Complex and expensive, online retail fulfillment costs form the bulk of retailers’ operating costs — 15% of sales, on average — and without close control, firms’ costs will spiral and service levels will plummet, according to a new report from Forrester Research (Nasdaq: FORR).

“Europe’s misguided retailers enjoy blissful ignorance of fulfillment performance,” said Forrester Senior Analyst Julia Woodham-Smith. “They fail to do the hard work needed to monitor and manage fulfillment despite the huge impact on the bottom line. Unless retailers develop a detailed and integrated picture of customers’ activities throughout the fulfillment process, they will continue to waste money and lose valuable customers due to poor service.

“Retailers don’t know their true costs and falsely believe that growing volumes and squeezing vendors will solve their cost problems. But the full cost picture is worse than firms think because economies of scale won’t materialize and vendor prices will rise. As external factors won’t drive fulfillment costs down, online retailers will have to get their own house in order by focusing on one key metric per component — contact center, warehouse, and delivery. Effective customer management requires that firms integrate processes not only across components, but also beyond fulfillment operations to include marketing and merchandise. Indeed, online fulfillment components interweave, cost dependencies reach beyond fulfillment, and customer value defines performance standards.”

The route from rock-bottom fulfillment costs to profit depends on the gross margin per basket, Forrester argues. The dream category is downloadable software, with next-to-zero warehouse and delivery costs. But nonwarehoused products that mail carriers can shove through a letterbox, such as event tickets and holiday trip folders and tickets, ensure that fulfillment costs can be as low as 2% of basket. Strong margins in household goods, clothing, and footwear, or high basket sizes for computer hardware, combined with easy-to-box-and-ship products, lead to a reasonable route to profitability; fulfillment costs should remain below 12% of basket value and consume no more than 20% of gross margin per order in these categories.

“In categories with high handling and delivery requirements, like furniture or home appliances, or low basket sizes with only moderate margins, like health and beauty products, there is little room for fulfillment error as fulfillment at base level captures between 12% and 23% of basket and between 39% and 64% of gross margin per order,” Woodham-Smith added. “Slim margins combined with bulky products, like pet supplies and toys, or low margins with low basket sizes, like books, mean that fulfillment costs account for a massive 80% or more of gross margin per basket. Online businesses with typical retail margins in this segment can barely survive.

“Retailers in every fulfillment segment have a laundry list of actions to cut costs. The skills required for cost control at the contact center, warehouse, and delivery stages span across components. For effective management, retailers must develop one set of skills that all three fulfillment activities can share. They are, respectively, accurate demand forecasting, creative labor management, and central vendor partnering.”

For the report “Managing Fulfillment For Profit,” Forrester spoke with 40 retailers across Europe.