Retailing Revolution: Category Killers On The Brink
ategory killers," those highly focused retailers that specialize in a category of goods including Barnes & Noble, Best Buy, and Staples, were once the bane of mass-market retailers' existence. Their wide assortment, aggressive pricing, large stores, extensive store network, and deep expertise in the categories they served proved a massive competitive advantage.
Today, however, these same distinguishing characteristics may prove to be the undoing of the big-box stores. We believe that retailing generally is at a tipping point, with category killers being the first significant casualties of the (r)evolution that is occurring. Retail store asset productivity has been in decline since the start of the recession in 2007, and we believe this trend will accelerate over the coming years.
For mass-market retailers that can see this trend coming and react quickly enough, this upheaval is survivable. But those slow to register the tsunami wave on the horizon stand to be swept away.
As retailing entered the new century, this slowing was hard to predict. Indeed, retail store asset productivity increased at an impressive pace in the early 2000s even though Internet sales in the United States grew dramatically. Retail sales advanced from $2.87 trillion to almost $4 trillion between 1999 and 2007. However, the current recession created many challenges for retailers: overall consumer spending has declined or held flat, and return on invested capital (ROIC) has suffered dramatically.
This decline in ROIC has been exacerbated by the significant growth in store square footage before the recession. Retail store count exploded through the mid-2000s, and the size of the prototypical store increased dramatically as well—retail square footage in the United States grew from 18.45 square feet per capita in 1999 to 23.06 square feet per capita in 2009. The hope among retailers (and commercial real-estate developers) was that as the recession faded and the economy began to grow again, retail productivity would improve—especially as the bricks-and-clicks retail model worked in an increasingly coordinated manner to offer the consumer a seamless shopping experience.
The Internet threat
While recent retail sales figures seem to be comforting, this hope misses a very important trend. We believe retail asset productivity will not recover anytime soon.
The Internet has created a daunting situation for category killers, one that will eventually impact almost all of retail. The focus that made category killers so powerful in the 1980s and '90s is creating the conditions for their struggles in 2011.
In the early 2000s, e-commerce was seen as a threat to entire store formats such as grocery, music, and toy stores. But as consumer behavior evolved over the last decade and as supply chains improved, it became apparent that the danger to retail stores from online shopping was also at the item and category levels, which over time would destroy the economics of the entire store. Amazon.com and other e-commerce players did a tremendous job focusing on goods and categories that shoppers were now willing to buy via the Internet, such as books and consumer electronics.
This has left big-box stores in a very precarious situation. Because of their intense focus, these retailing giants have many fewer degrees of freedom to respond to the threat of e-commerce. For many, the economics of a store can suddenly become negative when 5 to 10 percent of their total floor space (in high-margin categories) becomes unproductive due to customers migrating to e-tailers. As entire sections of these stores die from online competition, category killers are being pressed to come up with solutions to keep their overall model afloat. The solutions so far haven't worked: over the last four years sales per square foot have not improved significantly since the depths of the recession—and the decline in ROIC is even more stunning for category killers.
The inexorable adoption of technology by consumers has proven that e-commerce pioneers were ahead of their time. While sales in stores declined dramatically during the economic downturn, sales on the Internet continued upward, totaling $165 billion by the end of 2010. While still only 5 percent of the overall retail market, online sales have grown from a base of just $28 billion in 2000. At current growth rates, 2015 purchases via the Internet will likely exceed $250 billion.
Online sales tend to be highly concentrated in several categories, and are so significant that it is increasingly difficult for physical stores to justify allocating space for these products. As a result, retailers will need to reconfigure as vast spaces become unproductive.
The most obvious victims so far of this shift are music, video, and book retailers—these categories are virtually nonexistent outside the Internet channel. Barnes & Noble is continuously trying to find alternative uses for its retail space, as many areas of its stores fall below critical levels of retail productivity. But these are not the only categories that suffer from the consumer' embrace of e-commerce.
Best Buy, arguably a bricks-and-clicks monopolist in the electronics segment, is a prime example of this impact. With the demise of Circuit City in 2009 one would have reckoned that Best Buy's best days were ahead. Instead, Best Buy is working fiercely to reinvent itself: its comparable store sales have barely kept up with inflation since 2008, and space devoted to its vast collection of music, computers, and televisions is becoming increasingly unproductive. Return on invested capital at Best Buy has declined from 23.68 percent to 15.01 percent since 2007, and domestic sales per square foot (including online sales) have also declined in the same period, from $909 to $853.