The Questionable Future Facing Global Retailers
- Nov 3, 2010
There are a number of financial ratios and other benchmarks that can be used to document the questionable future of retailing after the formal recession has ended: comparable or same-store sales data, sales per square foot, net profit as a percent of sales, increases in bankruptcies, store closings, the proportion of retailer-based credit accounts that are delinquent beyond 90 days, and so on.
The most troubling barometer of the poor health of the retail industry is data showing stagnant or declining same-store sales of many retailers. Slow or negative same or comparable sales growth directly affects a retailer’s profits, stock market valuation, and capability to purchase new goods, pay current operating expenses, and raise capital. Indirectly, slow sales growth also results in increased competition as retailers seek to expand their offerings into unrelated merchandise to offset their recent sales declines. This form of increased competition is commonly referred to as format blurring.1
To illustrate the effect of low growth across a broad spectrum of retailers, Retailer Daily compiled comparable store data from the Securities and Exchange Commission for 26 major retailers in 2009. Comparable store sales were negative for 12 of these retailers: Target, Sears, Supervalu, Best Buy, Home Depot, Lowe’s, Staples, Macy’s, J.C. Penney, Kohl’s, Gap, and Arby’s.2 Even more troubling, many of these retailers have faced declining same or comparable store sales for several consecutive periods. Both a decline in consumer spending, as well as a new frugality among consumers, have contributed to this slow growth.
Consumer spending is considered to be vital to the economic recovery because it accounts for about two-thirds of total economic activity. Although the U.S. economy has been growing since the middle of 2009 (after going into a recession in December 2007), the March 2010 income growth was the slowest since July 2009. According to Scott Hoyt, senior director of consumer economics for Moody’s Economy.com, “The near-term outlook is still problematic. Wage income is rising only modestly. With unemployment near 10 percent, the labor market power is clearly in employers’ hands, so there is little prospect for much more acceleration in wage income.”3 This unemployment rate does not include an additional 7 percent as of June 2010 that is either underemployed, that is so discouraged that they are no longer seeking employment, or that has accepted early retirement as an alternative to being laid off. What is clear to the author is that job losses associated with the recession will not be quickly restored in certain key industries, such as banking, finance, and automotive (as well as firms that service these industries). There has also been a shift in consumer mentality as to the role of savings versus spending. According to a strategist for Janney Montgomery Scott, “the broader issue here is that the credit crisis taught the consumer that borrowing is bad, savings is good.”4
The high level of real estate foreclosures and more strict overall lending standards by banks and financial institutions has reduced consumer spending. In the first quarter of 2010, the seasonally adjusted mortgage delinquency rate was 10.06 percent on all outstanding loans. The delinquency rate includes loans that are at least one payment overdue but not in the process of foreclosure.5 The situation is particularly poor in Nevada (with 1 of every 17 homes receiving a foreclosure filing), Arizona (with 1 in every 30 homes in foreclosure), and in Florida (with 1 in every 32 homes in foreclosure). The high number of foreclosures and underwater loans serves as a threat to the overall stability of the housing market.6
Much of the temporary economic recovery of the past recession has been due to the federal government’s purchasing billions of dollars of mortgage-backed securities, offering tax incentives for first-time home buyers, a “cash for clunkers” auto rebate program, and other programs that have reduced foreclosures. Many of these programs are now expiring. It is questionable as to whether consumer spending activity will increase without these government incentives.7
A second major factor impeding growth in retail sales is the continuation of consumer caution that was originally associated with the most recent recessionary period. The authors of a Harvard Business Review article argued that unlike in previous recessions when consumers “greeted the return of financial stability with a buying spree,” after this recession is over, “they’ll continue to buy simpler offerings with the greatest value.”8 Similarly, the president of Retail Metrics, a research firm, stated that “It’s [Wal-Mart] going to be a primary destination for a lot of people who may not have gone there in recent years, but who will elect to go there for the price and the value.”9
A survey of 2,000 U.S. consumers conducted by Booz & Company suggests that only 9 percent of consumers intend to spend at pre-recession levels on household products, 10 percent on cellular phone service, 11 percent on health and beauty products, and 18 percent on apparel, clothing, and shoes as of 2011. Close to two-third of consumers (64 percent) stated that they’ll shop at a different store with lower prices even if the store is less convenient.10
Finally, a Kantar Retail/PricewaterhouseCoopers report states that post-recession shopping will become more purposeful in nature. Rather than limiting purchases, the post-recession shopper will become more prone to seeking deals, being more open to comparison shopping, buying fewer items, shopping less often, and purchasing more private labels.11 This report states that retailers that rely on Baby Boomers will be particularly hard hit due to their loss in wealth and the need to fund retirement.
Overall, these studies suggest that many of the competitive inroads made by web-based merchants and discounters, such as off-price chains, warehouse clubs, and dollar stores, will continue even after the recession ends. Even firms with a loyal base of customers and a clear market positioning as a “fun place to shop” like Whole Foods have had to adjust pricing strategies to deal with an increasingly value-conscious consumer base.12
Increased Competition Across Retail Formats
The current retail environment is characterized by increased competition across retail formats (called format blurring), as well as a significant increase in retail bankruptcies. This new competitive environment will be discussed separately for food and nonfood retailers.
According to two academic researchers, the sales of similar categories of merchandise across different types of retailers has resulted in format blurring.13 Although retailers have always looked for opportunities to increase sales through selling goods and services not normally part of their line of merchandise, the pressure to pursue format blurring is much greater when retailers need to quickly increase sales levels.
Format blurring is self-perpetuating, as it generates a vicious cycle of action and reaction. A retailer that has recently lost sales to another retail format needs to quickly and aggressively seek out opportunities to offset its lost sales and profits. As an example, pharmacies need to sell greeting cards, chocolates, and cosmetics to make up for lost sales from Wal-Mart and Target that now have in-store pharmacies. Supermarkets now increasingly sell seasonal merchandise (such as barbecue grills, lawn furniture, and snow blowers) to make up for lost sales of paper towels, toilet tissues, and frozen foods to warehouse clubs. And similarly, traditional appliance retailers increasingly sell mattresses and other furniture-related items to make up for lost sales in major appliances due to increased competition from Home Depot and Lowe’s.
As a result of format blurring, the broad competitive environment for grocery stores now includes supercenters, drug stores, warehouse clubs, convenience stores, dollar stores, and limited assortment stores, as well as fast-food and traditional restaurants. As Stew Leonard, Sr. aptly stated, “Anybody who sells food and has their lights on is a competitor.”14 Bill Bishop, president of Barrington-based Willard Bishop Consulting, has commented, “There is almost a game of musical chairs being played as the market share of the general purpose supermarket is reduced by all sorts of players that are taking a fraction of that business.... You can buy an awful lot of groceries at places other than grocery stores.”15
Similarly, the competition for consumers’ clothing dollars comes from a variety of retail formats, including specialty stores, department stores, mass merchants, warehouse outlets, factory outlet stores, and off-price merchants (that operate store and web-based formats). Another example of format blurring is Target’s book club, which the retailer calls “Bookmarked Breakout.” Unlike traditional booksellers such as Barnes & Noble that stock 200,000 titles per location, Target sells about 2,500 titles. Although Target stocks best-sellers, it also resembles independent bookstores by offering a collection of “hand-picked titles from emerging authors.”16 In another example of format blurring, Best Buy is experimenting with selling patio furniture and electric scooters. According to Barry Judge, the chain’s chief marketing executive, Best Buy could “eventually end up [selling] electric cars.”17
Competition Across Retail Formats—Food-Related Products
Progressive Grocer magazine, in its 72nd Annual Report of the Grocery Industry, stated: “...we find it difficult to argue against the overwhelming amount of data we’ve collected that shows the demise of the supermarket, as a format, over the past decade.”18 Support of this statement comes from several key statistics relating to supermarket market share data, as well as the increased competitive environment. The Food Marketing Institute recently reported that traditional supermarket chains (those for which food generates at least 65 percent of total sales) have lost 30 percent of the grocery market (down from 89 percent in 1988). Another forecast by TNS Retail Forward estimates that supermarkets will have zero real growth from 2008 to 2013. The 3.3 percent forecast growth during this time period will be totally offset by a 3.3 percent inflation rate.19
Traditional grocery stores now receive only a portion of a consumer’s total purchases of foods and other items (like health and beauty aids) that in the past were purchased there in much greater quantities. An example of this trend is a family’s purchase of bulk-package sizes of paper towels, toilet paper, and freezer bags at warehouse clubs; milk and eggs at a local drug store; prepared soups, breads, and coffees at specialty grocers; ready-to-serve “heat and eat” prepared fish dinners at a local fish market; and light bulbs and batteries at dollar stores. Many of these alternate channels for food and related products have established strong competitive positions in these product categories due to a combination of very low prices, unique merchandise, and one-stop shopping appeals.
A major potential threat to the traditional supermarket industry is that its overall market share will be continually eroded by price-oriented merchants at one end (such as dollar stores, warehouse stores, extreme value stores like Aldi, and Wal-Mart), by convenience-oriented merchants (such as convenience stores, supercenters, and combination stores), and by quality-oriented merchants (such as specialty independently owned food stores and chains like Whole Foods) at the other end of the spectrum.
Firms as disparate as Wal-Mart, Costco, Target, and Dollar General are now formidable competitors to traditional grocery stores. In its 2009 fiscal year, grocery items (meat, produce, deli, bakery, frozen foods, floral, dry groceries, and consumables—health and beauty aids, household chemicals, paper goods, and pet supplies) made up 51 percent of Wal-Mart’s total sales.20 Similarly, 54 percent of Costco’s 2009 sales consisted of sundries (such as candy, snack foods, and tobacco), packaged foods, and fresh foods (meat, bakery, deli, and produce).21 In its listing of the top food retailers for 2009, Supermarket News reported Wal-Mart as the largest food retailer; Costco was third largest.22 Wal-Mart has been the largest U.S. food retailer since 2003, largely through growth in its supercenter format.23
Target is also using food as a means of improving shopping frequency and shopper convenience. Each of its SuperTarget stores has an in-store bakery, as well as a full-service deli. SuperTarget has also been a U.S. Department of Agriculture-certified produce retailer of fruits and vegetables since 2006.24 In its 2009 fiscal year, household essentials (including pharmacy, beauty care, personal care, baby care, cleaning, and paper products) and food and pet supplies made up 39 percent of Target’s sales, up from 32 percent in 2006.25
Dollar stores continue to expand their offerings, particularly in the perishables area. They have added coolers and freezers in many locations as a means of increasing shopper frequency, average sales per transaction, and same-store sales. Dollar General has instituted its cooler program in a majority of its 8,877 stores. Family Dollar has installed coolers in 5,600 of its 6,500-store chain as of the end of fiscal year 2008. In 2009, 70.8 percent of Dollar General’s net sales consisted of packaged foods, candy, snacks and refrigerated products, health and beauty aids, home cleaning supplies, and pet supplies (up from 65.7 percent in 2006).26 Consumables (household chemicals, paper products, candy, snacks, health and beauty aids, hardware and auto supplies, and pet foods) accounted for 64.4 percent of Family Dollar’s net sales in 2009, up from 58.8 percent in 2007.27 These are the same product categories that are sold by supermarkets.
Competition Across Retail Formats—Nonfood-Related Products
The high degree of competition among retail formats exists in virtually all sectors of retailing. Pharmacies currently face competition from in-store pharmacies at supermarkets, warehouse clubs, and mass merchants (in addition to mail-order pharmacies). Wal-Mart, Kohl’s, Costco, and Target have extensive selections of housewares, clothing, electronics, jewelry, and so forth. One can purchase eyeglasses at Costco, Sears, BJ’s, and J.C. Penney, as well as in chain and independent optical stores. Costco’s ancillary businesses—which are made up of gas stations, pharmacies, food courts, optical, one-hour photo, hearing aids, and travel—accounted for 15 percent of Costco’s total revenues in 2009.28 In addition, 19 percent of Costco’s revenues in 2009 came from hardlines (items such as major appliances, garden, sporting goods, patio, and furniture) and 10 percent came from softlines (apparel, jewelry, cameras, and small appliances). Home improvement centers like Lowe’s and Home Depot now feature major appliances and carpeting and offer home installation for many of their products.
With the demise of Circuit City, retailers like Wal-Mart have upgraded their selections of electronics and high-definition televisions to more effectively compete with specialty electronics stores. According to one report, more than 25 percent of Wal-Mart’s sales increase in mid-2009 has come from new shoppers, more than half of whom have household incomes of at least $50,000. Wal-Mart will work hard to keep these new shoppers because this higher-income group spends 40 percent more on their average visit than Wal-Mart’s typical shopper.29 To attract and keep this higher-income segment, Wal-Mart has begun to offer appliances from KitchenAid and Dyson and electronics from Dell, Palm, and Sony and has moved its apparel buying group to New York to become more sensitive to fashion trends.
In addition, competition from web-based retailers now covers virtually all areas of retailing (including new and used autos and real estate), as well as all price lines (from used items sold on eBay to collectibles). Forrester Research forecasts that U.S. web-based retail sales (not counting vehicles, travel, or prescription drugs) will grow to $248.7 billion in 2014, a 60 percent increase from its 2009 level.30 Forrester projects that the fastest growth will occur in consumer electronics, apparel, accessories, and footwear.
As is the case with traditional supermarkets, the situation affecting department stores is also especially bleak. There are only 10 department store chains left with sales of at least $3 billion in the United States: luxury chains Neiman Marcus and Saks; upscale Nordstrom; mid-tier Macy’s and Dillard’s; value chains J.C. Penney, Kohl’s, and Sears; and regional chains Bon-Ton and Belk. Mervyn’s and Goody’s both ended operations in 2008.
Like supermarkets, department stores have faced substantial competition at both ends of their market for apparel. There has also been significant competition for “value” shoppers from factory outlets, off-price chains, and closeout web retailers like www.smartbargains.com and www.overstock.com. European chains such as H&M, Mango, and Zara are also able to offer trendy merchandise at very low costs. According to one report, these chains have “[developed] a new category of disposable clothing.”31 And at the high end, department stores face competition from specialty stores with access to fashion designers, on-premises alterations, a well-trained sales staff, and so forth. In cosmetics, a highly profitable segment for department stores, retailers like Sephora and Ulta have been aggressive competitors of department stores. Estée Lauder has also begun to sell cosmetics online. If successful in its offerings, other cosmetics firms would undoubtedly follow suit.
Increased Number of Retail Bankruptcies
As a result of reduced sales, competition from other retail formats, and high operating costs, 26 supermarket chains filed for bankruptcy earlier in this decade. Bi-Lo and Bruno’s Supermarkets have also recently filed for bankruptcy protection. In addition to these bankruptcies, a wave of consolidation has swept through the supermarket business. These include the acquisitions of Wild Oats Markets Inc. by Whole Foods, Pathmark by A&P, and Albertson’s by Supervalu.
There has also been a large overall increase in retail bankruptcies in other product categories, including restaurants, electronics, furniture, and jewelry retailers. These include such major retail chains as Bennigan’s, Bombay, Boscov’s Department Store, Circuit City, Crabtree & Evelyn, Dial-A-Mattress, Eddie Bauer, Filene’s Basement, Fortunoff’s, Friedman’s, Goody’s Family Clothing, Gottschalks, KB Toys, Levitz Furniture, Linens ‘N Things, Mervyn’s, Mrs. Fields, Ritz Camera Centers, Samsonite, The Sharper Image, Steve & Barry’s, The Walking Company, Whitehall Jewelers, and Wickes Furniture.
Retailers have been especially hard hit by this recession due to high fixed costs for store leases, high interest costs for store fixtures and renovation, and utilities. Unlike manufacturers, retailers cannot reduce labor costs by shutting down plants on a temporary basis or through outsourcing production to suppliers with low-cost manufacturing facilities. According to an analyst with Bernstein Research, this recession will wipe out 5 to 10 percent of all retail stores.32 Although some retailers have closed stores as a result of bankruptcy, such as Ritz Camera, Circuit City, and Zale Corporation, others like Sears Holding Corp., Starbucks, and Talbots have shut down underperforming stores.33 According to a report from the CoStar Group, the retail availability rate (which includes vacant locations and locations being marketed by landlords even though the existing retail tenant has not left) was 9.9 percent as of February 2010.34
Retailers that are number two or three in market share in their respective markets are particularly vulnerable to bankruptcy or liquidation. This is especially the case for retailers that have increased their debt in recent years when interest rates were low and credit availability was high to fund major store expansions. Retailers owned by private equity firms that were purchased during prior boom years due to their strong cash flow and property assets are also suspect.
The overall effects of the economic downturn have been felt around the world. A major global credit insurer, Euler Hermes, estimates that about 35,000 Western European retail businesses became insolvent in 2009, up 17 percent from 2008. Retailing was the second-worst-hit sector after manufacturing.35 Among the major recent European retailer bankruptcies were Woolworths, a British chain selling toys and housewares; MFI, a British furniture retailer; The Pier, a housewares chain; and Arcandor, a German retailer whose Karstadt department stores anchor downtown shopping areas throughout Germany.
There are several major concerns with retail bankruptcies and liquidations. Unfortunately, these bankruptcies and liquidations bring down price expectations for the remaining retailers. This forces surviving retailers to reduce their prices (and profit margins) to remain competitive. Store closings also decrease the desirability of many retail locations, particularly malls, making it more difficult for the surviving stores to continue to attract customers. This is especially the case where stores rely on each other to generate store traffic or when one of a mall’s major anchor tenants close. And finally, many mall developers are adversely affected. Lower rental income due to both empty stores, as well as lower percentage lease payments from existing retail tenants, may affect the maintenance of retail properties.