Retailers: An Uncertain Future

The Consumer Revolution

As consumer preferences have shifted over the past decade, so has the retail industry; but what does that mean for investing in retail stocks? Although overall retail is growing and remains a massive part of the US economy, the growth in physical retail is being outpaced by inflation which has contributed to a profit squeeze for most companies causing a slump in stock prices.

Why is this? Consumers are seeking an elevated experience. They are no longer impressed with the optionality that a department store offers: they already have access to everything through their smartphone. That is why we see many of the most successful malls reformatting to include restaurants, theaters, and other differentiating experiences. Mall tenants are becoming less retail focused; so while malls may be adapting, this impacts the bottom line of developers and real estate holders. Those retails stores are still closing.

And that’s because shopping is becoming mobile.

With 4.8 billion people using smartphones in 2016, we see companies such as eMarketer predicting that 25% of all US e-commerce sales will take place on a mobile device. According the McKinsey, between 2008 and 2013 alone, e-commerce sales grew ten times faster than in-store retail, and that growth rate has only accelerated. Social commerce is expected to accelerate growth as companies such as Twitter, Pinterest, and Facebook have all adopted buttons inviting users to engage in transactions without leaving the platform.

It’s Not All Bad for Investors

Anyone who speaks of the death of retail is being dramatic; death of any industry takes time and a seasoned investor must understand that sometimes there are storms to weather. Retail sales grew 4.1% for Q1 from 2016 to 2017, making it $2 trillion industry; so in that sense, the future for brick and mortar stores doesn’t have to be as dreary as it looks. The concept of a physical store, whether at malls, downtown districts, or shopping centers, is not going away anytime soon. In fact in 2020, more than 80 percent of US retail sales will still happen within the four walls of a store.

What we are seeing now is not the death of an industry. Instead we are seeing a cyclical consolidation. Since the 1970s, shopping malls and sale space grew at a rate of four times US population growth. This yielded an unsustainable real estate bubble for departments stores. Sure, technology is playing a factor, but the store closings we’re seeing now are an expected contraction.

Department store companies pursued growth as their ambition rather than profitability. Company stock prices fluctuated on new-store openings and as a result of cheap financing, companies overbuilt. This business model is broken, particularly in our current economy. Unlike many companies that can pullback and pivot, construction of a department store is a large, upfront, long-term investment. Even if retailers simply lease the space, there are numerous renovations required to maintain brand consistency. This is a problem in a new-age economy which values versatility and the ability to adapt to change in consumer spending habits.

It’s for this reason that we see a one-time correction in an over-stored and over-malled economy prompting retail to shift from the massive departments that defined their industry into smaller, one-stop shops where there may not be everything, but there is a bit of everything.

This is both an attempt to bring needed flexibility to the organization, and to attract new crowds: the small size, in fact, enables these retailers to open downtown locations, where they can target young, affluent city dwellers.

The Elusive Middle Class

This emphasis on attracting young, affluent city dwellers is a byproduct of our changing consumer economy. More simply, we’re losing our middle class (if it’s not already lost). That’s why when we speak about the death of retail, what we actually mean is the death of retail which caters to the middle class: the middle class simply does not exist in a similar capacity to what it once was.

The US economy is plagued by inequity and inequality, and that economic gap is resulting in depressed demand which is hurting retail.

According to an IHL study of retail in the first quarter of 2017, where companies are managing to sustain growth is actually in off-price and dollar stores which fits the narrative that customers are no longer visiting physical stores in as great of numbers.

Sure, there are new stores opening at a similar rate to store closings, but they are fundamentally different. They have less square footage and they cater to a different type of customer (think JC Penney and Macy’s closing versus TJ Maxx and Dollar General stores opening).

 

Will Shopping Be Like Sci-Fi?

Beyond discount stores, we see that the nature of retail shopping is evolving, and in many ways, these changes make it seem like shopping will become similar to the experiences shown in sci-fi movies.

Will stores be staffed by artificially intelligent robots that identify our preferences through facial recognition technology? Will they have robots capable of communicating on a human-level to assist in the shopping experience and eliminate the idea of checkout counters as purchases are delivered by drones?

Amazon, the online giant that many say will bring an end to brick and mortar sales, has been looking at physical stores as blank slates and creating a shopping experience which combines the digital and real-world in an intuitive and (hopefully) indispensable experience. Currently Amazon only has one physical store location that they are using to test their check-out-line-less style: when you pick up an item, it automatically adds to your cart on your phone and all you have to do is walk out of the store to pay. Amazon has plans to expand such physical stores and projects that they would need as little as three workers to run a large, 2-story store. That is compared to roughly 280 employees which each Walmart has to hire. By saving all the salary expenses, Amazon can keep high profit margins at these stores and pass savings along to customers.

But change takes time; even for Amazon. At the moment, they’re product testing one store. Now granted, ten years ago, traditional stores view IT as only an operational expense — technology was utilized to improve back office operations, not as a strategic investment in customer experience. That much has certainly changed. Every retailer recognizes that they must adapt to survive.

But the speed at which they adapt and how they evolve is still undetermined.




A Realistic Future

In an interview with Jose Neves, the founder of Farfetch, a luxury fashion online platform, he claims that retails stores “are not going to vanish and will stay at the center of the seismic retail revolution that is only just getting started.” So what exactly does that mean?

It means that retail will persist in our daily lives, but the experience might fundamentally shift. Instead of physical shopping feeling like a detachment from the digital world, we will experience a synthesis of the two in an augmented reality setting.

At the moment, technology is under-utilized in the retail space because technology lacks empathy. Consumers want to try on an outfit and feel materials run through their fingers; they want to speak with employees and feel a sense of belonging to a store. Buying clothes is not as simple as what looks good. And that’s why we see department stores such as Lord & Taylor investing heavily in both their online presence as well as the in-person consumer experience: both are integral parts of a more sophisticated business model.

So what type of stores should we expect? A few options include…

  • Drive-through pick-up locations, as some shoppers will move away from large stock-up shopping trips to more targeted, time-efficient, needs-based trips.
  • Product showrooms that enable the customer to interact with products and interact with sales associates and other customers (both physically and remotely).
  • Immersive, augmented reality, experiential centers, as technology will enable shoppers to control their shopping experience. These stores will be venues for collaboration and experiences that cannot be provided online.
  • Brand stores that focus more on promoting the brand than on selling merchandise which will increasingly move online.

Not So Fast, We Care About Speed

For the time being, technology will add delivery speed and broader choices. It will improve efficiency but that does not mean it will radically transform the shopping experience. As Lord & Taylor’s president says, “not everyone wants a high touch or overly complicated experience. People want an extensive and rich assortment of options, but they also want a human connection.”

And beyond that, they want efficiency. “Timely delivery of product remains the top of all criteria for luxury consumers,” Mr. Neves of Farfetch said. “They want storytelling and theater of course, but they also want their chosen item, in the right color, size and in their hands as quickly as possible.” Think about Uber or Instapay or the numerous pre-made meal delivery startups: they all help customers save time and simplify their day-to-day routines. Ultimately the use of data to transform stores and make them more efficient will separate those who make it to the next step and those who won’t.

Retail is not the ominous bubble that investors have been fearing but it is changing and one thing is for certain: those long checkout lines are certainly a relic of the past.

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Related Retail Companies

Wal-Mart Stores (WMT); The Kroger Co. (KR); Costco (COST); The Home Depot (HD); Target (TGT); Best Buy (BBY); Sears Holdings (SHLD); Macy’s Inc (M); J.C. Penney Co. (JCP); Nordstrom (JWN); Gap (GPS); Amazon (AMZN); Lowe’s Companies (LOW); Walgreens (WBA); Dollar General (DG)




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Brian Curcio

Brian Curcio is a 22-year-old senior at Amherst College majoring in Mathematics and passionate about connecting the investment community. After numerous internships at hedge funds in New York, Brian recognized the disconnect between his own financial literacy and his friends’ lack of understanding of financial markets. He recognized there had to be a better way to invest than in the isolated bubbles that sever communication between individual investors, and he became driven by a desire to educate and empower the ordinary investor to leverage their social network to achieve higher returns.

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