Why is the Retail Apocalypse Playing Out Now? A Few Thoughts on Structural Changes

Through the first 90 days of 2017, nine retailers have filed for bankruptcy - as many as in all of 2016.

Year-to-date Chapter 11 filings:

  • BCBG Max Azria
  • Eastern Outfitters
  • Gordmans Stores
  • Gander Mountain
  • General Wireless Operations (formerly RadioShack)
  • HHGregg
  • Limited Stores
  • Michigan Sporting Goods Distributors
  • Wet Seal

Additionally, J.C. Penney, RadioShack, Macy’s, and Sears have each announced more than 100 store closures and Payless ShoeSource announced they would be closing over 400 stores as part of a reorganization. Ralph Lauren announced it would close its flagship Polo store on Fifth Avenue and retailers from Lululemon to Urban Outfitters to American Eagle are seeing their stock prices hit multi-year lows. All told some 4,000 stores (and perhaps more to come) were shuttered over the last 12 months and is being called a retail apocalypse. While the retail segment is highly sensitive to economic forces, traditional macroeconomic pressures don't appear to be the driving force behind the retail apocalypse. The consumer has been the catalyst for most of our economic growth in recent years, unemployment is extremely low, gas prices are restrained, and wage growth is accelerating.

Rather than cyclical economic dynamics, structural changes appear to be at the root of the retail apocalypse. Here are seven structural drivers I see playing out right now and two bonus trends to watch in the years ahead:

  1. Inflection Point for Online Shopping. The rise of e-commerce has been putting pressure on physical retail for years. This is nothing new but I would argue it has hit an important inflection point in the last 6-12 months. E-commerce now represents roughly 9.5 percent of total retail sales. Headed into the 2016 holiday shopping season, I predicted online sales would grow 16 percent and mobile would growth by 45 percent (representing 24 percent of all online sales for the period) while overall retail would grow roughly 3.8 percent. In February, the Commerce Department reported that fourth quarter 2016 overall retail sales grew by 3.9 percent while e-commerce grew by 14.3 percent so my early forecasts where inline with final results. Deloitte recently published their annual Global Powers of Retailing report looking at the world's 250 largest retailers to which Amazon broke into the top 10 for the first time. Amazon is the largest online apparel retailer  with "sales more than the combined online sales of its five largest online clothing competitors -- Macy's, Nordstrom, Kohl's, Gap, and Victoria's Secret parent L Brands." Amazon now represents over 10 percent of the apparel retail business with total sales behind only Walmart, Macy's, and TJX Cos. Today roughly 80 percent of U.S. households have a smartphone, 60 percent have a tablet, and some 90 percent or so of U.S. households have a tablet or some type of home computer. Home broadband dominates home internet connections, in spite of recent declines as some households switch to become mobile-only households.  Walmart, following their $3.3 billion purchase of Jet.com, is slowing physical store openings in order to invest more heavily into their online presence. PetSmart's $3.35 billion acquisition of Chewy.com will be the biggest e-commerce acquisition in history. In fact, seven of the largest 14 acquisitions have taken place in the last 24 months.   There are all developments that have materialized in recent months. Change are accelerating not declining.
  2. Shifts to Online Shopping + Service. The shift to online shopping has also brought with it a shift towards what I'll refer to as online shopping + service. This is still a small trend but one that is percolating in a number of retail niches. This trend is the blurring of e-commerce and curated service. We are seeing it in food delivery with companies like Blue Apron, Plated, and Hello Fresh. We are seeing it in fashion and apparel with companies like Stitch Fix, Trunk Club, and even Warby Parker - though recent results from Nordstrom-owned Trunk Club suggest the concept is still far from mainstream and mature.
  3. Growth of Two-sided Marketplaces. Related to #2, the growing prevalence and maturity of the Internet has spurred the growth of two-sided marketplaces which are exerting pressure on the demand for traditional retail space. For example, if you needed to groom or board your dog in the past you probably would have used a company with a local retail location. Today you might use an online service line Rover to a find a local boarder or groomer. These individuals are generally using their private homes and don't maintain a retail location. These two-sided markets are allowing for the more efficient deployment of previously underutilized capital which is putting pressure on the demand for physical retail space. Platforms like Etsy offer an eclectic mix of products from a myriad of sellers - products you might have previously purchased in a physical store. One of the greatest benefits found in the emergence of online retailing is not the creation of a different distribution channel or a cheaper distribution channel. but a rather a distribution channel that can support the long tail of consumer choice. The internet fosters an environment where niche products can gain sufficient scale to survive and thrive.
  4. Shift to Services. A fourth structural change is the shift from material purchases to services like healthcare and restaurants - the so-called "restaurant renaissance." This is also tied to the shift towards the experience economy.
  5. The Rise of the Boutique. As the masses begin to move online, the demand for locally-sourced, niche, unique retailing experiences have cropped up. At the same time we've seen a move way from mass shopping. As Derek Thompson noted in the Atlantic, "the U.S. has 40 percent more shopping space per capita than Canada, five times more the the U.K., and 10 times more than Germany...mall visits declined 50 percent between 2010 and 2013, according to the real-estate research firm Cushman and Wakefield." The simultaneous move online and away from mass shopping has driven demand for boutique shopping experiences. These physical stores are generally found in urban settings and tend to have both small online footprints as well as small physical footprints. These boutiques generally offer an assortment of home and food products from local merchants that are not widely available online.  They might also offer more customized products and "small batch" products that do not scale well for broad online distribution.
  6. The End of Cheap Money. Over the last decade, retailers were able to take advantage of an era of low interest rates. Private equity investors also took retailers with small debt profiles private and then highly leveraged these positions. Rising interest rates are changing the risk profile of these retailers who will need to refinance at potentially higher rates or find ways of aggressively paying down debt burdens. Moody's has noted that the number of distressed U.S. retailers has more than tripled since the 2008-2009 recession.
  7. The End of a Real Estate Cycle. Related to #5, I think some investments over the last cycle were more keenly focused on underlying assets like real estate than the actual underlying retail business. Rising interest rates lower the attractiveness of these type of deals and the low hanging fruit has already been picked.

Bonus trends to watch in the years ahead:

  1. The Digitization of Commerce. E-commerce has played an important role in redefining the retail experience. I believe some of the next big transformative steps for retail will materialize around the digitization of the commerce experience that is taking place inside physical stores. There has been some early exploration of beacon technology but we have yet to see wide deployment. Voice User Interfaces (VUIs) are beginning to show up in homes through Amazon Alexa and Google Home but have yet to materialize in physical retail stores. We are seeing deployment of enhanced back-end systems but the coupling of physical stores with digital platforms has yet to really materialize. Smartphone apps and relevant loyalty programs might be the glue that binds these two together - enabling stores to recognize you (your shopping history and preferences) whether you are online or in the physical store.    
  2. Autonomous Shopping. It isn't here yet, but its building on the horizon and I think it's coming. We are releasing digitally connected objects that can shop on our behalf. At CES for example Whirlpool launched a washer and dryer that can monitor the number of cycles you do, recognize when you are running low on supplies like detergent, and then proactively order on your behalf. Many of the Wall Street analysts I speak with today believe e-commerce might double in the coming years - jumping from 10 percent of overall retail sales to maybe 20 percent of overall sales. But I believe autonomous shopping - when machines makes purchases on our behalves - could drive online share of total retail much higher. In this environment, I wouldn't be surprised to see online sales capture 40 percent of total retail.   

 

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