The Death of Retail

By Christopher Coyle - August 12, 2012 | Tickers: AMZN, AAPL, BBY, TGT, WMT | 0 Comments

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When Circuit City filed for bankruptcy in 2008, the future suddenly looked very bright for Best Buy (NYSE: BBY). With their main competitor out of business, Best Buy was given an excellent opportunity to solidify its status as the top consumer electronics retailer in the United States.

Unfortunately for Best Buy, it was an opportunity that they absolutely squandered, and now they are starting to find themselves on a similar path as Circuit City. Although things are certainly not that bleak yet, there are several alarming signs that have scared investors away from the stock. The company lost $1.2 billion in the 2012 fiscal year, and they are now engaged in a round of cost cutting, which includes the closure of 50 stores, in order to save $800 million over the next three years.

The result has been a stock price that has fallen by more than 40 percent in the past two years, which has led founder Richard Schulze to devise a plan to take the company private. However, it still isn't clear if he will be able to rejuvenate stagnating sales growth – revenues have grown by less than 3 percent since 2010 – and reverse a two-year decline in comparable same-store sales.

It is a tale that is becoming all too common in the retail industry. Department store chains like JC Penney and Sears are desperately attempting to implement turnaround strategies of their own, but the current environment is not particularly propitious for such endeavors. Although retail sales were surprisingly strong in July, economic growth continues to remain weak. Consumer confidence is still very depressed and is not likely to improve as long as the unemployment rate remains above 8 percent.

With many families struggling to survive in this tough economy, price competition has become even more rampant in order to attract cash-strapped consumers, slashing margins to razor-thin levels. This has been great news for Dollar General and Dollar Tree, two companies that compete at the low-end of the retail market, but it has made it very difficult for larger competitors to maintain attractive levels of profitability.

However, it is not the nimble dollar stores that the lumbering giants of the retail industry fear the most; instead, it is the 800-pound gorilla of retail, Wal-Mart (NYSE: WMT), that has been able to take advantage of its unmatched logistical capabilities to slash prices and gain market share at the expense of mid-market retailers such as Kohl's and Target (NYSE: TGT). These companies are in a very precarious position in the retail industry: They can't compete in a price war with Wal-Mart, yet they still lack the brand prestige to compete for very affluent consumers, who are doing relatively well in this economy.

As if the massive shadow of Wal-Mart wasn't bad enough, retail chains must now deal with another burgeoning bete noire: Amazon (NASDAQ: AMZN). The company that was once a simple bookseller now sells everything from diapers to golf clubs, and without the massive overhead costs of brick-and-mortar stores, Amazon has been able to take price competition to a whole new level. Now the company is attempting to counteract one of the last remaining advantages of traditional retail stores – the ability to buy things immediately – by slowly expanding the number of locations to which it offers same-day delivery.

In response, traditional retailers have adopted numerous strategies to expand their online offerings and reduce their real-world footprint. For instance, Barnes and Noble has gone into the hardware business with the surprisingly successful Nook in the hopes of surviving the transition to digital books. Target is embracing a new initiative, called City Target stores, that will offer city dwellers a scaled-down version of its large chain stores, and Best Buy is also adopting the smaller-is-better concept with its Best Buy Mobile stores.

It remains to be seen whether or not such ideas will revive the fortunes of these companies. As RadioShack has clearly shown, small is not necessarily synonymous with success. In addition, the transition to the Internet will not be a smooth one for traditional retailers: Many companies aren't even bothering with an independent online strategy, choosing instead to use eBay or Amazon to establish their online presence.

Of course, the reports of traditional retail's death may be greatly exaggerated. Despite all the hype, Internet-based purchases still account for less than 5 percent of total retail sales, and Apple (NASDAQ: AAPL) has clearly demonstrated that brick-and-mortar stores, if done correctly, can be incredibly profitable. In fact, given that Apple produces five times more revenue per square foot of retail space than Best Buy, there have been calls for Best Buy to adopt Apple's sleek retail aesthetic and simplified product line.

It is always a perilous undertaking when companies are forced to react to events that are out of their control, which places them in uncomfortable situations that are beyond their core areas of competence. However, if companies like Best Buy are to have any hopes of avoiding the fate of erstwhile competitors like Circuit City and CompUSA, they have no choice but to adapt to the new realities of retail merchandising in the 21^st century.

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