In this three-part series, we start with an overview of why retail experts Rajiv Lal, José B. Alvarez, and Dan Greenberg believe retail is at an inflection point. In Part Two, coming next week, they identify effective strategies for retailers caught in these turbulent times. And in Part Three, the authors look to the future—what will the shopping experience be like for us, and for retailers, as ecommerce becomes an ever larger part of the market.
In early February, 93-year-old retailer RadioShack announced it was filing for bankruptcy. A few days later, Amazon.com—the online giant seller of everything—was reportedly in conversations to buy some of those storefronts—possibly its first real beach-head in the brick-and-mortar world.
As harbingers of the future of retail, these events certainly caught the attention of Harvard Business School Marketing professors Rajiv Lal and José B. Alvarez, and research associate Dan Greenberg (Harvard MBA 2012). Their new book Retail Revolution: Will Your Brick-and-Mortar Store Survive?, predicts, among many other things, the continuing decline of major brick and mortar brands including Staples and Barnes & Noble; the acceleration in closings of shopping malls across the country; Amazon's aggressive expansion of its Prime service; and tough times ahead even for venerable retailer Walmart.
In short, retail is at an inflection point, even though ecommerce still makes up a relatively small percentage of all retail sales. The trends lines are clear: many retail segments are under assault by cheaper, more convenient retailers selling online.
"The surprising thing is that despite the success of lots of big businesses in having developed Internet businesses, despite the fact that they have launched omnichannel strategies, the health of many of these businesses is still challenged," says Lal, the Stanley Roth, Sr. Professor of Retailing. "From a profit perspective, from a growth perspective, and more importantly from a return on investment perspective."
In addition to providing new insights into how ecommerce is changing the nature of retail, the book offers prescriptive advice to store-based retailers caught in the squeeze. "First off, there is no one size fits all answer," says Alvarez, a senior lecturer. "Your strategy depends on what type of items you sell, who your competition is, and whether Amazon can effectively sell the items in your category—think drywall for example."
Rajiv Lal, José Alvarez and Dan Greenberg
For retailers looking for immediate advice, the book details three courses of action to help them. As the threats are not identical across all retail segments, step one is to assess their own strengths and vulnerabilities relative to ecommerce competitors under a framework the authors term TIPS, for technology, inventory, people, and space (size, location, and ambiance). These are the four major assets that retailers must use effectively and efficiently to create a compelling and distinctive value proposition. Based on the answers, retailers then need to consider one of three strategies: Enhance the Value of the Box, Shrink and Transform the Format, or Wind Down.
Sean Silverthorne: Why do you think we are at an inflection point? Ecommerce has been around for several decades, yet still accounts for just 6 percent of retail sales in the United States.
Rajiv Lal: Around the turn of the twentieth century, many of the bricks and mortar players did not have an Internet presence. Now most of them have an ecommerce strategy and have transformed themselves into omnichannel businesses. It's an inflection point because despite all of the good work they have done, many still find themselves in a precarious situation with weak returns on invested capital.
José Alvarez: There are a few other things that make this an inflection point. One is the fact that technological development reached a point where ecommerce is easy and omnipresent. If you think back before smart phones and tablets, shopping on line was much less convenient. Today online shopping is omnipresent. Now as we have our discussion, I can use my smartphone to order tonight's dinner and a necktie for the occasion. Technological developments allow consumers to shop when they want, where they want for almost anything they desire. Associated with that, people are much more comfortable with ecommerce, giving their credit card numbers to Amazon and others, so the comfort and trust levels are much higher.
Also, the logistics networks that companies use to deliver have improved significantly in respect to speed, convenience, and cost. For example, I get Sunday delivery of Amazon through the post office as part of my Prime membership while Amazon, Instacart, and Google Express are currently experimenting with same-day delivery.
The other important factor that leads us to believe that we are at an inflection point is demographics. You have this new generation of digital natives who are used to operating online. Their default option for shopping is through a digital interface. These consumers do not hesitate to place an order for almost any class of goods including shoes, clothing, and other items that were traditionally considered safe from ecommerce.
Q: It also seems that as people have become more comfortable with shopping online, they are buying a wider array of goods.
Alvarez: I remember having conversations with consumers a few years ago where they'd say "there is no way I'm going to buy apparel online". But now over 10 percent of apparel is purchased online. This may not seem like a lot but this level of penetration for ecommerce is often enough to destroy the economics of a brick and mortar chain store.
Lal: You used to think that many categories were immune to the Internet. We thought touch and feel was important in many categories. What we see today is that that assumption is no longer true. Think of how much jewelry is sold online—diamonds—it's incredible.
Q: Does Amazon's growth and market power also add to this feeling of a tipping point?
Alvarez: We are in a place now where ecommerce has become big enough in enough categories to make brick and mortar retailers very nervous about store profitability. Amazon doesn't have to own 50 percent of a category to wreak havoc on the economics of a store. If ecommerce can get 5 percent of a category, that starts to create trouble. Amazon already has a significant percentage of almost every category except groceries and hardware. If ecommerce gets to 10, 15, or 20 percent of a category, your business is in real, serious trouble. A number of categories now are in the 20, 30 percent range and retailers who serve these categories are among the walking dead.
Q: The book outlines three strategies for retailers to consider as responses to the online threat. What are those strategies?
Alvarez: One strategy is what we call is Enhancing the Value of the Box. This strategy is for players who aren't yet significantly impacted by ecommerce and have some runway; Home Depot for example. They use the omnichannel strategy to help their businesses thrive instead of just survive. Home Depot uses the Internet synergistically with their brick and mortar business to enhance the consumer experience and allow them to dream about and complete bigger projects.
Lal: There is the potential to use the Internet to make your store more valuable, like Home Depot does in letting you plan a project online and then coming into the store to discuss it with someone. The customer and the store employee can work together on a project, so it's really about enhancing the value proposition instead of just defending against the threat of the Internet.
If you think of the service side of it, you have businesses like PetSmart where almost a third of their sales are in services, which can't be sold on the Internet. If you need a vet, you aren't going to do that over the Internet.
Q: The second strategy is Shrink and Transform the Format.
Alvarez: The other two strategies we describe—Shrink and Transform the Format and Wind Down—are really about a decision as to whether you think that in the long term the category of goods you are selling can be sold profitably in a brick and mortar store. That's the first decision people need to make if they are being impacted by ecommerce.
Shrink and transform works if you have figured out that the categories you sell aren't going away for good—you aren't Barnes & Noble. What can you do to revitalize your business? You really have to come up with a new format and likely shrink the space. It's likely that consumers are not only going to be looking for something different out of you in terms of value proposition, but you probably don't need all the space you are currently using for two reasons. One, the assortment you are going to be carrying is not going to be as broad. And the space you make available for products is going to support a different value proposition, whether its service, or it's a showroom for the products of a manufacturer, but you really need to reimagine what the right customer experience is and what the right cost base is to make this capital efficient for shareholders.
Best Buy is a good example. Best Buy has taken most of its commodity TVs and said we are not selling them in the store anymore. If you want to, you can get them online and Best Buy will sell them to you in a more efficient way. Their stores are going to be all about the cool, interesting, new—what I would call the fresh items. This idea of freshness is to keep the consumer engaged in what you are doing, and also from a profitability perspective to make sure you are selling items that have good profit margin. That is critically important.
So it's taking a cold hard look at your business and asking, are there enough people who are going to continue to buy your goods in a store over time?
Q: If the answer is no, that I'm doomed to be disrupted by ecommerce, it sounds as if the third strategy, "Wind Down," is for me. How does that work?
Lal: If you look at any retail business there will be some categories that will be in that class. If you think of Barnes & Noble, almost 100 percent of what they sell is seriously affected by the Internet; it's all digital goods or digitizable goods. The same is true of media retailers, games retailers, software retailers.
Alvarez: If you're being digitized or people just aren't buying your categories anymore, then you just have to wind down that business and make it into an appropriate cash-flow generator for the shareholders. Basically you are managing to create an attractive annuity for shareholders.
Lal: It's not just about eliminating the stores, but managing the business to maximize cash-flow. If done intelligently this can generate a lot of value.
Q: One piece of advice you give to brick and mortar retailers is to think of their business in terms of TIPS: Technology, Inventory, People, Space. What do you mean?
Lal: Those are the four big assets that retailers must optimize. If store based retailers cannot figure out how they can put these assets together efficiently to create a unique and distinctive value proposition for customers, these assets will not return their cost of capital. The store will not be attractive to customers and investors will no longer be willing to invest. To make your store relevant, you have to ask: can I use each of these assets in a distinctive, effective, and efficient way?
Q: For decades, Baby Boomers have driven the economy. Now, as you point out, Millennials are climbing into the driver's seat. From the retailers' perspective, how does this change the market?
Alvarez: As people get older they buy less stuff and buy more experiences. As Baby Boomers age, you are hearing this big sucking sound as consumption goes away from retail and goes much more to cruises and vacations, grandkids and college. So it's important for retailers to think about how to keep Baby Boomers engaged and coming into your store. But they also have to start catering pretty heavily toward the millennials. And millennials may not be that interested in what you are selling in a store, because their viewpoints are so different.
For example, they are probably a lot more frugal. We don't know going forward, but we do know right now they have a lot less disposable income and they are little bit scarred from the recession. They have taken the biggest lumps in terms of financial hits, which has led them to delay getting married, delay having babies, delay purchasing homes, etc. It is not certain what the long term consequences of the recession will be for millennials but for the time being this group has a gun-shy nature and they are pretty frugal.
Lal: Millennials are also attracted to experiences, like Baby Boomers.
Alvarez. Yes, they are interested in experiences and social communities. They are driven towards cities and this is driving a reurbaniztion of America. That has a big impact because you have all these stores that have been built in the suburbs where fewer people want to live today. Retailers are going to have to think long and hard about these trends. They need to find compelling answers to some key questions: How do you create experiences? How do you create community? How do you make sure consumers feel like they've got a good deal? And how do you make yourself closer and convenient to a customer who is now more and more in cities.