The Scale Of The Threat
After years against the ropes, many retailers are fighting out of the corner: revisiting store layouts and shifting particularly hard-hit merchandise categories or sub-categories online. Best Buy, for example, allots floor space only to higher-end televisions—commodity-level TVs are mostly merchandised online. Virtually all major retailers have rolled out or are experimenting with programs, such as buy-online-pick-up-in-store (BOPIS) and ship-from-store (SFS), to increase their store productivity and expand their integrated presence across multiple retail channels (i.e. brick-and-mortar store, web, and mobile; also known as omnichannel retailing).
The Scale Of The Threat
Nonetheless, we hold that these arguments admire the forest while forgoing an inspection of the trees. And many trees in the retail forest, that is, many brick-and-mortar stores, are in ill health. Like trees, retail stores are long-lived, often with leases lasting ten or more years, and are unable to rapidly adapt to meet a changing environment. Online sales, no matter if they come from pure-play online retailers or omnichannel retailers, suck volume out of a store and often lead to more intense price competition. For reasons we'll cover later in this book, neither buy-online-pick-up-in-store nor ship-from-store are enough to save these categories. The online threat is different from what retailers have faced in the past. Although Walmart took an enormous amount of market share in a diverse set of categories, many retailers were able to respond to and effectively co-exist with Walmart.
However, with ecommerce we believe we are now at a tipping point for many retailers.
Category killers are highly focused retailers specializing in a category of goods that succeeded against Walmart due to their deep assortment, aggressive pricing, large stores, extensive store network, and knowledgeable salespeople with "deep expertise in the categories they served." Against Amazon and other online retailers, these advantages fade. Online retailers have appropriated the strengths of category killers, and can offer wider assortments than any store, have driven prices to new lows, and replace associate knowledge with editorials, professional and customer reviews, and ratings systems. Expanding fulfillment networks get products to customers in increasingly shorter time windows, defeating any convenience advantage that category killers might have. Additionally, online retail is open 24 hours a day, 7 days a week and is available from one's own home without a trip. While Amazon has been compared to Walmart, it's probably most apt to compare Amazon to category killers.
Amazon's sales are only a fraction of Walmart's, but like category killers, its market share in some categories, like books, is enormous. Later in this chapter, we've modeled the levels of gross margin or same-store sales declines, which, everything else equal, retailers in categories particularly hard hit by eCommerce could incur before their stores are in serious trouble. We found that small declines in same-store sales or gross margin could turn a profitable store base into one that is best left to wither.
“Online retailers have appropriated the strengths of category killers, and can offer wider assortments than any store, have driven prices to new lows, and replace associate knowledge with editorials, professional and customer reviews, and ratings systems”
Understanding how online retailers can cause these same-store sales and gross margin declines by affecting the operating metrics of a retail store is fundamental to understanding the threat brick-and-mortar retailers face. Margin compression is where most studies of the online threat begin. In most, though not all, retail verticals, online retailers can offer lower prices than brick-and-mortar retailers because of their lower cost structures. In the face of this price competition, brick-and-mortar retailers find themselves either lowering their prices across the board, instituting price-match policies with online retailers, or accepting that they will lose sales to customers who are showrooming. In all of these circumstances, either because of price reductions or fixed cost deleveraging (when low or negative sales growth reduces the amount earned on fixed costs), the brick-and-mortar retailer finds itself with shrinking margins.
Online retailers' lower cost structures are driven by a variety of cost efficiencies. From an employee perspective, positions such as cashiers and sales clerks are eliminated. Automated check-out procedures take their place and the need for stocking or tidying up merchandise at store level doesn't exist. Without a store network, real estate costs are confined to a handful of distribution centers. Inventory aggregation at a few key points of distribution rather than throughout a store network means that forecasting can be more accurate and replenishment more timely, and thus markdowns, shrink costs, and working capital needs are reduced.
Online fulfillment and home delivery also create traffic problems for brick-and-mortar retailers. Brick-and-mortar retailers have long benefitted from merchandise lines that matched needs and trip-drivers with impulses and wants within their stores. If shoppers can get their primary purchases online, brick-and-mortar retailers can't sell them the rest. For example, if customers cease buying their high-ticket electronics in-store, Best Buy associates can neither upsell the customer to a device that may suit their needs better or make complementary sales of cables and ancillary devices that may improve the experience, and that customers are unlikely to buy online themselves. On a broader scale, while still a very small part of the total market, online fulfillment of basic needs, such as Consumer Product Goods and apparel basics, is growing. With customers increasingly ordering these and other products online, potential shoppers have fewer reasons to leave their homes, and the clothing store collocated with the supermarket can't benefit from grocery trips that don't happen. As a result of increased online shopping, traffic across the retail sector is falling (by as much as 50% when the holiday months of 2010 are compared to those of 2013). Exacerbating the traffic decline, when shoppers do leave their homes, they have often already researched the products they are interested in purchasing online. This makes them less likely to browse, research, and compare prices across brick-and-mortar locations, and thus shoppers visit fewer stores per trip, resulting in a decline in overall traffic. This same behavior also leads to more targeted buying both online and in-store, which can reduce stores' ability to upsell, make complementary sales (recall the Best Buy example), and make impulse sales (think candy at the checkout), resulting in smaller shopping baskets. This basket disruption could cause the business models of many retailers to fall apart.
“If this cycle continues, whole retail chains can quickly become full of zombie stores”
Taken all together, lower price points, decreased traffic, and smaller baskets means lower sales and margins for brick-and-mortar stores. Given recent promotional intensity and continued declines in retail store asset productivity since 2007, these issues become even more pertinent. Compounding the issue, most retailers have already reduced their in-store labor to such an extent that further cost-cutting has a negative impact, and thus the costs of operating a store today are largely fixed. Retailers arrived at this point in part due to the recession when many retailers reduced headcounts as customers focused more on price and less on service, but also as a result of long-term initiatives like self checkout, which eliminated many cashier positions; inventory, ordering and logistics systems implementations, which reduced merchandise handling; labor scheduling systems coupled with a greater use of part-time labor sector-wide, which aligned employee levels closely with customer visits and left little spare capacity; and through outsourcing many tasks that used to be performed in-store, such as pre-packaged meat eliminating butchers in supermarkets and apparel goods retailers contracting third parties to sort, hang, and tag incoming products so that they are shelf-ready. As a consequence, the ordinary levers that retailers could pull to respond to crises have already been used, and, barring radical changes, stores with long-term leases are largely at the mercy of the deteriorations in same-store sales and gross margin caused by eCommerce.
As brick-and-mortar sales per store decline, fixed assets become less productive, and retailers face declining profitability. As prices are lowered, gross margin declines directly eat into net margins. Although this dynamic does not necessarily send retailers directly to bankruptcy, falling store profits will force many retailers to a point where the return from continuing investments in stores is less than investors could achieve elsewhere. Pursuing higher returns, retailers then enter a vicious cycle of reduced investment and cost cutting that leads to customer dissatisfaction and a lack of differentiation. Supervalu's Jewel and Albertsons stores went through this vicious cycle when, due to Supervalu's high cost structure and heavy interest payments, the chains cut store investments during the recession, leaving many stores unremodeled for years and "cluttered," which turned off shoppers. If this cycle continues, whole retail chains can quickly become full of zombie stores.
Zombie chains still generate cash flow, but reinvesting in the store base—to paint the walls, introduce new fixtures, and spruce up the establishment—doesn't make financial sense. Instead, the zombie stores continue to exist, eating away at sales that their healthier, competitive counterparts could instead capture. When these chains eventually enter bankruptcy, they are allowed to break leases and shut down their unprofitable stores. The newly reorganized chain generally has not solved the basic underlying issues created by the online threat. However, it now has a smaller, healthier set of stores that begin anew the downward spiral. A&P provides a strong example of this spiral, and, remarkably, is still around, and still not on solid ground, after numerous rounds of store closures and selloffs.