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Next (NXT) and N Brown (BWNG) have been hugely successful, mainly because internet shopping was a natural extension of their catalogue businesses. But companies such as Kingfisher(KGF), who are lumbered with vast store estates, are still behind the curve, with only 5 per cent of UK sales bought online.

Searches from overseas to UK retailers' sites grew by 25 per cent year on year over Christmas, according to the British Retail Consortium (BRC), demonstrating the importance of a good web offering in securing a foothold on the global stage. Yet for many, the internet has been a double-edged sword. On the one hand, it attracts shoppers, generates sales and fosters customer and brand loyalty. But it's also costly, a logistical nightmare and unprofitable in some cases.

Delivery wars

Part of the challenge with online shopping is that it's no longer enough to simply offer it. Retailers now have to be 'multi-channel' - stores and online - as spoilt consumers demand a smorgasbord of delivery options, from click & collect to home delivery, a choice of ways to pay and special websites for their handheld devices. They also want a seamless experience, which means having the right sizes in stock at all times. Delivery is competitive too, with next-day delivery becoming the norm and many shops shipping goods for free.

For companies that don't have their multi-channel houses in order, keeping up with this staggering pace of change is both difficult and costly. Take Marks & Spencer (MKS), which is undergoing an expensive overhaul just to catch up with better-positioned rivals such as John Lewis. A lot of investment is going into the online operation rather late in the day; a massive new 900,000 sq ft distribution warehouse for online orders has just become operational, but incredibly a revamped website won't be ready until 2014.

The profit conundrum

Making money from the web isn't easy, either. Retailers will trumpet their online sales growth, but it's telling that few disclose the profitability, or margins, of their internet operations, probably because they are pretty poor. In clothing, for example, up to 45 per cent of stock is returned - with retailers footing the bill. Food margins are already paper thin, but delivery and fulfilment costs are higher because the goods are perishable and need to be kept chilled or frozen.

Food isn't as easily automated as general merchandise, either, so orders are more expensive to fulfil. Online-only grocer Ocado (OCDO) has a state-of-the-art fulfilment system that is more efficient than any other, but the company has yet to post a full-year of pre-tax profit. In fact, analysts believe supermarkets subsidise the cost of fulfilment and delivery to the tune of £15 a shop to shield consumers from the true price.

"Online generates great growth but this is often offset by the effect on margins and profitability," explains Neil Saunders, managing director at retail consultancy Conlumino. "It's a margin depleting problem for everyone, but bigger for the grocers. Most grocers would push a button to dis-invent online if they could. It doesn't do their business models any favours."

Kate Calvert, an analyst at Cantor Fitzgerald, argues that no single retailer is failing online, but does question whether they are actually making much money. Either way, she insists online is still vital because it prevents consumers from going elsewhere. "The multi-channel customer is more loyal and if retailers don't offer a multi-channel service, they will lose market share," she explains.

That's beautifully illustrated by Morrison (MRW), whose lack of an online proposition has lost it customers. Rivals Tesco (TSCO) and Sainsbury's (SBRY), who have been doing business over the internet for years, claim their online operations are profitable, but won't reveal margins. Clearly, the important thing for them here is market share, not profit. Still, Sainsbury's says revenue from customers that shop online and in store is more than double that of a store-only shopper, which helps offset the extra cost of the net. Others make similar claims about 'multi-channel' shoppers, highlighting how a good website can actually drive store sales, rather than cannibalise them.

The space race

For businesses that have been traditionally heavily store-based, it can be difficult to reconcile physical space with cyberspace. Many are at a tipping point where the impact of the web means stores have to close. BRC data shows the national town centre vacancy rate in the UK was 12 per cent in April - the highest since the survey began almost two years ago - while footfall in out-of-town malls, home to the superstores, is falling. But getting out of long-term leases is both difficult and expensive. Kingfisher, with its bloated B&Q estate, knows how slow and painful it can be.

There's also the problem of customers going into shops for the expertise, only to buy the product more cheaply online. Dixons (DXNS) is trying to stop this by offering high-quality service, aftercare and tutorials. It has had some success; same-store sales in the UK and Ireland grew 13 per cent in the fourth quarter, while multi-channel sales rose 7 per cent over the year.

But for some retailers the internet will only ever generate a fraction of total sales, if any at all. For Topps Tiles (TPT) and car dealer Lookers (LOOK), online is more about showcasing the products and offering information than delivering sales directly. Once, shoppers used to visit five car showrooms before buying a new motor, now it's just one, having done all the research online. Topps' customers like to browse online before hitting the store, too.

"The high street is not dying, it's evolving and still has an important role," argues Mr Saunders. "It's about using stores in tandem with online and understanding that the two are better together than their individual parts. That is key." 

IC VIEW:

After a strong 2012, retailers will find this year tougher as consumers continue to tighten their belts. True, the general retail sector is up a fifth and food retailers are up 14 per cent in 2013, but there are huge variations here. That's why investors should favour companies with flexible, well-established multi-channel businesses. Retailers with a good internet offering won't necessarily outperform - online is only part of the wider picture - but those who lag behind will be at a big disadvantage.