Being Remarkable · Omni-channel · Retail

Reports Of JC Penney’s Death Are Greatly Exaggerated

The last several years have not been kind to JC Penney. Not only have they been swept up in the long-term decline of the moderate department store sector, but they also hemorrhaged huge amounts of market share during Ron Johnson’s failed re-boot. Under current leadership, the picture has not improved much. In fact, last week shares sank again after a disappointing earnings report. The stock is off nearly 90% in the past five years and some 40% year to date.

Many observers have concluded that Penney’s is on a slow slide to oblivion. And while I agree that much more needs to be done to right the ship, I am cautiously optimistic. In fact, full disclosure, I bought some Penney’s shares last week. While investing in the company is clearly not for the faint of heart, I believe there are a few reasons to conclude that the news on Penney’s going forward is more likely to be positive than not.

Store closings muddy the picture. The biggest reason for the miss on gross margin was from unusually high markdowns. Both Penney’s own store closings and those of competitors put pressure on pricing as stores liquidate merchandise. While clearly the industry is facing a great deal of promotional intensity, margin pressures should subside a bit as the pace of store closings slows.

New initiatives are gaining traction. Penney’s continue to expand its partnership with Sephora, opening 32 new locations and expanding 31 others. The beauty category is key to driving incremental traffic. The company also is growing its appliance showrooms and seeing positive sales momentum. The repositioning of its critically important apparel business also seems to be going well, with most categories seeing positive comps despite a difficult market.

Gaining share in a down market. Wall St. is overly focused on same-store sales growth, which I continue to deem retail’s increasingly irrelevant metric.  With nearly 20% of sales in Penney’s core categories occurring online it’s more important to understand combined e-commerce and physical store performance on a trade-area by trade-area basis. If Penney’s closed a bunch of stores but overall sales grew, it suggests that they gained omni-channel share, which speaks to their improving digital commerce capabilities. While there is considerable room for improvement, that’s still encouraging. And unlike some, Penney’s seems to get that stores drive e-commerce and vice versa–and they are acting accordingly and wisely.

Well-positioned to gain from Sears demise. While Sears may still technically survive as a holding company for intellectual property, it seems obvious that most of their mall-based department stores will be shuttered within the next year or so. That will give Penney’s a crack at hundreds of millions of dollars of home and apparel business, not to mention solid upside from their expanding appliance presence.

Maybe Amazon buys them? Amazon clearly has its eyes set on growing market share in traditional department store categories. And the reality is a physical store presence is going to be required to access the majority of the business. Both Macy’s and Kohl’s market caps are around $7b. Penney’s is under $2b. You do the math.

Of course, even if my prognostications prove accurate, I know other risks exist. JC Penney’s is highly leveraged. The Amazon Effect remains real. The off-price sector continues to steal share away from department stores. The full effect of retail consolidation is yet to be realized

However, the broader “retail apocalypse” narrative is nonsense and the notion that mall-based retail is doomed is overblown. Physical retail is different but far from deadMost malls are not going away. And recent earnings reports from many “traditional” retailers suggest the broader market is beginning to stabilize. Either way, more capacity needs to come out of the market before any of the struggling retailers have any shot at significantly improved performance. For Penney’s in particular, they need further work to make their assortments and experience more relevant and remarkable, while right-sizing their store fleet for optimal performance. They need to reduce their debt burden.

Perhaps it’s wishful thinking on my part, but I think they are fundamentally pointed in the right direction. Only time will tell.

A version of this story recently appeared at Forbes, where I am a retail contributor. You can check out more of my posts and follow me here.

Customer experience · e-commerce · Omni-channel

Many unhappy returns: E-commerce’s Achilles heel

It’s a common misconception that e-commerce is inherently more profitable than brick & mortar retail. The fact that very few online dominant brands’ profit margins exceed those of “traditional” retailers is one clue that this isn’t true. But a better way to understand the longer-term outlook is to look at the underlying economic drivers.

Above a basic level of scale, online retail is largely a variable cost business, whereas physical stores succeed by driving sufficient revenue to leverage their mostly fixed costs. At the risk of oversimplification, this means that to make money online gross profit/order needs to exceed the variable costs associated with that order. The reason that many eCommerce companies (or the e-commerce divisions of “omni-channel” retailers) don’t make money is that the marginal cost of acquiring a customer, plus the supply chain cost of fulfilling that order, exceeds the gross profit (essentially, revenue less the cost of goods).

The challenges of profitably acquiring customers online is an article for another day. But even where that hurdle can be overcome, e-commerce is often unprofitable due to high supply chain costs–and a huge driver is the high rate of returns. Consider this quote from Michael Kors’ CEO John Idol in a 2016 Bloomberg story: “Unfortunately today, e-commerce generates a lower operating profit for us than four-wall, brick-and-mortar. We think over time that will reverse itself but…when the consumer requires free delivery, free return, wonderful packaging, plus there’s a new trend that people are buying multiple sizes of things to try them at home and then return them, that all is a negative headwinds for us.” Bear in mind, this comes from a brand with significant consumer awareness, a sizable online operation and a high average transaction value.

While returns are not an issue for products that can be delivered digitally–or for many commodity items–in categories like apparel, accessories, footwear and home furnishings, where fit, coloration, fabrication and the like determine whether the consumer ultimately keeps the product, return rates between 25 and 40% are often the norm. When retailers pay for free shipping & exchanges handling costs can quickly erode any chance for a profitable transaction. We must also consider that returned or exchanged product often cannot be sold at the original gross margin, either because it is shop-worn (or otherwise “defective”) or because by the time it comes back the retailer has taken seasonal markdowns.

Some analysts have taken certain retail brands to task for their failure to aggressively invest in e-commerce. Yet many dragged their feet (or were rather deliberate about how they invested) quite intentionally because they understood that aggressive online growth was detrimental to their profitability. The fact is that unless returns rates can be mitigated significantly and/or the cost of handling returns can be lowered dramatically, some retailers will continue to suffer from what I call “omni-channel’s migration dilemma.”

While outside observers may gloss over this phenomenon, brands that face this growing profitability menace are taking action. One trend flies in the face of the retail apocalypse narrative. It turns out that physical stores can be incredibly helpful in lowering both the rate of returns and supply chain costs. While it is not the only reason that formerly digital-only retailers like Bonobos, UNTUCKit! and others are opening stores, it is a key driver. Large omni-channel brands have also tried to make it easier to return online orders in their brick & mortar locations. Not only are handling costs typically lower, but–surprise, surprise!–driving store traffic often leads to incremental sales.

Another avenue for taming the returns monster is using new technology and processes. TrueFit is a venture-funded company that uses artificial intelligence (among other tools) to help consumers choose the right product during the ordering process. Happy Returns is a more recent start-up that has also attracted solid VC funding. This expanding brand focuses on reducing consumer friction in the returns process and helping lower the cost of eCommerce returns for brands by operating “return bars” in major malls. The malls may also benefit by seeing incremental traffic.

Clearly e-commerce will continue to grow at much faster rates than physical retail. And with Amazon and newer disruptive brands helping drive the share of apparel, accessories and home furnishings that is sold online, the impact of high returns rates will become a bigger and bigger issue for many brands. Industry analysts would be wise to dig into this more deeply. Consumers can continue to enjoy the free ride until some rationality takes hold. Retailers would be well served to not gloss over this growing problem.

Taj Sims

A version of this story recently appeared at Forbes, where I am a retail contributor. You can check out more of my posts and follow me here.

Being Remarkable · Forbes · Omni-channel · Store closings

Honey, I shrunk the store

While the “retail apocalypse” narrative is nonsense, it’s clear that we are witnessing a major contraction in traditional retail space. Store closings have tripled year over year and more surely loom on the horizon. The “death of the mall” narrative also tilts to the hyperbolic, but in many ways it is the end of the mall as we know it, as dozens close and even larger number are getting re-invented in ways big and small.

While the shrinking of store fleets gets a lot of attention, another dynamic is becoming important. Increasingly, major retailers are down-sizing the average size of their prototypical store. In some cases, this is a solid growth strategy. Traditional format economics often don’t allow for situating new locations in areas with very high rents or other challenging real estate circumstances. Target’s urban strategy is one good example. In other situations, smaller formats allow for a more targeted offering, as with Sephora’s new studio concept.

By far, however, the big driver is the impact of e-commerce. With many retailers seeing online sales growing beyond 10% of their overall revenues–and in cases like Nordstrom and Neiman Marcus north of 25%–brick & mortar productivity is declining. It therefore seems logical that retailers can safely shrink their store size to improve their overall economics.

Yet the notion that shrinking store size is an automatic gateway to better performance is just as misunderstood and fraught with danger as the idea that retailers can achieve prosperity through taking an axe to the size of their physical store fleets. To be sure, there are quite a few categories where physical stores are relatively unimportant to either the consumer’s purchase decision and/or the underlying ability to make a profit. Books, music, games and certain commodity lines of businesses are great examples. But brick & mortar stores are incredibly important to the customer journey for many other categories, whether the actual purchase is ultimately consummated in a physical location or online.

Often the ability to touch & feel the product, talk to a sales person or have immediate gratification are critical. In other cases, lower customer acquisition and supply chain costs make physical stores an essential piece of the overall economic equation. Shrinking the store base or the size of a given store can have material adverse effects on total market share and profit margins. For this reason, retailers are going to need (and Wall St. must understand) a set of new metrics.

The worst case scenario is that a brand makes itself increasingly irrelevant by having neither reasonable market coverage with its physical store count nor a compelling experience in each and every store it operates. Managing for sheer productivity while placing relevance and remarkability on the back burner is all too often the start of a downward spiral. Failing to understand that a compelling store presence helps a retailer’s online business (and vice versa) can lead to reducing both the number of stores and the size of stores beyond a minimally viable level. But enough about Sears.

In the immediate term, we may feel good that by shooting under-performing locations and shrinking store sizes through the pruning of “unproductive” merchandise we are able to drive margin rates higherAlas, increasing averages does nothing if we are losing ground over the long-term with the customers that matter.

A version of this story recently appeared at Forbes, where I am a retail contributor. You can check out more of my posts and follow me here.

 

Digital · Mobile · Omni-channel · Retail

Retail’s Single Biggest Disruptor. Spoiler Alert: It’s Not E-commerce

There is no question that the retail industry is under-going a tremendous amount of change. Record numbers of store closings. Legacy brands going out of business–or teetering on the brink of bankruptcy. Venture capital funded start-ups wreaking havoc upon traditional distribution models and pricing structures. Discount-oriented retailers stealing share away from once mighty department stores. And, oh yeah, then there’s Amazon.

In assessing what is driving retailers’ shifting fortunes most observers point to a single factor: the rapid growth of e-commerce. But they’d be wrong.

To be sure, online shopping has, and will continue to have, a dramatic impact on virtually every aspect of retail. One simply cannot ignore the dramatic share shift from physical stores to digital commerce, nor can we under-estimate the transformative effect of e-commerce on pricing, product availability and shopping convenience.

Yet a far more profound dynamic is at play, namely what some have termed “digital-first retail.” Digital-first retail is the growing tendency of consumers’ shopping journeys to be influenced by digital channels, regardless of where the ultimate transaction takes place. It’s obvious that this shift helps explain the success of Amazon and other e-commerce players. But when it comes to how traditional retailers need to reinvent themselves, several factors related to this phenomenon need to be better understood and, most importantly, acted upon.

The majority of physical store sales start online. Deloitte has done a great job tracking digitally influenced sales and its most recent report indicates 56% of in-store sales involved a digital device–and this will only continue to grow. Moreover, quite a few major retailers, across a spectrum of categories, have publicly commented that they are experiencing 60-70% digital influence of physical stores sales.

Digitally-influenced brick & mortar sales dwarf e-commerce. While e-commerce now accounts for (depending on the source) some 10% of all retail sales, both Forrester and Deloitte have estimated that web-influenced physical store sales are about 5X online sales.

Increasingly, mobile is the gateway. We no longer go online, we live online and smartphones are the main reason. As the penetration of mobile devices–and time spent on them–grows, mobile is becoming the front door to the retail store. Digital-first now often means mobile-first. It may not be the predominant behavior today, but it won’t be long before it is.

It’s a search driven world. Sometimes consumers turn to the web for rather mundane tasks: confirming store hours or looking up the address of a retailer’s location. Other times they are engaged in a more robust discovery process, seeking to find the best item, the best price, the best overall experience and so forth. Retailers need to position themselves to win these moments that matter (what Google calls “micro-moments.” Full disclosure: Google’s been a client of mine).

Digital-first can be (really) expensive: Part 1. Having a good transactional e-commerce site is table stakes. Becoming great at enabling a digital-first brick & mortar shopping experience is the next frontier. As customers turn to digital channels to help facilitate brick & mortar activity, be that a sale or a return, retailers need to be really good at creating a harmonious shopping experience across all relevant engagement points. This isn’t about being everything to everybody in all channels. It isn’t about integrating everything. It is about understanding the customer journey for key customer segments, rooting out the friction points and discovering points of amplification, i.e. where the experience can be made unique, intensely relevant and remarkable at scale. It’s not easy, and it’s rarely cheap to implement. It turns out, however, it’s a really bad time to be so boring.

Digital-first can be (really) expensive: Part 2. Estimates vary, but it’s clear that search (or engaging on social media) is an intrinsic part of most consumers’ shopping process. And that means that an awful lot of customer journeys intersect with Google, Amazon, Facebook or some other toll-booth operator. I say toll-booth operator because so often a brand’s ultimate success in capturing the consumer’s attention, driving traffic to a website or store and converting that traffic into sales requires paying one of these companies a fee. And that can add up. Fast. Of course the best brands generate consumer awareness and interest through word-of-mouth, not paying to interrupt the consumer’s attention. The best brands get repeat business through the inherent attractiveness of their offering, not chasing promiscuous consumers through incessant bribes. The best brands don’t engage in a race to the bottom because they are afraid they might win. This shift in who “owns” (or at least can dictate) access to the customer is profound. A strategy of attraction rather than (expensive) promotion is the far better course, but not so easily done.

While e-commerce–and Amazon in particular–is re-shaping the retail industry, having a compelling online business is necessary, not sufficient. In fact, in my humble opinion, many of the retailers that are reeling today got into trouble because they spent too much time and money focused on building their e-commerce capabilities as a stand-alone silo, to the detriment of their physical stores and without understanding the digital-first dynamic that determines overall brand success and the ultimate viability of their brick & mortar footprint.

Blaming struggling retailers’ woes on Amazon, or e-commerce more broadly, is only part of the story. Figuring out how to thrive, much less survive, in the age of digital-first disruption requires a lot more than shutting down a bunch of stores and getting better at e-commerce. A whole lot more.

A version of this story recently appeared at Forbes, where I am a retail contributor. You can check out more of my posts and follow me here.

 

Customer Growth Strategy · Omni-channel · Retail

Is off-price the next retail sector to go off the rails?

Amidst all the pain that most of the retail industry has endured during the past few years, the “off-price” sector has been one of the few shining stars.

While most retailers struggle to eke out any top-line growth, the segment’s big four–TJX, Ross, Burlington and Nordstrom Rack–have delivered solid growth. While many retailers are closing stores in droves, the off-price leaders have been opening new outlets at a brisk pace while announcing plans to open hundreds of stores over the next several years. TJX, the parent company of T.J. Maxx, Marshalls, HomeGoods and Sierra Trading Post, added nearly 200 stores this past year alone.

So while it’s easy to blame Amazon for department stores’ troubles, there is ample evidence that it’s been the major share grab on the part of the off-price and outlet sector that’s inflicted a great deal of the pain.

Of course, the bifurcation of retail has been going on for some time. Consumers have been steadily shifting their spending toward more price-oriented brands since the recession. In some cases it has been driven by an economic need to spend less. In other cases by a realization that strong value can be obtained at a lower price, whether that is from a traditional retailer (e.g. Walmart), a leading fast fashion brand (e.g. H&M and Zara), a newer business model (e.g. Gilt and Farfetch) or, of course, Amazon.

Yet there is growing evidence that the segment is beginning to mature and that future results may be quite different from the boom of recent years. In the most recent quarter, TJX saw same-store sales growth slow to 1%. Archrival Ross posted better results but struck a decidedly cautious note. Nordstrom Rack, which has been the star within Nordstrom, has seen its growth slow to below the industry average.

So while one or two quarters do not indicate cause for alarm, there are several reasons why investors might want to beware.

Sluggish apparel growth

Average unit prices for apparel continue to contract, the discounting environment shows no sign of abating and consumers continue to shift their spending away from products to experiences. This means most sales growth must come from stealing share. That’s not likely to come easily.

Growing competition.

Competition is always intense in retail, but with the number of new stores that are opening, the rapid growth of online competition and Amazon’s growing and intense focus on apparel and home products (including an almost certain big push into private fashion brands in the next couple of years), sales and margin pressures are certain to become more pronounced.

Here comes e-commerce–and its challenges.  

The off-price industry was slow to get into digital commerce. Some of this was for good reason: it’s almost impossible to make money online in apparel with low transaction values and high rates of returns. But given consumer demand, the convergence of channels and pressure from growing competition, none of these brands have a choice but to invest heavily. But as e-commerce becomes an important growth driver, much of that growth will come through diversion of sales from a brand’s own physical stores–and often at a lower profit margin (what I call “the omnichannel migration dilemma”). As e-commerce becomes a more important piece of the overall business, the economics of physical stores will become more challenging, calling into question the reasonableness of the current store opening pace.

Brand dilution and saturation. 

The key driver of the off-price business has been offering major brand names at deeply discounted prices. While this is a bit of a con, the consumer is either blissfully ignorant or doesn’t care–at least so far. But as more brands grow through heavily discounted channels the risk of brand dilution goes up. And we’ve already seen several major brands pull back from factory outlet channels and tighten their distribution to wholesale channels where discounting was rampant. As Nordstrom, Neiman Marcus, Saks, Macy’s and Bloomingdales emphasize off-price growth (both physical store openings and online) the brand dilution concern to their “parent brands” looms large.

Overshooting the runway on store growth.

The over-expansion of most major retail chains is plaguing much of the retail industry right now. So far the off-price sector has escaped this fate, largely because the sector has been gaining share. But if growth continues to moderate and a greater share of the business moves to e-commerce, today’s store opening plans seem awfully aspirational. This is not a 2017 issue, and probably not one for 2018 either. But if I were a betting person, I’d wager that in 2019 we will view today’s plans as incredibly optimistic.

While the off-price sector is unlikely to experience the shockwaves of disruption pummeling its retail brethren anytime soon, we should remember that no business is immune from fundamental forces. And no business maintains above average growth forever. Investors would be wise to take a more cautious approach.

A version of this story recently appeared at Forbes, where I am a retail contributor. You can check out more of my posts and follow me here.  

Omni-channel · Retail · Store closings

Wall Street’s Misguided (And Dangerous) Fascination With Retail Store Productivity

An unprecedented number of retail store locations are closing this year and more announcements are surely coming–though perhaps not quite as many as I suggested in my April Fool’s post.

Given the lack of innovation on the part of traditional retailers, rampant overbuilding and the disruptive nature of e-commerce, this ongoing and massive consolidation of retail space was both inevitable and overdue. Yet much of the way the investor community sees the need for even more aggressive store closings is wrong and, one could argue, pretty dangerous.

One of the more ridiculous ways Wall Street firms have tried to determine the “right” number of store closings is to calculate how many locations would need to be shuttered to return various chains to their 2006 store productivity levels. A somewhat more responsible, though still alarming, analysis comes from Cowen, which focused more on the need to more closely align retail selling space supply and demand.

The most obvious problem with this type of analysis is its focus on ratios. The fact is that many stores with below average productivity are still quite profitable, particularly department stores, given their low rent factors. So while closing a lot of locations may yield a temporary productivity boost it often has a direct and immediate negative impact on earnings, which is a far better indicator of a retailer’s health.

The bigger issue is an underlying misunderstanding of the role of brick & mortar stores in retail’s new world order. Just as “same-store” sales is an increasingly irrelevant metric, so are store productivity numbers. Yes, more stores need to close. Yes, many of the stores that remain need a major rethink with regard to their size and fundamental operations. But what many still fail to grasp is how a retailer’s store footprint drives a brand’s overall health and the success of its e-commerce operations.

A given store’s productivity can be below average and decline yet still contribute to a retailer’s overall success, particularly online. Stores serve as an important–and often low cost–channel to acquire new customers. Stores serve as showrooms that drive customers online. Stores serve as fulfillment points for e-commerce operations. Stores are billboards for a retail brand. Without a compelling store footprint, a brand’s relevance will likely decline and its e-commerce business almost certainly will falter. Stated simply, store productivity numbers, taken in isolation, no longer get at the heart of a brand’s overall performance in an omnichannel world.

While there surely is merit in closing stores that drain cash and management attention, store closings can often make a bad situation worse. Ironically–as Kevin Hillstrom from MineThatData does a great job of illustrating–closings stores to respond to e-commerce growth can actually have the opposite effect. In fact, from my experience, massive store closings often initiate (or at least signal) a coming downward spiral.

Store closings are hardly the panacea that Wall Street seems to believe. And the notion that a brand can shrink its way to prosperity is typically horribly misguided. Macy’s, J.C. Penney and a host of others need to close more stores. And Sears and Kmart just need to go away. But, as I’ve said many times before, show me a retailer that is closing a lot of stores and you’ve likely shown me a retailer that doesn’t have too many stores, but a retail brand that is no longer relevant enough for the stores it has.

The danger of closing too many stores is increasingly real. The danger that struggling retailers will continue to appease Wall Street’s thirst for taking an ax to store counts instead of working on the underlying fault in their stores seems, sadly, clear and present.

A version of this story recently appeared at Forbes, where I am a retail contributor. You can check out more of my posts and follow me here.  

Being Remarkable · Customer experience · Digital · e-commerce · Frictionless commerce · Omni-channel

Omni-channel is dead. Long live omni-channel 

“Omni-channel” has been one of retail’s favorite buzzwords for years now. At last week’s excellent ShopTalk conference, several speakers challenged the relevance of omni-channel. This conversation is long overdue.

The shift from a “multichannel” strategy–being active in multiple channels such as physical stores, catalogs and e-commerce–to omni-channel, suggested some form of profound change. It created a veritable cottage industry in related buzzphrases like “seamless integration,” “frictionless commerce” and “being channel agnostic.” To be honest, I’ve been known to throw some of these terms around in blog posts and keynote talks with reckless abandon.

Yet five years or so into this journey, it’s increasingly obvious that omni-channel isn’t all it’s cracked up to be. Many of the retailers at the forefront of omni-channel evangelism–Macy’s being the most glaring example–have only delivered quarter after quarter of disappointing performance. Many struggling retailers have problems that go far beyond merely drinking the omni-channel Kool-Aid. But the fascination with, and massive investment in, all things omni, have in many cases made matters far worse. A recalibration is needed. Perhaps the term needs to be buried.

The first problem is that retailers have been chasing ubiquity when they need to be chasing relevance and differentiation. Clearly, customers are engaging in more channels as part of their shopping journeys and retailers must respond accordingly. But in trying to be everywhere many brands have ended up being nowhere when it comes to a compelling offering. Undifferentiated product, less than remarkable customer service and uncompetitive pricing aren’t helped by extending their reach.

The second problem stems from investing in e-commerce and digital marketing with insufficient focus and prioritization. The majority of retail purchases in virtually all categories start online and, despite conventional wisdom, digitally influenced physical store sales are far bigger than online sales. Many traditional retailers made their e-commerce offering better while underinvesting in their physical stores, seeming to forget that the lion’s share of shopping is still done in brick & mortar locations. Not every aspect of e-commerce or embracing a “digital-first” strategy is important.

The third problem is that a lot of e-commerce remains unprofitable and many digitally-based customer acquisition strategies are uneconomic. The future of omni-channel will not be evenly distributed. Retailers need to have a well-sequenced roadmap of digital marketing and channel integration initiatives rooted in a deep understanding of customer behavior and underlying economics. Too much of what has been done thus far has been more shotgun, rather than laser-sighted rifle, in its approach, and the generally poor results illustrate this quite dramatically.

The fourth problem is somehow thinking that customers care about channels. Customers care about experiences, about solutions, about shopping with ease and simplicity. At the risk of advocating yet another buzzphrase, “unified commerce” is far more descriptive of what needs to happen than “omni-channel.” “All channels” never suggested a meaningful consumer benefit. And it never will.

Of course, engaging in semantic arguments doesn’t ultimately accomplish very much. But neither does continuing to plow mindlessly ahead, chasing a once bright and shiny object that is rapidly losing its luster.

A version of this story appeared at Forbes, where I am a retail contributor. You can check out more of my posts here.

Digital · e-commerce · Omni-channel

An inconvenient truth about e-commerce: It’s largely unprofitable

The disruptive nature of e-commerce is undeniable. Entirely new business models are revolutionizing the way we buy. The transformative transparency created by all things digital has revolutionized product access, redefined convenience and lowered prices across a wide spectrum of merchandise and service categories. The radical shift of spending from brick & mortar stores to online shopping is causing a massive upheaval in retailers’ physical footprint, which looks to continue unabated.

But the inconvenient (and oft overlooked) truth is that much of e-commerce remains unprofitable–in many cases wildly so–and many corporate and venture capital investments have no prospect of earning a risk-adjusted ROI.

While it was once thought that the economics of selling online were vastly superior to operating physical stores, most brands–start-ups and established retailers alike–are learning that the cost of building a new brand, acquiring customers and fulfilling orders (particularly if product returns are high) make a huge percentage of e-commerce transactions fundamentally profit proof. Slowly but surely the bloom is coming off the rose.

Despite the hype–and a whole lot of VC funding–it’s increasingly clear that most of pure-play retail is dying, as L2’s Scott Galloway lays out better than I can. We have already seen the implosion of the flash-sales sector and the collapsing valuations of once high-flying brands like Trunk Club and One King’s Lane. Just the other day Walmart announced it was acquiring ModCloth, reportedly for less than the cumulative VC investment. A broader correction appears to be on the horizon and I suspect we will see a number of high-profile, digitally native brands get bought out at similarly discounted prices. And, ironically, we will continue to witness a doubling down of efforts by many of these same brands to expand their physical footprints, some of which is certain to end badly.

The challenges for traditional retailers and their “omni-channel” efforts are even more vexing. Walmart, Pier 1, H&M and Michaels are among the many retailers that have been criticized for their slowness to embrace digital shopping. Yet I suspect their seemingly lackadaisical approach owes more to their understanding of e-commerce’s pesky little profitability problem than corporate malfeasance. Alas, more and more retailers are increasing their investment in online shopping and cross-channel integration only to experience a migration of sales from the store channel to e-commerce, frequently at lower profit margins. Moreover, this shift away from brick & mortar sales is causing these same retailers to shutter stores, with no prospect of picking up that volume online. The risk of a downward spiral cannot be ignored.

Given the trajectory we are on it’s inevitable that more rational behavior will creep back into the market. But with Amazon’s willingness to lose money to grow share and investor pressure on traditional retailers to “rationalize” their store fleets, I fear it will take several years for the dust to truly settle.

In the meantime, e-commerce continues to be a boon for consumers and a decidedly mixed bag for investors.

A version of this story appeared at Forbes, where I am a retail contributor. You can check out more of my posts here.

 

Fashion · Luxury · Omni-channel · Retail

Should Hudson Bay Buy Neiman Marcus? The Case For And Against.

Tuesday morning the Neiman Marcus Group reported another quarter of disappointing financial results and announced that it was going to “explore strategic alternatives.”

To be sure, some of Neiman’s problems are idiosyncratic, largely owing to a botched systems implementation and a now crushing debt load taken on in a 2013 private equity buyout. Yet the brand’s continuing struggles also underscore how luxury retail has hit the wall and how it now seems increasingly likely that the storied company may need to run into the arms of yet another owner.

Recent reports have suggested that the Hudson’s Bay Company was hot on the trail of Macy’s. Yet to many, the notion that HBC would acquire a badly wounded company several times its size, seemed a bit crazy. But the rationale for HBC–the owner of Saks Fifth Avenue and Gilt–to acquire Neiman’s seems, at least at face value, more strategically sound and (perhaps) more easily financed.

When I worked for Neiman Marcus as the head of strategy and corporate marketing we took a hard look at acquiring Saks. Years later, many of the pros and cons of combining the #1 and #2 luxury department stores remain the same.

The Case For

It seems increasingly obvious that the luxury department store sector is quite mature. While e-commerce is growing (now representing 31% of Neiman’s total revenues), most of that is now merely channel shift. Moreover, there are virtually no new full-line store opportunities for either Saks or Neiman’s, and the jury remains out whether or not US brands can find a meaningful number of store openings outside their home markets. Shifting demographics also do not bode well for long-term sector growth.

Faced with this reality, consolidation makes a lot of sense. If Saks were to merge with Neiman’s there would be considerable cost savings from combining many areas of operations. Rationalization of the supply chain would yield material savings as well. Managing the two brands as a cohesive portfolio would allow for optimization of marketing spending and promotional activity. There might even be some benefits from combining buying power to extract greater margins from vendors. Less tangible, but potentially meaningful, is the ability to cascade best practices from each organization.

The more interesting benefits could come from addressing store overlaps. As the market matures and more sales move online, there will be a growing number of trade areas (and specific mall locations) where Saks and Neiman’s going head-to-head only waters down the profitability of each respective location. Selectively closing stores and redeploying that real estate could drive up the remaining locations’ profitability dramatically, while unlocking the underlying real estate value of certain locations. All of which certainly plays into Richard Baker’s (HBC’s Chairman) strengths.

The Case Against

By far the most challenging element of any buyout of Neiman’s by HBC (or by anyone for that matter) would be the price and the related financing. Neiman’s was sold in 2013 for $6 billion dollars and still carries about $5 billion in debt. Since the buyout the company’s EBITDA has gone south, with no prospect for an imminent major turnaround. Given the maturity of the sector and the company’s recent weak operating performance, it’s hard to see why anyone would pay the sort of multiple that would make the current equity and/or debt owners whole.

Unless the real estate value can be unlocked in a transformative way, the only rationale for a merger hinges on the ability to generate operational efficiencies and optimize trade area by trade area market performance. With regard to the former, this isn’t trivial. The Saks and Neiman’s cultures are very different. To say one is very New York and the other is very Texas merely hints at the challenges. It’s easy to sketch out the synergies on paper. Making them actually happen is another thing entirely.

With regard to the latter, the fact is that Saks and Neiman’s are very similar concepts (though Neiman’s historically has been operated far better). When I was at Neiman’s we struggled with how we would operate two virtually identical brands often operating in the same mall–or in places like San Francisco, Beverly Hills, Boston and Chicago–just down the street. Even if we could get out of a lease (or sell the store), would closing a shared location actually be accretive to earnings? If we continued to go head-to-head could we shift the positioning of each brand enough to actually grow market share and profits. Ultimately, other issues trumped this particular concern, but this issue isn’t trivial either and the degree to which it is important mostly comes back to the ultimate price to get a deal done.

Without access to proprietary data it’s impossible to completely assess the likelihood of an HBC/Neiman’s deal. But it seems increasingly likely that something dramatic needs to happen with Neiman’s capital structure and it’s difficult to imagine how another leveraged buyout gets done with private equity sponsors. And it’s hard to see another strategic buyer that makes much sense. More and more, HBC looks like the only game in town.

A version of this story appeared at Forbes, where I am a retail contributor. You can check out more of my posts here.

Being Remarkable · Digital · Omni-channel · Personalization · Retail

The fault in our stores

Last week Target became the latest retailer to report weak earnings and shrinking physical store sales. They certainly won’t be the last.

As more retail brands disappoint on both the top and bottom lines–and announce scores of store closings–many may conclude that brick-and-mortar retail is going they way of the horse-drawn carriage. Unfortunately this ignores the fact that roughly 90% of all retail is still done in actual stores. It doesn’t recognize that many retailers–from upstarts like Warby Parker and Bonobos, to established brands such as TJMaxx and Dollar General–are opening hundreds of new locations. It also fails to acknowledge the many important benefits of in-store shopping and that study after study shows that most consumers still prefer shopping in a store (including millennials!)

Brick-and-mortar retail is very different, but not dead. Still, most retailers will, regardless of any actions they take, continue to cede share to digital channels, whether it’s their own or those of disruptive competitors. To make the best of a challenging situation, retailers need a laser-like focus on increasing their piece of a shrinking pie, while optimizing their remaining investment in physical locations. And here we must deal with the reality that aside from the inevitable forces shaping retail’s future, there are many addressable faults in retailers’ stores. Here are a few of the most pervasive issues.

The Sea Of Sameness

Traditionalists often opine that it all about product, but that’s just silly. Experiences and overall solutions often trump simply offering the best sweater or coffee maker. Nevertheless, too many stores are drowning in a sea of sameness–in product, presentation and experience. The redundancy in assortments is readily apparent from any stroll through most malls. The racks, tables and signage employed by most retailers are largely indistinguishable from each other. And when was the last time there was anything memorable about the service you received from a sales associate at any of these struggling retailers?

One Brand, Many Channels

Too many stores still operate as independent entities, rather than an integral piece of a one brand, many channels customer strategy. Most customer journeys that result in a physical store visit start online. Many customers research in store only to consummate the transaction in a digital channel. The lines between digital and physical channels are increasingly blurred, often distinctions without a difference. Silos belong on farms.

Speed Bumps On The Way To Purchase

How often is the product we wish to buy out of stock? How difficult is it to find a store associate when we are ready to checkout? Can I order online and pick up in a store? If a store doesn’t have my size or the color I want can I easily get it shipped to my home quick and for free? Most of the struggling retailers have obvious and long-standing friction points in their customer experience. When in doubt about where to prioritize operational efforts, smoothing out the speed bumps is usually a decent place to start.

Where’s The Wow?

As Amazon makes it easier and easier to buy just about anything from them, retailers must give their customers a tangible reason to traffic their stores and whip out their wallets once there. Good enough no longer is. Brands must dig deep to provide something truly scarce, relevant and remarkable. Much of the hype around in-store innovations is just that. For example, Neiman Marcus’ Memory Mirrors are cool, but any notion that they will transform traffic patterns, conversion rates or average ticket size on a grander scale is fantasy. Much of what is being tested is necessary, but hardly sufficient. The brands that are gaining share (and, by the way, opening stores) have transformed the entire customer experience, not merely taken a piecemeal approach to innovation.

Treat Different Customers Differently

In an era where there was relative scarcity of product, shopping channels and information, one-size-fits all strategies worked. But now the customer is clearly in charge, and he or she can often tailor their experience to their particular wants and needs. Retailers need to employ advanced analytical techniques and other technologies to make marketing and the overall customer experience much more personalized, and to allow for greater and greater customization. More and more art and intuition are giving way to science and precision.

Physical retail is losing share to e-commerce at the rate of about 110 basis points per year. While that is not terribly significant in the aggregate, this erosion will not be evenly distributed and the deleveraging of physical store economics will prove devastating to many slow to react retailers. This seemingly inexorable shift is causing many retailers to reflexively throw up their hands and choose to disinvest in physical retail. The result, as we’ve seen in spades, is that many stores are becoming boring warehouses of only the bestselling, most average product, presented in stale environments with nary a sales associate in sight.

The fault in our stores are legion. But adopting an attitude that stores are fundamentally problems to be tolerated–or eliminated–rather than assets to be leveraged and improved, makes the outcome inevitable and will, I fear, eventually seal the fate of many once great retailers.

PurpleCow

A version of this story appeared at Forbes, where I am a retail contributor. You can check out more of my posts here.