so quickly that retailers haven’t been able to adapt and prioritize everything at once.

With other innovations such as checkout-free shopping, virtual fitting rooms, voice commerce, and other amazing omnichannel experiences monopolizing retailers’ attention, delivery speed has slipped to the bottom of the list.

While retail was never an easy business, the stakes have never been higher (or more complex) than they are today. Capacity constraints, carrier limits, consumer expectations — this confluence of factors is stretching retailers to the financial, operational, and strategic breaking point.

Most retailers we surveyed know that in order to sustainably meet the rise of e-commerce orders at scale, they need to increase their fulfillment capacity and implement a distributed strategy that will free them from their overwhelming dependence on national carriers and enable the fast deliveries that consumers have come to expect. But how?