The bricks-and-mortar albatross: James Saft

November 27, 2012

Nov 27 (Reuters) – To understand why the retail sector will
continue to be such an investment minefield consider just two
phrases: Black Friday and Cyber Monday.

The latter, the mock tradition of buying stuff online when
the boss isn’t watching on the Monday after Thanksgiving, is
emblematic of the forces challenging a retail industry much of
which was built for a U.S-centered cars, parking lots and box
store paradigm which makes less and less sense every day.

Black Friday began to be so called in the 1980s because it
marks the kick-off of the holiday shopping season during which
retailers are thought to move from the red ink of annual loss
into the black of profit.

That such an insider term, the kind of language favored by
analysts and investors, came into general use says a lot about
the age of consumption and speculation which began in the 1980s.
After all why should a shopper, other than one who thinks we can
all get rich by buying things and investing in stocks, care
about when a store moves to profitability?

But underlying the term Black Friday is a business model
reality, which, once examined, poses real problems, especially
given the impact of the Internet. Physical stores are not simply
a combination of assets, labor and merchandise, they are
systems, ones with a lot of sunk costs.

Why after all do stores even stay open during slack periods
if in fact they only are truly profitable during the holiday
rush and other peak periods? They do so because there are huge
upfront costs to setting up a physical retail outlet and once
you’ve made those investments in people, facilities and
everything else, the economics dictate that you sweat those
assets, work them as hard as possible in order to gain as much
revenue as you can to recoup fixed costs.

Just as airplanes on the ground are hemorrhaging money for
their owners, so are shuttered stores. And, to the extent that
retail has an advantage over internet distribution, and there
are real ones, it is in part speed and availability. If J.C.
Penney starts closing on Tuesdays, or in September, they
are training their customers to use the Internet, a bad thing
for a retailer with a big physical investment.

As sales via the Internet grow and steal market share from
physical retailing those fixed costs will only hang more heavily
on businesses with large existing retail networks.

A GROWING SHARE

Black Friday and Cyber Monday made quite a contrast this
year, and the data clearly points to a growing market share for
virtual retailing. While footfall on Black Friday rose by 3.5
percent, according to ShopperTrak actual sales decreased by 1.8
percent to $11.2 billion. This may in part reflect the way in
which mobile Internet access allows shoppers to use stores as
display galleries, viewing merchandise in person but nabbing the
lowest price available on the Internet.

In contrast to the retail till shrinking, online sales
surged 26 percent to $1.04 billion, a record for the day.
Tracker ComScore expects Cyber Monday online sales to hit a
record of about $1.5 billion.

And it is not just over the holidays that online growth is
outpacing physical retail. Data from the Census Bureau shows
that online sales rose 11.8 percent this year through October,
against a 5.5 percent gain in physical retail sales. With online
comprising 8.6 percent of all sales that’s significant, but as
the sector grows the pain for retailers will become more acute.

Forrester Research predicts that U.S. consumers will
increase online spending to $1,738 each by 2016, a 44 percent
increase over 2011. Some of that surely will come from a growing
pie, but much will come out of physical retail’s market share.

Physical shopping won’t ever end, and will always probably
comprise a majority of retail sales. But the journey from the
current cost structure and approach to one which is profitable
and sustainable will be difficult. Managing decline is never fun
and investing in it, with the rare but inevitable value bargains
excepted, is even worse.

The growth of “pop-up” stores, which open in empty retail
space for a short time, is emblematic of the industry’s attempt
to get in front of this curve. So too are companies such as
Apple which have moved into vertical integration of
distribution. If you both manufacture and distribute you can
capture more of the profits, benefit from the exposure and
advertising that a retail outlet represents and be in a better
position to bear the fixed costs.

It works a lot better, though, if you can charge premium
prices, as opposed to selling coats or books.

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