Wednesday, February 20, 2013

Dealing With the 900 Lb. Gorilla

It’s hard not to notice a growing trend toward retailers going into downsizing mode. The current inclination of larger brick-and-mortar retailers is to develop smaller prototypes; simply put, big stores are getting smaller. There are several reasons for this – higher unemployment, the economy in general, changing technology - but the biggest factor has a great deal to do with the large, menacing creature mentioned in the title – the looming, gargantuan presence known as e-commerce, about which more in a moment. This downsizing trend is especially pronounced in certain merchandise categories, from office supplies, electronics and appliances, to clothing and accessories and, perhaps most dramatically, books.

Office Depot announced last November that in the next five years 500 stores would be downsized or relocated to smaller 5,000 to 7,000 square foot units, or mid-sized 15,000-17,000 square foot prototypes. Staples announced in September that it was shrinking its average store size from 24,000 square feet to 15,000 square feet. Just this month Office Max indicated it will debut smaller prototypes of 5,000 to15,000 square feet, a fraction of the size of their current stores, which run as large as 30,000 square feet (as I write this, there’s news in the industry press about a possible Office Max/Office Depot merger). As noted, higher unemployment has had a role in the downward trend of the office supply category, but the introduction of tablets and other handheld devices, which is paring demand for personal computers, printers and other office accessories, is also taking a toll on this sector. While the Commerce Department doesn’t specifically report e-commerce sales of office supplies, you can be sure they’re significant.

Another brick-and-mortar store type under very severe pressure is electronics and appliances. The demise of Circuit City is no better example. Smaller chain Ultimate Electronics had no better fate, lasting less than a year in New England. And now, even with considerably less physical store competition, Best Buy is struggling to survive. Similar to office supply stores, the trend toward tablets and smaller hand held devises in lieu of personal computers is crimping profits. Regarding clothing and clothing accessories, Kohl’s announced as far back as 2011 that it was reducing its prototype from 90,000 square feet to 60,000 square feet. As part of that announcement, it said that 30 of its next 40 stores would be the smaller prototype, a size it had been testing in smaller markets since 2002.

The greatest damage, however, has been inflicted on brick-and-mortar book retailers, most notably Borders, which of course is no more, and Barnes & Noble, which recently announced that it would shrink its store base from 689 stores today to something in the neighborhood of 450 to 500 stores within a decade.

As noted above, there have been several reasons for the downsizing trend, but by far the biggest is the exponential growth of e-commerce, represented most dramatically, although not exclusively, by that 900 Lb. Gorilla called Amazon. Online sales of books and magazines exhibited 120% growth in the 2005 -2010 period. In 2010, excluding autos and pharmacy, 15% of all online sales were in this category, second only to clothing and clothing accessories at 20%. And who buys a CD or DVD at Barnes & Noble or Best Buy anymore when you have digital offerings available through iTunes, Pandora, and the like? Between 2005 and 2010, e-commerce sales in music and videos grew a whopping 224%, a stronger percentage jump than any other merchandise line.

Other categories are not immune from the 900 Lb. Gorilla’s King Kong-like rampage. Another burgeoning e-commerce category of note came as a surprise to me. With the exception of music and video, this category grew more than any other, 190% between 2005 and 2010. The category is sporting goods. After seeing that growth statistic, I was curious to see how Dick’s has been doing of late. Based on fiscal 2011 results, the sporting goods retailer reported a 2.0% consolidated same store sales increase – which includes an 0.8% increase in Dick's Sporting Goods stores, a 4.3% increase in Golf Galaxy - and a 36.4% increase in e-commerce! That’s a pretty clear statement about the state of retail today, and about the relationship between actual stores and online stores.

Now, before anyone jumps off any bridges, let me be clear: the shopping center industry is not disintegrating any time soon. There will still be stores, and plenty of them, and we’ll see new configurations of retailers. For example, as a result of the fallout of large format booksellers, the American Booksellers Association recently announced that its ranks had grown by 43 stores in 2012, as independent shops sprouted up from coast to coast. Six of those new stores are expansions of existing independent businesses, which would indicate that these smaller operations are not merely able to stay afloat, but flourish even as larger formats fade away.

Perhaps the best news in this regard is that the enforcement of a state sales tax on online purchases is getting closer, with members of both parties in Congress sponsoring legislation this month that could potentially resolve states' decades-long struggle to tax businesses beyond their borders – a major step toward eliminating a key advantage for e-commerce merchants such as Amazon. This will assuredly curtail some of the double digit growth in e-commerce, and be a sizeable competitive boon to brick-and-mortar retailers. Also, as I write this, Best Buy has announced that it is extending its price-match guarantee, and will now match advertised prices from brick-and-mortar rivals as well as 19 major online competitors, including Amazon – a step toward curtailing "showrooming”. With an aging population and the propensity of boomers to spend more and more online purely for convenience, retailers (for the sake of developers as well) need to take direct aim at the 900 Lb. Gorilla.

Bob Sheehan, Vice President of Research

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