In my retail recruitment experience, I’ve found that there are types of retail stores that clients need and those that they want. The need category generally includes groceries, specialty food shops, pharmacies, etc., while the want category overwhelmingly includes GAFO operations — i.e., general merchandise, clothing and footwear, home furnishings, electronics and appliances, sporting goods, book and music stores, and office supply stores. The shops that respond to needs did relatively well through and after the Great Recession, while the GAFO stores have been in consistent decline or weakness since about 2009. Recent research indicates that e-GAFO retailers are now eating the lunch of brick and mortar GAFO merchants.
An Enormous 45% Hit on B&M Retail Sales Potentials!. One of the most significant trends that has helped define the new normals for retailing and our downtowns is the increasingly significant share of the sales of the merchandise sold in GAFO stores that are being captured by online operations. Obviously, the more sales dollars the e-stores win, the less there are for brick and mortar shops (B&Ms) to capture.
A while back, in another blog posting, I presented the above table, taken from a provocative study by Hortacsu and Syverson, that showed e-store market penetration for a range of retail categories in 2013 along with estimates of the years in which they each would reach 25%, 50%, 75% and 90% market shares.
A more recent 2019 report by Morgan Stanley suggests that the Hortacsu and Syverson study was pretty sound. It found that while “…e-commerce penetration reached 11% of total retail sales at the end of 2018” that “e-commerce penetration in the GAFO segment” was now over 45%.(1) That makes it so much harder for B&M GAFO retailers to survive, much less thrive, unless they are executing or part of an omni-channel marketing strategy.
The Morgan Stanley report also found that “the shift to e-commerce has hit the home-furnishings segment the hardest,” while clothing, linens and other “soft” goods have experienced a significant “e-commerce disintermediation” with a 22% e-commerce penetration expected in 2019. (2) It was long thought that these two retail segments would be resistant to e-store penetration because one offers large and heavy merchandise and the other offers merchandise that consumers would want to touch, feel and try on. One weakness of such thinking was the failure to recognize that so many of the soft goods we buy are like commodities and we don’t need to touch them, feel them or try them on. For example, lots of people have long bought shirts, trousers, shoes, dresses, swimsuits, parkas from catalogs. They often are buying more garments like the ones they already have – e.g., I have countless blue, button down collar shirts — or replacements for them. Then, too, lots of home furnishings products are not furniture suites or otherwise prohibitively large, while others have been re-imagined – e.g., Casper Mattresses – so they can be shipped “small.”
How Are the Leakage Analysis Data Providers Dealing With This? Frankly, I do not know the answer to this, but I think the data providers owe their customers a clear explanation of how they are handling this situation. One technique they might be using for estimating consumer demand is to take the sales of retail stores by NAICS code within a certain fairly large geographic area and then divide the sales by the number of households in that study area. That defines demand solely in terms of B&M store sales, ignoring the huge Internet sales and demand. If, instead, they are using extrapolations from BLS consumer expenditure surveys to determine demand, then they must have whopping “leakages” in each of the NAICS codes analyzed unless they also are using data on e-store sales by NAICS code.
The leakages to the Internet for GAFO store merchandise now are probably several magnitudes larger than traditionally defined leakages to B&M shops located beyond the trade area’s boundaries.
Of course, an increasing number of downtown merchants now have both a B&M shop and an e-store. Most of their e-store revenues often come from distant customers and represent “e-surplus” sales. How are these e-sales revenues included in the leakage analysis? How do leakage analysts know which e-sales come from within the B&M store’s traditional trade area from those that come from beyond it?
A growing number of retail sales are “click and collect” transactions that involve ordering online via a retailer’s server that probably is located hundreds of miles away and then picking up the merchandise at the retailer’s local store. Are those transactions to be deemed leaked or “unleaked” sales? The local store’s involvement may be key to the sales transaction, though it may not logically be part of the monetary transaction. Would the sale have occurred if the local store were not there? If the answer is no, then somehow the role of the local shop has to be recognized in the analysis.
Vacancies, Store Closings and Openings, Changing Functions
A Word or Two About Vacancies. I fear that I’m very much an outlier, a contrarian, when it comes to downtown vacancies. While I don’t like vacant storefronts, my jockeys don’t always get in an uproar when I see them. Too often, they are not viewed from the proper perspective. Rule 1 for looking at vacancies should be to ask: where is the downtown on its revitalization arc? If it’s in the initial very troubled stages, then the prospects for recruiting really good retail tenants are not great, especially with today’s upheavals in the retail industry. Moreover, recruiting crappy tenants would be worse for the downtown’s revitalization effort than the empty shops. Also, at these early points in the revitalization process, an EDO’s scarce resources are probably better spent on working for improving the infrastructure and housing and reducing quality life issues such as the fear of crime, than paying for very problematic efforts to recruit good retail tenants.
Rule 2 is don’t be snooty — look at pamper niche tenant prospects such as hair and nail salons, yoga and martial arts studios, etc., especially early in the revitalization process when their relatively low revenue needs and desire for low cost spaces can put them among the downtown’s best tenant prospects.
I take vacancies more seriously when the downtown is much further along on its revitalization arc. In these situations, Rule 3 is the locations of the vacancies are far more important than their number. Those that are in strategic locations such as on or near the district’s “100% corner” or near other strong assets will certainly need attention. A cluster of them is also significant and probably indicates the existence of an important underlying problem.
Rule 4 is that the downtown EDO should identify and address such underlying problems, otherwise any “fill the vacancies” recruitment program undertaken either by it or local commercial brokers will most likely yield paltry results.
In the mid-arc downtowns, Rule 5 is to determine if new downtown projects have raised landlord expectations about:
- Their ability to attract national chains, even though they are looking for fewer and smaller spaces and have become much more finicky about their new locations.
- Potential rental incomes to the point that their spaces are too pricey for their most likely tenant prospects, small independent merchants.
If either of the above is the case, then there’s a landlord problem, not a tenant prospect problem. This leads into Rule 6: as downtowns revitalize, erroneous landlord estimates of viable rent increases can result in more vacant spaces than diminished consumer retail demand or its associated reduced retailer demand for store spaces.
In the past, I argued that a vacancy rate of about 5% was the sweet spot for mid-arc downtowns. Some vacancies are necessary to allow for the tenant churn that can bring in new merchant blood and help keep the district vital. That still strikes me as an ideal goal. Many years ago, my real estate mentors taught me that vacancy rates above 10% indicated the existence of serious downtown problems that needed immediate identification and remediation. Well, these days, under the New Normal, it seems that a 10% vacancy rate is about average for retail spaces (3). Of course, I am not clear whether that statistic refers to all the spaces in shopping centers and malls or just to those allocated for retail tenants. Given that so many malls and shopping centers have saved themselves by bringing in non-retail tenants, I would say it probably is the former. One disturbing implication for downtowns is that, these days, a 10% storefront vacancy rate may not be all that bad, comparatively speaking. Even more unsettling for me have been the reports I’ve seen of downtown vacancy rates in the 10% to 20% range in some of our small and medium sized communities, Another implication is that downtowns must look more to nonretail tenant prospects to fill their vacancies, but ones that are able to stimulate and reinforce pedestrian traffic on nearby sidewalks.
Because of Omni-Channel Marketing, B&M Retail is Not Going Away. One might expect that if the addressable retail markets for B&M chain stores have shrunk substantially, that lots of the stores would be closed. In fact, there have been a huge number that were closed –e.g., 7,000 just in 2017. However, new shops are also opening and an accelerating number of them are by Internet-birthed retailers (4). For example, so far in 2019, there have been 1,674 retail chain store losings, but 1,380 store openings (5).
Today, successful retailers do not see B&M store customers as a different set from their e-store shoppers. Instead, they just see customers who they can individually reach through several channels, e.g., B&M shops, websites, social media, traditional media, etc. They know that while most consumers may still prefer shopping in B&M stores over e-stores: (6)
- Convenience is an important driver of which shopping channel the consumer will select
- Unless the B&M store provides an attractive shopping experience, it will not attract as many customers as its management might want.
B&M retail shops, under an omni-channel marketing strategy can play a number of functions, besides being a place where sales transactions occur, that can justify their existence:
- SONY and Samsung, for example, have had important store locations that are nothing more than showrooms. Many other retailers use their shops as places where customers can experience the use of their merchandise. You can, for example, book a nap at a Casper Mattress Sleep Shop.
- More and more large retailers are offering “click and collect” purchasing, e.g., Best Buy, Walmart, Amazon.
- Some retailers are developing special store formats, e.g., Nordstrom Local, where they can provide extremely high levels of customer service to shoppers with a proven record of spending large sums in their stores.
- Almost universally, the B&M store is seen as the venue where the retailer can best provide experiences that will strengthen their relationships with customers.
- B&M stores also can generate website traffic. For retail chains, a new B&M store in a market area sparks “a 37 percent increase in overall traffic to that retailer’s website” by area residents. (7) “For emerging brands, new store openings drive an average 45 percent increase in web traffic following a store opening, according to ICSC research” (8). Of course, web traffic does not mean web sales (see below).
Very importantly, B&M stores outperform e-stores in several very critical ways:
- They have a much higher sales conversion rates (visitors who turn into actual buyers), averaging about 22.5% across all retail sectors, than the less that 3% for e-stores (9).
- Merchandise return rates for e-stores are three to four times higher than for B&M stores, probably because e-shoppers cannot touch, feel, try on or otherwise experience the merchandise. Returns have become an enormous ball and chain on e-retailer profitability, while bad returns experiences are really ticking off e-shoppers (10).
Bottom Line: B&M retail stores are not going away, but there will be far fewer of them, they will occupy smaller spaces, and perform many new functions that justify their existence besides making sales transactions. How is your downtown planning on dealing with such a scenario?
6) https://www.retaildive.com/news/why-most-shoppers-still-choose-brick-and-mortar-stores-over-e-commerce/436068/ . Pew surveys have had similar findings.