Reports of Bricks-and-Mortar's Death Have Been Greatly Exaggerated
Daniel is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
This week, shares of appliance and electronics retailer hhgregg tumbled after the company announced that, under heavy pressure from Internet retailers like Amazon.com (NASDAQ: AMZN), it was cutting profit outlook. The company's plunge brought Best Buy down with it, triggering a renewed round of speculation about the imminent demise of bricks-and-mortar retailers. It's time to step back and remember this is not the first time we've heard this refrain.
First it was catalogues. Then it was home shopping channels. Then the Internet, and now, relatedly, mobile commerce. All of these things were or are predicted to end traditional retail, but none of them have, and none of them will. Of course, e-commerce is certainly changing the retail landscape. Netflix took down Blockbuster, and Amazon's list of victims just keeps growing. More and more of our shopping does take place online: online retailers now make up 9% of total retail sales, up from 5% just five years. That's strong growth, but it's still relatively small market share. While any physical store that relies on selling items people are happy to buy online will struggle in the Internet age, some stores have little to fear. There are two things you can do to protect your portfolio from Amazon and its ilk.
The first, obviously, is to buy Amazon—online sales have been growing at double digits over the past few years, and with first-mover advantage, unrivaled scale, and a massive distribution system, Amazon will be hard to beat. Indeed, many retailers actually outsource their online presence to Amazon. Why not back a winner? The second method is to identify the qualities of physical stores that will enable them to not only survive, but thrive in an era of online retail.
The most tangible advantage brick and mortar retailers can wield is just that: tangibility. People may be content buying fungible products they're already familiar with online, but novel or non-standard goods just beg for a customer to see with their own eyes, touch, use, and maybe even smell the product. Clothing stores seem to fit the bill here, as most buyers like to try on clothes. However mass-market clothing stores can fall prey to being used as showrooms for the Internet—customers try on the clothing in the store, and then order the right fit more cheaply online.
For my money, the best bet to cash in on tangibility is food, particularly fresh upmarket food. Processed food is standard enough to buy online, but no foodie would be caught dead buying avocados, say, without being able to poke, probe and sniff for ripeness. One retailer that boasts both a deep inventory of fresh meats and produce as well as an upscale clientele that tends to be choosy about food is Whole Foods Market (NASDAQ: WFM). At 33 times forward earnings, the company is richly valued. With overcrowding rampant at their existing stores and low penetration in secondary markets, however, the company's plan to more than triple its store count in the US looks realistic.
Whole Foods also employs a second advantage of certain physical retailers: a fun in-store experience. When retail locations are enjoyable places, with helpful and knowledgeable staff and the opportunity to test products, customers actually want to visit, especially when they can utilize services not available online. Whole Foods gives out free samples, and has a café where customers can sit down and eat.
The master of creating an entertaining in-store experience with services to add value is probably Apple (NASDAQ: AAPL). Futuristic stores and ready-to-use devices entice customers. Once inside, services like the Genius Bar, offering on-site technicians to field your problems, and classes teaching users how to handle their new devices, have proved an intoxicating combination for customers. Come to fool around with the gadgets; leave $500 lighter.
On the opposite spectrum of the value chain, some retailers can still sell goods more cheaply in their stores than online. This may be thanks to incredibly efficient distribution networks, like that of Wal-Mart, but may also be due to prohibitive shipping costs. Heavy, low-value items like lumber will almost always be cheaper to pick up in your own truck than have mailed, so there will always be a place for materials purveyors like Home Depot (NYSE: HD), which also benefits from specialist store staff ready and able to consult customers on their project needs.
My favorite retailer combines all three of these advantages. Costco (NASDAQ: COST) sells products people want to touch and see, creates an environment customers want to return to through helpful staff and value-adding services like free samples and a food court (featuring its famous $1.50 hot dogs), and has prices competitive with Internet retailers thanks to a powerful advantage in logistics. Not coincidentally, Costco, Whole Foods, and Home Depot have all handily beaten the market despite the rise of online shopping. Look for retailers like these three that understand how to turn brick and mortar into an asset instead of a liability, and your portfolio will ride out the Amazon age just fine.
Daniel Ferry owns shares of Apple, Amazon.com, Costco Wholesale, and Whole Foods Market. The Motley Fool owns shares of Apple, Amazon.com, Costco Wholesale, and Whole Foods Market. Motley Fool newsletter services recommend Amazon.com, Apple, Costco Wholesale, The Home Depot, and Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.