N. David Milder
A retail leakage (a.k.a. gap) analysis essentially compares consumer expenditures sorted by NAICS codes in a trade area (demand) with the corresponding retail sales of trade area stores (supply). Sometimes it may be confined to just a few code categories or even just one.. A leakage exists when demand exceeds supply. The demand that is not met locally is seen as leaking out to shops beyond the trade area’s borders. These leakages are usually interpreted as identifying local untapped retail demand that, if recaptured, can not only support growth, but do so without taking market share away from existing retailers. Understandably, such leakage analysis findings have become the foundation stones of many downtown retail revitalization plans and strategies. Unfortunately, too many of these plans and strategies are on very shaky ground because the leakage analyses on which they are based utilized bad or incomplete data and/or the analytical framework through which they were given meaning and significance suffered from fatal conceptual errors. This article will focus on those conceptual errors.
This analytical tool appears to have a heap of usefulness since it seems able to answer two important questions: how much can a downtown’s retail grow and in which sectors. It also appears to have a lot of basic prima facie validity, after all, it does numerically compare retail supply to retail demand. It looks like sound, basic economics. Moreover, it makes retail growth appear safe; the leakage/untapped demand seems to identify retail sectors where growth can occur without hurting existing small merchants. It also can state the growth potential in tangible numerical terms such as retail sales dollars and sometimes, with additional calculations, the number of new stores and the amount of new retail space that would have market support.
Additionally, leakage analyses can be done quickly, easily and cheaply – e.g., an ESRI report costs $50, the calculator on the UWEX website is free to use (1). You can generate a basic leakage/leakage report in under an hour at either source.
An economic analysis tool that can apparently do so much and also be very affordable is very appealing, indeed. What’s not to like? Well, here are some strong cautions.
Problems in the Analytical Framework
These analytical problems are often found in leakage analyses and can sink a retail revitalization plan or strategy.
Retailers That Are Unfazed About Fighting for Market Share. An assumption often attached to a leakage analysis is that retailers will only go into market areas where they do not have to fight for market share. This is demonstrated when the lack of leakages in NAICS categories is interpreted as indicating low growth potential. However, it is a well known fact that many retailers are neither risk averse –- especially those that are the most successful and powerful – nor afraid of fighting for market share. For example, does Walmart really care that small merchants are already capturing most of the retail household expenditures in a market area it wants to enter? Some retailers may not care at all about local competitors, they just want to know how many of their type of customers live in a potential new trade area and how the other retailers in the area (hopefully including some of their frequent co-tenants) are doing. Other retailers may care about having to compete with some specific rivals – information that a leakage analysis itself can not provide. Conversely – and perversely —sometimes it is the presence of the rivals that attracts retailers because they figure that they share a common customer base and that together they will draw more shoppers from a wider geographic area. Years ago, the famous example of this was the proximity of Macy’s and Gimbel’s in New York City. Today, Home Depots and Lowe’s are often found within a few minutes drive of each other. Other examples are successful retail niches and clusters. For these retailers, a leakage analysis might help them define the geographic boundaries of their trade areas, but it is unlikely to have much a determining influence on their locational decisions.
It can be reasonably argued that the retailers many downtown leaders very often want to recruit, the so-called trophy retailers, are not afraid of competing for market share with other chains, if the potential rewards of sales revenues and profits can justify the risks. For these retailers, total consumer incomes and expenditure potentials are a much better indicator of retailer perceived potential rewards than any reports of sales leakages.
Small independent operators may be more concerned about not having to fight for market share, so a good leakage analysis may provide a useful indication about their ability to enter and thrive in a market area. However, given how many of them open their new shops without any detailed knowledge about the retail market area they have entered, there are bound to be some limitations to the value of a leakage analysis that could inform their locational decisions.
The Improbable “Immaculate Retailing” Assumption and the Need to Win Market Share: There is no research showing that retailers entering a market area will only recapture residential expenditures dollars that are now going to retailers located beyond a trade area’s borders, while leaving the local expenditures captured by any similar existing local retailers untouched. This assumption is a bit of fantastical thinking that has not been properly called out. For example, can anyone imagine a new retailer asking shoppers if they otherwise would be patronizing another downtown shop and then refusing to make the sales transaction if the customer said yes?
Expanding on that argument, consider the following scenario:
In Community X, with a downtown filled by small merchants, a leakage analysis shows that there is a $5 million leakage of residential expenditures for apparel. What the leakage analysis does not show is that most of the leakage is being captured by strong and attractive apparel specialty shops and department stores in the powerful 1.5 million SF Shopping Mall Beta located about 2 miles beyond the borders of Community X’s trade area.
The mall’s apparel merchants, with their very large and frequently updated selections will have a great deal of retail gravity and consequent customer drawing power. That means a very substantial portion of their trade area likely overlaps with that of any Community X apparel merchants, even though the mall’s shops are located beyond Community X’s trade area’s borders. Viewed from the perspective of Community X’s trade area, it might be argued that greater proximity could give a new apparel merchant some competitive advantage, but viewed from the perspective of the mall’s far greater strength and far larger trade area, proximity does not offer Community X’s merchants that much potential advantage. Facing that level of external competition, is it likely that a new apparel merchant in Community X could resist knowingly trying to take market share from other nearby apparel merchants?
The bottom lines here are that:
- Recapturing leaked shopping dollars often means that small downtown merchants must compete with very powerful retailers who are located beyond THEIR trade area’s borders while their supposed competitive advantages are related to their proximity to the targeted shoppers
- Unstated and unresearched, of course, is the fact that if these small merchants do not provide a sufficient selection of merchandise and at the right price/quality value ratios, they won’t be able to even win back the expenditures of shoppers who live next door or in apartments over their shops
- There is no free lunch no matter what many leakage analysts may assume. Any merchant – be they large or small – must compete and win market share. There is no way around that fact! The merchants they are competing with may be located in and/or beyond their trade area
- Of course, competition may be less fierce in some market areas than others. However, a strong argument can be made that the level of competitiveness is determined more by the capabilities of the retailers in and near the market area, than by how many sales dollars are being leaked out of the market area
- Retail revitalization plans and strategies need to specify a lot more about the needed characteristics of new retailers that could compete successfully. Just identifying and quntifying the presence of a leakage is not enough.
The Existence of a Retail Leakage Does Not Mean All or Even Most of It Can Be Recaptured. A review of numerous reports containing downtown leakage analyses revealed that far too many of them assumed that most of the identified leakages can be recaptured. This is a basic and fatal mistake for any plan or strategy that builds upon leakage analysis findings.
Besides indicating that retail demand exceeds supply within a trade area for a specified type of goods or service, finding a leakage is usually interpreted by analysts as an indication of local unmet demand that is:
- Legitimate to “recapture” because it is somehow owned by the trade area in which its consumers reside and recapturing these retail sales dollars will not hurt local merchants
- Easier to reclaim, because these dollars are now being captured by more distant, less conveniently located merchants whose shops are outside the trade area than the sales revenues of local merchants.
However, the advantages of proximity do not mean that the leakage dollars are just lying there to be easily scooped up by some observant businessperson. Also, because these dollars are being captured by shops beyond the downtown’s trade area does not mean that those more distant merchants lack strong competitive advantages of their own. For example, they may be very competent operations offering larger merchandise selections, better merchandise quality, better overall values, better customer service, a more attractive shopping environment, etc. These assets may more than outweigh the proximity advantages of downtown merchants when competing for local residential retail expenditures.
Furthermore, the competency and ability of new small downtown merchants to compete are certainly not assured, as indicated by their high failure rates nationally. Whether the new merchants like it or not or whether the leakage analysts like it or not, new downtown merchants will have to take away the sales revenues from someone else, no matter the size of any leakage. How difficult it will be depends on their abilities, the strength of their proximity and convenience advantages and the strengths and weaknesses of their competitors both inside and outside of their trade area.
Consequently, it is an enormous error to assume that any identified retail sales leakage can be mostly recaptured.
The Critically Important Assessment of How Much of a Retail Leakage Can Be Recaptured Requires Well Reasoned Judgments, Not the Magical Use of a Complex Equation or Simple Arithmetic. Assessing how much of a leakage it is reasonable to expect downtown merchants can recapture is the most important part of any leakage/leakage analysis. It can only be properly done if the leakage findings are viewed from a larger analytical perspective that looks at such things as:
- A SWOT analysis of the downtown as a retail location, with special attention paid to the magnitude and nature of the strengths of the downtown’s retail competition that may be located beyond the boundaries of the downtown’s trade area.
- An analysis of the types of retailers who can utilize the downtown’s locational assets to successfully compete with rival retail centers.
- The capabilities of local merchants to compete.
There is no formula to apply or simple arithmetic manipulations of the leakage data that can inform this assessment. Rather it is a judgment call. Analysts, alone or as a team, may add some quantification to this process by using their Bayesian probability estimates to assign capture rates to the leakage estimates. This assignment hopefully is based on their analysis of the strengths and weakness of the competition, the downtown as a retail location and the abilities of the retailers most likely to be recruited.
Retail Surpluses Are Often a Much Better Indicator of Viable Potential Growth Opportunities Than Leakages/Leakages. A leakage analysis can not only identify leakages, but also the surpluses that exist when a downtown’s retailers are strong and importing sales dollars from customers living beyond the boundaries of the studied trade area. In far too many studies, however, the discovered surpluses are treated as realized growth opportunities that signal no ability to generate any additional growth. They are then largely ignored. The analysts, quite obliviously, only see leakages as indicators of potential growth.
A niche analysis has its own way of viewing leakage/leakage data. It first looks for strong exiting niches that can be grown and leveraged. A NAICS category that has a surplus is probably such a raptor niche or part of one. Its surplus shows it is strong and successful. It’s real trade area is probably much larger than the one that was used to reveal its “surplus sales.” In many instances, such a raptor niche is bringing in strong customer traffic flows that, through effective cross marketing, can facilitate substantial growth among other downtown niches.
A niche analyst looks at leakages in a more ambivalent manner. On one hand, they represent potentials for future growth, but on the other, they also demonstrate weaknesses. Total leakages best demonstrate this point. The fact that there is no retailer in a particular retail sector certainly suggests an opportunity framed by obvious unmet local demand and the lack of obvious local competition. A niche analysis would call the situation a potential niche. However, a good analyst would also ask why no retailer has successfully entered this market space? Very often, there are strong factors that have impeded firms from doing so, such as:
- The lack of appropriate spaces, a problem that also may be very expensive to remedy
- Rents that are too high for that particular kind of retail activity
- The lack of a local workforce having required special skills
- While the local demand my be unmet, it is still too small to support a successful shop in that retail category
- The competition sitting outside of the trade area is very, very strong and has a long reach.
With the understanding that it is far easier to organize, grow and leverage an existing strength than to turn a growth potential into a reality, a niche analyst will prefer finding surpluses (strong existing niches) to leakages (potential niches).