Retail Leakage/Gap Analyses Should Be Treated With Great Caution by Analysts and End Users: 1. Analytical Issues


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.

The Appeal

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).

These Downtown Emperors Too Often Are Not Wearing Any Clothes

As a child I was very taken by Hans Christian Anderson’s tale about The Emperor’s New Clothes, especially the part where every adult seems to go along with the new clothes until a child simply states that the Emperor is nude. Often in working on downtown revitalization I am reminded of that tale: lots of what appear to be basic axioms or essential parts of conventional wisdom about downtown revitalization are too often partially or entirely wrong. They are to me emperors with no clothes. Below I call some of them out and briefly explain why they are “nude.”

Emperor 1Urban Sprawl Is Killing Our Downtowns

Reality Check 1– This is a nice one. Thanks to the Great Recession, many recognized experts are now arguing that sprawl is ending. See, for example, John McIlwain at Brookings on the end of urban sprawl

Let us rejoice that sprawl now has a stake in its heart! However, what are the policy implications? Are they really simple and apparent? I believe we definitely need to put our thinking caps on and properly think this through.

Emperor 2 – Retail Gap/Leakage Analyses

Reality Check 2 – Doing a retail leakage or gap analysis is appealing because comparing supply with demand sounds like such fundamentally good economic analysis. But, there are a number of data reliability and interpretive issues that cloud their validity (are they measuring what they say they are measuring?)  and their value in program and policy development. First of all, collecting data on business firms and their revenues is a lot more difficult than one might think. The census is out of date by the time it is published. Business data from market research firms such as ESRI and Nielsen Claritas are based on data from InfoUSA, which does large national telephone canvasses of businesses and claims to be 95% accurate on the national level. However, on the local level we have found their data to often have far lower accuracy, and we now try to confirm the accuracy of their data before using them.

Another issue: the basic data on firms’ revenues and consumers’ expenditures are collected by two different federal agencies and, of course, they use two different sets of categories to organize the data. To be able to match the supply and demand data requires statistical manipulation and to my knowledge there has never been any published empirical test that demonstrates the accuracy of the data those manipulations produce.

Interpreting the leakages data also raises issues. For example, a surplus, where store sales are more than consumer expenditures, is usually seen as a situation where there is little prospect for future growth. But, according to niche theory, such a surplus may indicate a powerful retail niche that can expand its trade area. Another issue is that leakage is often seen as an indicator of growth potential, as the presence of “unmet local demand” that might somehow be more easily recaptured by a merchant who does not have to be all that capable. If the merchant is very capable, then he or she could fight for market share and then the whole leakage issue would be irrelevant. From policy, program and business recruitment perspectives, a business operator who will fight for and win market share is far more preferable than an operator who is looking for a situation where there is putative weak competition. Of course, the leakage analysis, does not get into the causes of the leakage, which often is that the competition is so strong that recapturing leaked sales is extremely difficult.

Despite these issues, we continue to do leakage analyses, but with very great care and considerable caution. We’ve found that doing a leakage analysis for a supermarket, restaurant or a women’s apparel shop, where we can gain a firm grasp on the business data gives us greater confidence than doing an analysis for all the downtown’s retail businesses. We also will use them when our prior research experience has given us an in depth knowledge about the local businesses or when the study area is small enough that we can readily confirm the accuracy of the firm-level data.

Emperor 3Street and Façade Improvements Will Attract New Customers and New Businesses

Reality Check 3 – Too many downtowns have followed this strategy and only succeeded in creating “decorated coffins.” Yes, these downtowns are more attractive, but after much effort and expense they are still deader than a doornail, with low customer traffic, little vibrancy and few, if any, strong new shops. Such physical improvements can be effective, but this is much more likely to happen when they are part of a comprehensive revitalization program that includes successful business recruitment, marketing, redevelopment and place-making elements.

The attractions of these programs are that they mostly require money, not innovative “rocket scientists”, can be done in a fairly predictable time frame, and provide visible proof of an organization’s ability to get things done. These should not be confused with economic impacts.

Emperor 4Nearby Strong Pedestrian Traffic Is Critical to a Good Downtown Retail Location

Reality Check 4 –This is a basic axiom of many downtown revitalization strategies and the cornerstone on which our understanding of “location, location, location” rests. Yet, there is pitiful research on it. Behind this axiom are three suppositions. The first is that there are a lot of pedestrians, though no metric has been presented that signifies when “a lot” has been attained. Second is that among the multitude of pedestrians many will be browsing and window shopping and incidentally discovering reasons to enter shops and make purchases. Finally, is the assumption that the more pedestrians passing by, the greater the likelihood that a store’s destination shoppers will pass through its doors.

My experience suggests that the impact of pedestrian traffic is most likely to be felt in large downtowns where pedestrian flows of thousands of people/hour are easily found, and 100,000+/day are sometimes reached. But, even here, because of e-commerce, surgical shoppers have emerged who are more focused, going to fewer shops and doing far less browsing and window shopping. The Internet also is guiding more shoppers directly to downtown destinations identified in their searches. Additionally, the Internet has changed a lot of these destinations into showrooms for shoppers who see and evaluate the merchandise first-hand, but then buy online.

Smaller downtowns – defined at some unknown cutoff point – with total daily pedestrian flows only in the 100s or perhaps even a few thousand, have never really benefited much from the browsing and window shopping customer. These downtowns frequently just do not have that many retailers that pedestrians are motivated to do much browsing. Moreover, the retailers in these towns usually do not often refresh their selections or windows, so the browsing is even less rewarding. Unless in a tourist area, the merchants in these smaller downtowns have been made or broken by their ability to be a destination for task-oriented shoppers. Strong destinations survived and weak ones disappeared – except when the weak ones endured, because there was no competition nearby.

I know of neither a simple metric nor a complicated formula that indicates how many pedestrians/shoppers are needed to support X square feet of a particular type of retail store.

Emperor 5Hair and Nail Salons, Spas, Gyms Are Bad for Downtown Retailing.

Reality Check 5 – Back in 2005, I wrote a column in the Downtown Idea Exchange on this subject. My argument then was that these firms are part of a “pamper niche” that are not only found in abundance in some of the world’s most famed downtowns, e.g., Beverly Hills, Midtown Manhattan, Paris, etc., but also in many smaller districts where they bring in a lot of women with demonstrated disposable income, who also like to lunch and shop. Downtown retail merchants are crazy if they do not develop cross-marketing programs with the operators of pamper niche shops.

I also argued back then, that because they did not have significant investments in stocking merchandise, pamper niche operators could afford to pay higher rents than retailers. That is why they often supplant retailers in many storefronts.

Today, my arguments all appear to be holding true, but due to the Great Recession, pamper niche operators are taking over even more storefronts as they are vacated by weakened retailers. In some districts, pamper niche shops account for most new commercial rentals.

Downtown leaders who attack pamper niche shops are really off base. Instead of criticizing them, these “leaders” should recognize the customer traffic they generate and help their retailers create cross-marketing programs with them.

Emperor 6 – The Multifunctional Character of Downtowns Gives Their Retailers A Unique Competitive Advantage

Reality Check 6 – The multifunctional character of downtowns and the traffic it generates supposedly means that downtown retailers need less power as a destination to be successful. The downtown, in a sense, generates a lot of traffic for them. But, far too often, the ability of downtown retailers to benefit from their district’s multifunctionality breaks down because of two factors: a) the downtown is too dispersed, so office workers, hotel guests and students are too far away to walk to district retailers, and b) the ability of retailers to captures sales from various “captured” daytime markets is inhibited by operational factors such as:

  • Companies trying to keep their employees in the building by providing cafeterias and subsidized meals
  • Retailers are closing their doors when hotel convention guests are ready to browse and window shop
  • Commuting students needing to quickly return to jobs, children, etc.

Although solutions are available, too many downtown organizations have given up on overcoming the dispersion and operational problems, giving up, in effect, on helping their retailers tap critical close-in market segments.

Other Often Naked Downtown Emperors

Here are some other “Naked Downtown Emperors” that I do not have enough space here to detail:

  • Attracting tenant prospects is the biggest challenge in retail recruitment – it’s more often a lack of appropriate locations with appropriate spaces
  • Increasing capacity will solve parking problems – easily finding existing spaces is usually the real problem
  • High crime rates hurt downtowns – crime rates are often comparatively low, it is the fear of crime that does the damage
  • Nobody will use the upper levels of a parking garage – they will if the garages are properly designed, e.g. see the garage at The Grove in L.A.

Are there others you would add to this list? Please let me know.

Now I feel like a proper curmudgeon!