Amazon: A Tipping Point For Brick And Mortar Retailers

Source: https://seekingalpha.com

I would be remiss in not beginning this article with an explanation as to why, at its end, the reader will see it marked that I am not invested in Amazon (AMZN). The reason is simple… I was invested in Amazon and, at what I thought an opportune moment, sold and allocated the gains elsewhere. Nonetheless, I remain closely interested in the company. “Is that not right, Alexa?”

Background

I need not go through a regurgitation of Amazon’s history to make the point that moving from a small online bookseller to the world’s largest online retailer is no small accomplishment. I will say that the time and decisions necessary to reach that size and develop their obvious capabilities required a willingness to embrace risk and make some good financial bets, the hallmark of effective management.

Still, growing into its name was a remarkable achievement and, until they run into intractable problems, I see them continuing to grow in a range of ways. As for share price prognostications, that is not my area of expertise. I do not give investment advice, I write articles that relate to strategy.

On that point is a strategic move worth noting… Amazon’s decision to create its own delivery fleet is a smart financial decision. Here is why I say that…

Having done consulting that allowed me to see some of the numbers Amazon was paying for third party delivery, the decision to vertically integrate downstream was strategically aligned and consistent with its cost leadership approach. This was the same basis for Walmart’s (WMT) decision to build its own proprietary fleet. Let’s be clear about that. No business that embraces the generic strategy of cost leadership (e.g., SWA, MCD, COST, WMT, AMZN) employs value chain activities that add cost unless they expect it to reduce overall value chain expenses and/or improve its revenues minus cost of sales.

Moreover, from an operational perspective, the delivery decision allows Amazon to control the process more effectively and, with its development of warehouses throughout the country, is a logical extension for Amazon’s distribution capabilities.

Also, as noted in this Seeking Alpha article, Amazon is using AI to reach new customers and enhance their experience by offering value through new brands and new products; thus, driving new product brand awareness, with Amazon as the logical online seller of choice.

As to other modes of delivery expansion, I do not have the crystal ball necessary to suggest there will be home delivery through the much-discussed use of drones. But, if past is prologue and the point is efficiency (cost reduction) that conveys effectiveness (increased revenues), Amazon’s management is capable of determining if that has real possibility.

Irrespective of its recent earnings announcement, when it comes to delivering online sales, Amazon is the clear leader, and, in the foreseeable future, no one will threaten it. I say “foreseeable” because one must recognize there have been market leaders in various industries that have eventually been overtaken due to consumer choices, changing demographics, tech development and improvement, not to mention stupid management decisions.

With all that in mind, I do not believe, as some do, that Amazon is killing brick & mortar retail businesses. A quick look at online sales (though growing, it is only about 10%) versus total retail sales suggests otherwise. Nor is this is a necessary path for Amazon’s future success, as the acquisition of Whole Foods infers. However, as in baseball, timing is important and what we can say is that Amazon found themselves at a point in time when the retail industry did not seem to want to change. And, why should it? For years, brick & mortar retail businesses had been rife with success born of the great demographic shift to the suburbs and the unconstrained growth of “malls” in American cities and towns. Brick & mortar retail was doing fine. Until it was not!

The Reality About Malls & Retail Stores

According to data, the last new enclosed mall was built in 2006, which meant 2007 marked the first time since the 1950s that a new mall was not built in the United States. With the 2008 recession, we saw an accelerant to already failing malls and stores. Between 2007 and 2009, 400 of America’s largest malls closed. According to the research, within the next 15 to 20 years it is expected that half of America’s malls could die and with them various brick & mortar locations. This raises the corollary compound question – are there too many malls and how did that happen?

In the common narrative, the mall’s rapid expansion is credited to urban flight and growing post-war wallets. Yet, while the mall’s early years certainly were marked by suburban growth and economic prosperity, it does not tell the whole story.

Malls were not just serving America’s new suburban population, they were turning out huge sums of money for developers. According to urban historian Thomas Hanchett, in his 1996 article “U.S. Tax Policy and the Shopping-Center Boom”:

Suddenly, all over the United States, shopping plazas sprouted like well-fertilized weeds. Developers who had been gradually assembling land and mulling over the shopping-center concept abruptly shifted their projects into high gear.

Thus, the first wave of shopping malls was born. Of course, what was needed to fill the malls were the brick & mortar retailers, and fill the malls they did. Until they did not.

The vacancy rate in America’s regional malls hit 8.6% in the second quarter of 2018, the highest since 2012. But the problem is more insidious.

Circuit City, the big box electronics store that filed for bankruptcy in 2008, was a significant driver of mall vacancies, and last year there were nine retail bankruptcies including Toys “R” Us, RadioShack and Payless Shoes. We also saw J.C. Penney (JCP), Macy’s (M), and Sears (SHLD) having each announced more than 100 store closures. In addition, several apparel companies’ stocks hit new multi-year lows due to decreased revenues, including Lululemon (LULU), Urban Outfitters (URBN), and American Eagle (AEO). And, Ralph Lauren (RL) announced that it is closing its flagship Polo store on Fifth Avenue in NYC, one of several brands to abandon that iconic thoroughfare. In sum, retail chains are shutting their doors at a rapid pace, further hurting malls and shopping centers. In fact, the number of major store closings in 2017 more than tripled to a record 7,000.

While a deep recession might explain an extinction-level event for retailers, GDP has been growing for eight straight years, gas prices remain low on a comparative basis, unemployment is under 5 percent, and the last 18 months have seen wage growth, particularly for middle and lower income Americans.

For some, the simplest explanation for the demise of brick & mortar stores is that Amazon is killing retail because of the consumers move to more online sales. Again, while growing, it remains just 10% of all retail sales. And, that is the point of the story. It is not about Amazon effectively growing by killing brick & mortar retailers; rather, it is that retail businesses, specifically those with brick & mortar locations, are struggling from self-inflicted, strategic mistakes in their choices for development and growth.

Still, for the smart and nimble business, this failure has created the realization that to flourish, not merely survive, they need to compete more effectively online and in ways that counter the convenience of Amazon by more effectively utilizing the sunk-cost value of the brick & mortar retail stores.

This demands retailers seek a new approach that allows the convenience of online but involves showcasing their products and making them available to be purchased seamlessly, both online and in-store. This move suggests retail recognizes the comparative advantage of brick & mortar locations that can offer the benefit of “seeing, touching and feeling” products. It also provides a clear branding opportunity.

In total, this is the direction the retail industry needs to go to flourish and why Amazon is not going to kill brick & mortar retailers. In fact, no small benefit, as this Seeking Alpha article noted, is the Supreme Court decision to allow states to compel out-of-state businesses to collect sales and use tax for all online sales. This enables brick & mortar retailers to compete on a more level playing field and dismisses as truly fake news the media headlines of “the retail apocalypse” courtesy of Amazon.

The “New” Brick & Mortar Retailer

Disruptive forces can cause dramatic reversals and they demand businesses make strategic adjustments to counter them. This need to adapt is clear in the retail industry that has seen dramatic changes. For example, in 2000, Kmart was the third-largest US retailer, with $36 billion in sales. By 2014, its annual revenues had declined by two-thirds; over the same period, Amazon’s US annual sales grew to $89 billion from about $2.8 billion.

But, going forward, it is not a simple matter of what brick & mortar retailers have “game,” there is also the question of whether there is an over-supply of malls.

The number of malls in the US grew more than twice as fast as the population between 1970 and 2015. The number of malls in America has been cited as more than 47,000; this includes about 1,100 enclosed malls, with the remainder what might be called strip malls.

In a decade the number is expected to decline further, as mall visits have declined more than 50% since 2010. To provide a comparative understanding, on a per capita basis, the US has 40% more shopping space than Canada, five times more than the U.K., and 10 times more than Germany.

Further, what poses trouble for malls today is that agreements with retailers often have clauses that allow for cancellation of a lease if a mall anchor departs. Also exacerbating the problem is that, while rising wages are good for workers and the overall economy, they can be difficult for low margin companies that rely on cheap labor, as do brick & mortar retail stores.

In fact, new minimum-wage laws and a tight labor market have pushed up wages for these low wage workers, squeezing retailers who are already under pressure from environmental and competitive factors.

But there is light from the source of the heat…

Consumer spending makes up 68% of the US economy, with two-thirds of that spent on services such as housing and health care and 25% is spent on non-durable goods, such as clothing and groceries. However, what should not be lost on brick & mortar retailers is that 31% of Americans still go shopping for fun. And… here is the punchline… while 59% check online for the best price, 61% have shopped at more than one store for similar items to get the best deal.

When we recognize the total 2017 holiday sales rose 3.9 percent, higher than the 10-year average of 3.5 percent before the recession, and the 2018 US retail sales remain strong, we can see there is opportunity for the smart and nimble brick & mortar retailers.

In truth, if retailers want to avoid “Death by Amazon” and stand out, it will be more important than ever to make the in-store experience as seamless as shopping online, while being more interactive. Perhaps, it may need to be similar to the business Amazon bought – Whole Foods – which raises the question as to what the experiences should look and feel like.

The answer to that question should guide the decisions for those business owners and executives seeking to encourage shoppers back to stores and malls; particularly when considering location, because there is an increasing vacancy gap between the “good” and the “bad” retail areas. What this means is that is the “vibrant and in-demand areas” in various cities and towns are much different from the more “economically fragile” areas. This disparity makes the old retail mantra of “location, location, location” an increasingly critical reality.

The brick & mortar retailers that are winning the competitive fight are those converging to an operational center, balancing online with brick & mortar locations. Those businesses succeed by being responsive to consumer needs, leading with mobile apps, and using personalization and experience as a means to differentiate themselves. For example, Nordstrom (JWN) customers can buy products not just in stores and on the web, but also on a mobile app, on Instagram, or via text message, and they can pick up, return, or exchange their online purchases at any Nordstrom brick & mortar location.

This means the consumer experience is more than just reconfiguring or making stores smaller to reduce cost and complexity, it is about making them feel more tailored and intimate, with a better aesthetic that appeals to the busy but interested consumer.

However, a problem that arises is when the economically stressed retailer seeks to appeal to the “loyal customer” by offering all-too-frequent discounts. Beyond suggesting poor product purchasing decisions, this quick fix action is the result of retailers seeking to combat decreased sales by shifting their focus to heavy promotional selling. While this may initially bring customers into stores, over time it devalues both the brand and products they sell. Do not misunderstand me, I love a good sale, and those that are well timed drive consumer foot traffic. However, when retailers put all their eggs in the 40% off basket, customers will always expect a discount and become less inclined to purchase full-price merchandise, not to mention questioning why bother visiting the stores.

If retailers have learned nothing it is that, if customers are going to spend their time in physical stores they need to feel stimulated and engaged. But this requires taking risks and allocating budgets towards marketing and technology that make the buying experience valuable enough to get people off the couch and into the stores.

There is nothing as appealing as walking into a store and being greeted by a familiar scent (think the new car smell) and a smiling face (think a neighborhood mom & pop retailer).

Although it has been many years later, I still remember the smell of baseball gloves in my hometown sporting goods store, and the owner smiling and talking baseball with me. Not an experience one gets when doing online shopping and that is the point and direction for the brick & mortar businesses of the future.

But in case it seems I am being starry eyed and longing for the days of boyhood and baseball, I understand that in a busy world, it is nice to simply order something online and have it show up. But the mistake is thinking it is an either/or world for retailers. It is not. This suggests there is and always will be space for the smart brick & mortar retail business that can best meet the customer needs by providing a valuable in-person experience that is beyond what Amazon can do for them online.

Besides, sometimes it is just nice to get out of the house and shop. Any doubts about that will be removed by a trip to Harrods in London.

Concluding Thoughts

According to McKinsey research, consumer spending is shifting due to the demographic changes that suggest global middle-class spending will almost triple by 2030, and that new patterns of personal consumption will emerge, suggesting not only the need for convenience but for the brick & mortar businesses that offer consumers the desired in-store experience that includes personalization and customization.

This focus on the shopping experience delivered in stores will be tied to an increasing desire to buy local, supported by the research that argues that retailers will need to be aware that demographic shifts will lead to US city dwellers increasing at a rate of 65 million each year through 2030. So, combined with the aging of the average consumer and the reality that populations in developed markets are increasing, there will be a strategic need for brick & mortar retailers to locate the right types of stores in the right place, with a simplification of choice that suggests the right sized stores, with better product selection.

Companies must bear such factors in mind when determining which trends are most relevant to their own business and the products they sell. But they must also recognize that engaging consumers in ongoing dialogue will become essential in an era of fast changes and the increasing impact of social media as a means to convey interest in products, brands, sites or locations. That means companies must strive for a thorough understanding of what consumers want and are willing to pay for, and systematically use that knowledge to inform the evolution of their products, brands and, yes, brick & mortar locations.

Far from killing brick & mortar businesses, it would seem that Amazon has engaged in the kind of creative destruction that will help remake the adaptive brick & mortar retailer into a new business concept focused on providing the consumer with the desired interactive, in-store experience.

It is also why, to further leverage its value chain and integration capabilities, Amazon is not done shopping for the right brick & mortar business.



Categories: Brands, Business, E-commerce, Retail, USA

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