The Surprising Winners and Losers in the Retail Revolution

The growth of ecommerce is creating new leaders in retail while putting many famous brands at risk. Professors Rajiv Lal and José Alvarez pick the winners and losers in part two of our series on their new book, Retail Revolution. PLUS: An excerpt on the future of grocery stores.
by Sean Silverthorne

The new book Retail Revolution: Will Your Brick-and-Mortar Store Survive? lays out the thesis that traditional store-front retailing is at an inflection point, under tremendous pressure from ecommerce and the changing wants and needs of a new generation of shoppers—the millennials.

In Part 2 of our three-part interview with Harvard Business School Marketing professors Rajiv Lal and José B. Alvarez, they discuss who is winning this revolution and which brands appear to be losing ground.

Sean Silverthorne: Among the retailers you have found to be most successful in striking a balance between brick and clicks are Home Depot and Pet Smart. What did Home Depot do right?

Rajiv Lal: Home Depot thought about the challenges facing their business very strategically. They've gone category by category and asked: What is the best way to service the customer in this category? Does it makes sense to sell these products online, in the store, or both, and how? Take lighting as an example. Home Depot asked: How do we best help customers with their lighting needs? What knowledge, products, and services do they need and in what form? What should we do with lighting in the stores? Should we eliminate it, sell it only online? If not, what is the requisite assortment we should carry? What's the appropriate pricing in the store? They decided on a limited assortment in-store, that is mostly private label and where price comparison is not possible.

Jose Alvarez: This approach to categories is seminal to what they've done to reinvigorate their business. They looked strategically at all aspects of their offering across the various channels they have at their disposal to maximize customer satisfaction and the return they get on their TIPS (Technology, Inventory, People, Space) assets. For example, if your toilet blows up, you aren't going to wait two days for delivery for a part from (competitor) Amazon Prime. You need that part right now. You need it to be in stock, and you need somebody to help you understand what to do, what kind of silicon sealer you need—Home Depot does a great job of that. They make sure they carry enough inventory so you can get that job done immediately. Lighting fixtures, on the other hand, are a different animal. There are hundreds of thousands of options to choose from and generally the need is not an immediate one. They carry a selection of good, better, and best options in-store along with the electrical supplies and tools you will need to install the fixture. Online they carry an endless aisle of products and they provide videos and expert advice to help with installation. They do not deploy their TIPS assets in a one-size-fits-all manner. Home Depot has studied deeply how to best deploy their assets in order to satisfy the customer in a way that allows for an excellent return on invested capital.

They have also paid very close attention to what is likely their most profitable customer segment, professionals. They have created wonderful technology and processes to support customers that align with their entrepreneurial culture. If you are a professional today buying from Home Depot, an app on your phone lets you order directly from the job site and gives you the option to get delivery to the site based on urgency of your need and willingness to pay.

Lal: They've created new sources of value for their customers that did not exist before.

Q: And PetSmart. What's made them so successful?

Lal: PetSmart saw the online threat early and built a strategy to insulate themselves from the damage that ecommerce could inflict. They saw what was coming, and entered services. If you look at the store today, almost a third of PetSmart's sales are in services, things like grooming or hoteling—those sales aren't going away, they are not threatened by the Internet. And while the pet parent waits for the services to be completed, PetSmart provides a wide array of in-aisle treats and accessories to drive impulse purchases. At the same time, they've maintained a strategy of exclusivity with pet food so that they are not stocking all of the same items that Walmart and the supermarket carry.

Alvarez: PetSmart saw the Internet challenge back in 1999 and 2000 when came along; they dreamed up this strategy very early on. To me, it's a lesson on just smart strategic leadership. They saw the threat and came up with a smart strategy that placed them where the puck was going.

Q: Those are two winners; which businesses do you think are at risk?

Alvarez: In the worst shape are the stores that said: I can fix that. Maybe it's not fixable—maybe 80 percent of your products are now going to be sold online or in a digital format, like books. Barnes & Noble and Staples are two companies in great peril because, not only is the Internet more efficient at what those stores sell, what they sell may no longer needed by the customer!

Those are the easier ones to see in decline. But there are some businesses that at first glance look to be OK but on close inspection are in trouble. A company that's going to be in trouble over the next few years is Kroger in the food space. They are a very large company. They have all this leverage against suppliers. They have huge cash flow, customer counts are fine, they've crushed the competition. But I think they are at an inflection point. Is the typical Kroger store going to be where the average person is going to want to shop in a few years? I don't think so. This is true for the supermarket space in general; it's really not about Kroger as an organization. Supermarkets are these very large, impersonal, and inefficient spaces for customers. Grocery shopping is one of the most unappealing chores for a large swath of customers. The supermarket space is ripe for disruption by ecommerce.

But it's not just about the ecommerce. Other changes are going on in the environment. People don't know how or don't have the time to cook, so they are eating pre-prepared meals more often. There is also the fact that if you go to a CVS or a Home Depot, there is a panoply of products that were once the sole domain of supermarkets. Twenty-five years ago supermarkets had more than 80 percent of the consumables market share; today that number is in the low 40s. Now it appears that everybody sells consumables including the 30,000 or so dollar stores in the United States. You only have to take a look at the UK supermarket space to see what is ahead for the US supermarket industry in this regard.

Q: The book makes the case that even Walmart is under threat by the changing environment.

Lal: Look at the business model. Walmart catapulted into a $400-billion-plus company by luring customers into stores with groceries at very low margins, reaping the benefits of additional trips, which generated increased sales of higher-margin general merchandise items. But if you look at what has happened to that model, it is challenged on all fronts. On the general merchandise side, Walmart has competition from the Amazons of the world. So their ability to make money with general merchandise has become compromised because ecommerce forces prices down. Amazon's cost structure and their formula for deploying assets is superior to Walmart's. At the same time, the traffic that was being generated by lower food prices is being threatened by much leaner and more competitive grocery stores. The icing on the cake is that the lower-income customer has another choice in the form of dollar stores. So, on all counts, you have a model that is under significant pressure.

Alvarez: What's fascinating is that the model has worked for Walmart for a very long time and looked like a juggernaut that nobody believed could be stopped. You had this strategy of drive-traffic-with-food and make money with everything else—but everything else is really under a lot of pressure.

With dollar stores you have this shopping trip interrupter that dissuades you from going to Walmart—they have paper, milk, frozen food, bread. The Walmart machine was driven by traffic; now they've lost the traffic, lost the margins, and you say, holy cow. That's the conundrum that Walmart is in.

Think about this. There are more than 30,000 dollar stores in the US, you can find one everywhere: in rural regions you find Dollar General and in the urban settings you have companies like Family Dollar. The Walmart machine is no longer printing dollars, it's minting quarters. It's very, very problematic. Walmart has a new strategy that uses smaller stores, supercenters, and their warehouses in an ecosystem that includes ecommerce, but it's going to be a lot of work for them to make that happen. The investments will be enormous and they will have to shift their very strong culture in ways that will be uncomfortable if not impossible. I believe this may push Walmart to make their first major acquisition in the US.

Q: For what companies will 2015 be a make-or-break year?

Lal: The thing about retail is that no year is a make-or-break year. Every retailer has nine lives. A&P, still alive. Sears Roebuck, which has been on its deathbed for Lord knows how long, still alive. JCPenney. Even though the business is sick, the patient fights on. Retailers always find a way to repurpose the real estate.

Alvarez: We have seen a huge number of store closings but not a concomitant number of store brands dying. The concept the brand represents may be dead to the consumer but the stores are still there generating cash flow. In retail location is still critically important.

Other Stories In This Series

Retail Reaches a Tipping Point: Which Stores Will Survive?
What Happened to My Mall?

Retail Revolution: Will Your Brick-and-Mortar Store Survive?book excerpt

Will The Internet Push Grocery Retailers Over The Edge?

From Retail Revolution: Will Your Brick-and-Mortar Store Survive?

By Rajiv Lal, Jose Alvarez and Dan Greenberg

Supermarkets, much like department stores, mass merchandisers, supercenters, and other broad-assortment retailers are facing impacts across almost every category in their stores. Reading the commentary of equity analysts, one is impressed by the extent to which supercenters like Walmart and warehouse clubs like Costco have stolen supermarket customers and taken over categories that were previously the sole domain of supermarkets. But the assault on supermarkets is actually much more widespread, and comes not just from traditional competitors like supercenters and warehouse clubs, but also from new entrants like dollar stores and online retailers, and from shifts in consumer habits. We believe that there are several key issues that will effect a dramatic change in the supermarket industry over the next five years.

First, eCommerce will shift significant dollars out of the industry. Although home delivery does not seem to be a viable alternative in the supermarket space today, a combination of fragmentation in consumer shopping behavior and emerging alternatives to home delivery will change how Americans buy consumables. The inexorable march of internet technology will create significant changes in the expectations and behavior of supermarket shoppers that will open up opportunities for new and creative concepts. Related to this, the consumer need for convenience will continue to explode and retailers will need to find solutions that solve problems for time-starved customers. While online retail of groceries doesn't generally have cost advantages, some segments of consumers are more than willing to pay for convenience.

Second, the bifurcation of income in the US will accelerate and lead to an even greater need for supermarkets to provide value. Supermarkets have long relied on a high-volume, low-margin model, and the large, vibrant middle class that characterized mid-twentieth-century America was essential to supermarket success. However, the supermarket sweet spot in the middle of the income distribution has been shrinking for decades. As income inequality accelerates, the ability of supermarkets to remain competitive will diminish as volume flees for Walmart or migrates to higher-end retailers like Whole Foods. Supermarkets have already reduced costs dramatically in order to compete with much more efficient competitors, and they can no longer generate price savings by cutting heads. Now too they lack the residual store-level talent to shift strategy and provide service. Consequently, these downward trends create an unstable situation for supermarket retailers.

Third, the bifurcation of consumer shopping trips will continue unabated with consumers looking for meal solutions on an almost nightly basis (trips that have been going disproportionately to Quick Serve Restaurants [QSRs]) and filling in their non-perishable needs (household items, canned goods, health and beauty care) on separate store-based trips. These non-perishable trips are a place where eCommerce and other non-traditional competitors like dollar stores will shine, and the winners of the past two decades, supercenters, will fail. This trend will continue to shrink the freedom supermarkets have to manage pricing, service, and product assortment. While beautiful perishables departments have been a cornerstone of many supermarkets' strategies and formats, Americans have greatly simplified their meals over the past three decades, and many have either forgotten or never learned how to pull these raw ingredients into a meal. Because of this, demand for the core perishables category is declining.

This will lead to a fourth significant issue: the amount of excess space that supermarkets will have on hand. This will manifest itself not just in the number of excess stores in a chain's network that will need to close but, more importantly, the excess space in every individual location that a chain operates. As we will show, supermarket store size has risen dramatically over the last 30 years yet consumer behavior indicates a need for this space to shrink dramatically. Space will become an albatross around the necks of most supermarket chains as they struggle to figure out how to productively deploy or shrink the space in what has become a very inflexible format.

Finally, the wave of human health concerns (especially relative to obesity) will cause supermarkets to rethink some of their core strategies.

We are currently in the midst of many of these changes, and because of them, the past two decades have been challenging for supermarket companies. The recent recession has made things worse. Store closures have become increasingly common, household names like A&P and Winn-Dixie (now part of Lone Star owned Bi-Lo) have entered (and emerged from) bankruptcy, and supermarket giant Supervalu is laying off workers, closing stores and selling assets to Cerberus Capital Management in a bid to stay afloat. Even large chains, like Safeway, have struggled with generating high returns on invested capital, and Safeway has also been purchased by Cerberus Capital Management. Kroger, for its part, has done very well and improved its operations significantly, as seen in its falling SG&A Expense Ratio. However, it is focused on improving a box and a style of retailing that, as we will see later in the chapter, may face an existential crisis if European-style, purpose-built Drive stores (small warehouse formats where customers order online and pick up orders) come to America. These Drive stores are apt examples of the "Shrink and Transform the Format" strategy.

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    • Torry
    • Brand Manager
    I'm interested in seeing how cosmetics and men's grooming do in e-commerce. I'm not sure I've seen much complementary omnichannel marketing done in these areas. That said, I like the hybrid approach of sending cosmetics customers sampler boxes of wares tied in with online ordering. Maybe men could get a "Razor blade of the month!"
    • Neil
    • Chairman, The NovaGroup (TNG)
    Insightful article to understand tectonic shifts in the brick & mortar stores and how successful players are rolling with the punches.
    • Peterman
    • Chief Cook and Bottle washer, NA
    Kroger in trouble? LOL, that's a good one. They are set to pass Whole Foods this year for the largest amount of organic offierings. They have general merchandise which they can bring into their food stores and sell alongside their food like a Wal Mart but without all the bad press. Oh and they recently bought Vita Cost which has even better service and faster shipping than Amazon. People still want to buy most of their food at brick and mortar stores and that won't change. What will come along is what Kroger is doing at their Harris Teeter stores, buy online and your groceries are ready to go when you arrive.
    • Kapil Kumar Sopory
    • Company Secretary, SMEC(India) Private Limited
    Try as much they can, e-marketing initiatives can never totally replace the brick and mortar stores. Therefore, supermarkets still have a long life and would continue to be patronized by many and most some time or the other.
    Yes, e-commerce provides ease of doing business to a great extent but it cannot serve immediate demands which are bound to arise quite often. Exercise of face to face choice is impossible and one is bound by online images which may not express every detail as clearly as when the item is viewed in a store.