News

Fools Errand: Downsizing Your Stores is No Panacea

BY CSA STAFF

By Tom Mullaney, [email protected]

In the last decade, electronic commerce (e-commerce) has grown relentlessly. As more consumers have access to the Internet and have become more comfortable with purchasing products and services online, many e-commerce businesses are enjoying double-digit sales growth year after year – and there is no slowdown in sight.

Panic is probably too harsh a term, but more and more retailers are getting very concerned about the negative operating leverage that results from lower sales being made out of the same physical square footage in their stores.

In the past year, there have been an accelerating number of retail companies trying to shrink their square footage in part because of the increasing amount of products sold online versus in a physical store (e.g., Best Buy, The Gap, Target). This change in market share between physical commerce and e-commerce has a significant impact on companies’ bottom lines. Unlike the proverbial frog in the slowly heating water pot, retailers are realizing that heretofore relatively minor annual sales losses to ecommerce are having a serious cumulative impact, particularly when one looks at lost contribution margin from those sales (which have a leveraged and disproportionate impact on lost profit dollars). Prominent companies have set forth new plans to implement a square foot reduction plan for new small format stores. When this involves opening a new location, the process is straightforward. However, when it involves downsizing existing locations in the middle of a lease term, many of these companies are headed for untold amounts of grief. Downsizing square footage of existing stores is much more difficult than it initially appears and retailers need to be careful to avoid promising more than they can deliver.

In choosing to downsize, companies have three options, each of which carries positives and negatives.

The first method is to wait until a lease expires and upon expiration, open a new smaller store. However, most retail leases in the United States average from five to 20 years in duration, so using this approach will take five to 20 years to resize a typical retail system. And imagine how big ecommerce is going to be in five to 20 years: As the old saying goes: “You ain’t seen nothing yet.” Clearly, resizing on natural lease expiry is a legitimate and relatively low out-of-pocket cost approach, but the downside is that it takes far too long and lost sales to ecommerce continue apace – so it actually costs a lot more than it looks.

Another method is to sublease to a tenant, effectively splitting (often technically described as “demising”) the space in order to decrease the square footage, all the while maintaining the current lease. This option is easier said than done, as there are many costs that can pile up when trying to divide a space. For example, in past years former HMS clients Blockbuster and Sports Authority tried to split existing spaces, yet found that the theory most definitely did not pan out in practice. For instance, there were conflicts as to who would take how much front footage and who would get inline space versus an endcap.

Additionally, there was disagreement as to the size and location of each company’s signage. Some retailers have tried to get around the understandable armwrestling between a prime tenant and his subtenant over issues of carving up the building exterior by effectively opening up a store within a store. Similar to a department store, where there is, say, a Ralph Lauren Polo section in a Saks Fifth Avenue, a “second” store would be located within a primary store. However, from the subtenant’s perspective, there is often no exterior indication or promotion of their store on the exterior of the primary tenant’s store. As companies greatly value their identity to foot and street traffic, the idea of being buried within the prime retailer’s location is suboptimal, albeit certainly possible for retailers willing to cede storefront visibility. As a result, the second option of subleasing to shrink square footage is easier said than done. It is worth considering, particularly if it can be done on a national relationship basis with another, similar quality retailer. But that requires complicated negotiation, test marketing and, ultimately a lot of time to roll out — all with the ecommerce clock relentlessly ticking.

A third method in downsizing is to buy-out the existing lease, which includes covering the rent and amount of space that is actually used. In effect, a retailer would inform the landlord of its need for only, say, 30,000 sq. ft. in a 40,000-sq.-ft. space. Buying out could entail compensating the landlord to insert a wall to split the space and funds to payoff the original rent payment as well as additional demising costs (e.g., additional bathrooms, HVAC upgrades).

However, this is a pricey option and it is difficult to convince landlords to agree to this approach. In today’s ugly economic environment, landlords are trying to keep their vacancy rates down from already high levels, not add increased vacant shop space. Accordingly, this third option of buyouts, while theoretically quicker, is the functional equivalent of hitting the landlord with your purse until he says “OK, OK; Deal!” But if time is of the essence, this is a viable way to proceed to stay in existing locations with a reduced footprint. Just bring money.

Clearly, the foregoing methods are time-consuming, expensive and complex. Imagine the amount of time, energy and manpower that goes into doing this for, say, a big box retailer with 1,000 locations around the United States? It is a huge undertaking. Companies should be wary before deciding to downsize and should presume that they will face a multi year, costly battle to shrink. And for public companies, they need to be careful not to overpromise Wall Street as to how quickly and deeply they will shrink their footprints; Wall Street has a long memory and likes to bring these kinds of issues up on a quarterly basis, providing repeated opportunities for spotlighting underperformance.

Instead of focusing on how to downsize square footage, many companies should take this opportunity to improve their business within their existing square footage. For example, rather than task their real estate departments with this hugely difficult task of downsizing, how about tasking marketing and operations to figure out how to drive more sales through the existing footprint? Or how about undertaking an initiative to transform cost of goods sold? With the advent of smart phone apps like Red Laser, consumers can immediately determine if a retailer’s price can be beaten online or by going to a nearby physical store competitor. Retailers who do not have razor sharp, competitive pricing in their stores are going to continue to lose sales to online commerce and those physical retailers (e.g., Costco) whose business systems allow rock bottom pricing – regardless of the size of their store footprint. The never ending battle to reduce cost of goods sold and maintain gross margin is only going to get a lot tougher going forward, and is going to require high cost retailers to make massive changes in their business system to avoid extinction. And if you think “extinction” is a term that is a bit hyperbolic, let me refer you to some fresh dirt in the retail graveyard, including companies like Blockbuster, Borders, Circuit City, Hollywood Video and Tower Records, all of whose demise was accelerated by the steady or (in some cases) rapid evisceration of their business model by e-commerce.

By all means, downsize, using some of all of the three methods described above. Lay in a lot of money, manpower and patience to do so. Don’t overpromise your board of directors or Wall Street. But be sure to focus on where the real opportunity lies: the time honored practice of driving more customer traffic, gaining bigger sales per customer, and managing cost of goods to keep competitive with lower cost ecommerce and physical commerce competitors.

Tom Mullaney is a founding principal with the financial restructuring firm Huntley, Mullaney, Spargo & Sullivan, Inc. He can be reached at [email protected] or (805) 259-9486.

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J.Hassan says:
Jun-16-2012 10:41 pm

Yes, e-commerce is a threat
Yes, e-commerce is a threat to stores. The trend is very alarming, but this is the challenge to the store owners. How can they attract consumers like us to go to the store instead of using the internet. - The Balancing Act Lifetime

J.Hassan says:
Jun-16-2012 10:41 pm

Yes, e-commerce is a threat to stores. The trend is very alarming, but this is the challenge to the store owners. How can they attract consumers like us to go to the store instead of using the internet. - The Balancing Act Lifetime

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OPERATIONS

Report finds retail in holding pattern, identifies major trends

BY Marianne Wilson

New York City — The retail sector continues to edge tentatively toward recovery, buoyed by a strong start to the holiday shopping season, but several obstacles stand in the way of sustained progress in 2012, according to Jones Lang LaSalle’s North America Year-end Retail Outlook.

“Everyone, including consumers, is in a continued wait-and-see mode, delaying major buying and investment decisions until they see how several dynamics play out, including the elections next year," said Greg Maloney, CEO and president, Jones Lang LaSalle Retail. "Until we have some market certainty in the U.S. and overseas plus sustained high levels of consumer confidence driven by higher paychecks, a stronger stock market and an improved housing market, a robust recovery will elude the retail sector."

One of the major trends impacting retail identified in the report is the growing prevalence of "web-influenced sales" whereby are consumers researching products online, reading reviews and searching for the best deals locally. The attractiveness of this practice lies in consumers’ desire for immediate gratification as well as the ability to save on shipping costs by buying locally in-store.

It’s estimated that web-influenced sales will generate almost $1.13 trillion in U.S. sales this year and, by 2015, will represent approximately 44% of total retail sales, or $1.55 trillion. Moreover, even though e-commerce sales are growing at a fast clip (10% annually), cross-channel commerce is growing even more rapidly, and is estimated to grow to five times the e-commerce market by 2015.

"To survive in the long-term, local retailers will have to ensure their products show up online, that the site reflects accurate availability, and that the online and in-store experiences are as seamless as possible," said Lew Kornberg, managing director, corporate retail solutions. "The rewards are direct — not only do shoppers come in for the researched product, they also stick around to buy other items once in-store."

Forrester Research reported that 45% of shoppers interviewed said they bought extra items once in a store, spending, on average, $154 on additional purchases.

Other major trends include:

  • Consumers’ increased reliance on their smartphones and tablets as an in-store shopping companion will motivate retailers to improve their mobile retail websites and capabilities and add mobile loyalty programs.
  • Amazon.com’s entrance into the designer fashion market with high-end fashion items, an online style guide and fashion recommendations based on previous choices will raise the stakes in this sector as the online retailer giant leverages its easy-to-shop, hassle-free reputation with fashion-forward consumers, eBay also launched its Fashion Outlet this year, offering savings up to 70%.
  • Consumers are splitting their grocery budget and time among several types of food retailers, from wholesale clubs to organic supermarkets to regular grocery stores. Mid-market chains, most squeezed by this trend, are responding by adopting one of two strategies — upgrading their shopping experience with increased organic selections or focusing on bargains.
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STORE SPACES

Supervalu steps up to the efficient buildings challenge

BY Staff Writer

Washington, D.C. — Supervalu announced that it has joined the U.S. Department of Energy’s Better Buildings Challenge, which aims to engage building operators nationwide in improving energy efficiency by 20% by 2020. The announcement was made by President Barack Obama and former President Bill Clinton during a leadership event attended by Craig Herkert, Supervalu CEO and president, this morning in Washington, D.C.

“Reducing our energy footprint and creating a more thoughtful and sustainable operation are important priorities, and we will continue to test innovative ways to build our stores with future generations in mind,” said Herkert. “These projects are good for the environment, improve our operating efficiency and create jobs — ultimately benefiting the communities we serve.”

Supervalu has invested $20 million in energy efficiency initiatives this year alone resulting in more than 1,300 projects across its enterprise.

In order to achieve its energy and carbon reduction goals, and support its commitment to the Better Buildings Challenge, Supervalu said it will continue to invest in innovative energy efficiency projects.

Supervalu said it has been working over the past five years to reduce total carbon emissions by 10% and landfill waste by 50% and is on track to reach those milestones by the end of 2012.

One of Supervalu’s projects is the nation’s first low-carbon, ammonia refrigeration system at an Albertsons store it is remodeling in Carpinteria, Calif.

Since 2008, Supervalu has completed 4,500 energy reduction projects.

“I am honored to attend today’s event and thrilled at our ongoing efforts around environmental stewardship,” said Herkert. “We appreciate the leadership shown by the Obama Administration and the Clinton Global Initiative and are committed to leading our industry through ongoing investments in projects that create energy efficient stores, offices and distribution centers.”

The Better Buildings Challenge is a leadership initiative launched in February by President Obama. It is spearheaded by former President Clinton and the President’s Council on Jobs and Competitiveness to support job creation by catalyzing private sector investment in commercial and industrial building energy upgrades to make America’s buildings 20% more efficient over the next decade, reducing energy costs for American businesses by nearly $40 billion.

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