Which retailers will survive? Part I

Until recently, retailing was a local, bricks and mortar affair. But the internet has driven a generational change to the way we communicate and shop.

Whatever you once bought at the shopping centre, you can now buy online, with more choice and better prices. According to the Australian Centre for Retail Studies, even those purchases not made online are researched there first.

Discretionary retailers like JB Hi-Fi, Just Jeans and the department stores are rightly petrified. Online retailers, with fewer or no physical stores pay little rent and enjoy lower inventory costs, allowing them to charge lower prices. They also have a cash flow advantage. Amazon’s early growth, for example, was funded by customers that paid for an item before they received it.

The Internet has finally allowed Australians to see how much they’re being ripped off. Myer charges $799 for a De Longhi EN680n Nespresso Lattissima machine (with a $100 cashback). Amazon in the US charges US$467. With price differentials like that, there is no such thing as brand loyalty.

Here, we’re going to examine how the traditional discretionary retailers can respond to this existential threat and whether they’re actually capable of it at all. In part two, we’ll offer recommendations on a full suite of discretionary retailers and what this means for your portfolio.

Digital disruption

Online retail now makes up around 5% of total Australian retail sales but is growing at 15%-20% per year. At some stage, food retailing aside, it’s highly likely that a large portion of purchases will be made online. Chart 1 shows how this situation is playing out in the US—average figures mask huge differences between product types—and we're not far behind.

But online retailing doesn’t have to take over for traditional retailers to suffer. Operating on slim margins, a small percentage of sales leaking to online retailers can spell disaster.

In 2012 alone, RED Group (books), Borders (books), Darrell Lea (chocolate), Game Australia (computer games), Allans Billy Hyde (music), Ojay (fashion), Retravision (electronics), WOW Sight and Sound (electronics), Fletcher Jones (fashion), and Retail Adventures (discount variety) closed their doors. More will follow this year. In the UK in the past six months 30 chain stores were closing a day.

It’s easy to see why. A big online store focused on distribution rather than hundreds of stores in shopping centres has lower operating cost and can drive down profits across the whole industry. Amazon, for example, has captured a huge percentage of the book retailing market and has in the process driven down total industry profits, killing off the likes of RED Group and Borders. The same phenomenon is playing out across the retailing sector.

Only now are incumbents waking up to the threat. They thought, and many still do, that people would want to shop for social reasons, and because lying on a mattress is a better way of deciding whether you want it or not than looking at a picture.

But online competitors are using technology to mimic much of the in-store experience, by adding 3D product samples, videos and social media integration to websites. As Timothy Dallen, outlined in Shopping Tourism, Retailing and Leisure ‘contemporary mass consumption is based almost entirely on desires rather than needs and thus, at its very core, is as much social and cultural as economic’. On sites like Amazon or eBay the internet is almost as adept at doing both.

Myer vs The Iconic

How should incumbents respond, other than to moan, ignore and campaign for government protection? Maxwell Wessel and Clayton Christensen, researchers from Harvard Business School, suggest a two-step strategy:

1. Identify the strengths of a disrupter’s business model, and try and match them;
2. Identify your own relative strengths and try and make them even stronger;

You can bet in the boardrooms across the country these sorts of issues are under consideration. How, for example, should Myer respond to new—and humbly-named—online fashion retailer The Iconic?

Launched just over a year ago to compete with the likes of Myer, The Iconic sells mid-market men’s, women’s and kid’s clothing, accessories and beauty products. The company has 300 staff and is rumoured to be generating $10m in sales per month.

What say Myer’s board? In all likelihood, ‘No big deal, small beer, don’t have to worry about it, at least not yet.’

Trouble is, this site generates three million unique visits a month and is believed to be growing at 30% a month. Myer’s online store, which accounts for about 1% of total sales, is growing at about 30% a quarter.

Ah yes, say the board, but a website isn’t a proper shop, it’s not a place where people go (and wait for service).

The Iconic, unlike many online retailers, doesn't try and compete on price but rather offers free delivery (for orders over $20), free returns and three-hour delivery in Sydney. It can also respond in real time to changing buying trends, and has the ability to deliver a more customised shopping experience.

The Iconic can’t offer in-person service or function as a social destination in the traditional sense but that seems to be changing. Recent research from Motorola suggests an increasing preference by the younger generation to choose internet based socialising over the real thing. The online threat can no longer be denied.

Finally, the board gets serious. In June last year Myer chief executive Bernie Brooks launched the 'omnichannel' strategy to bridge the gap.

It’s an attempt to identify the strengths in the disrupter’s business model and match them. Myer’s online range is being extended to 70,000 products, although the website remains typically difficult to use (similar to David Jones see David Jones forgets it's 2012).

But the really tough bit is recognising your own strengths and making them stronger. Myer’s major advantage, at least from a customer perspective, is its retail outlets and brand. It also possesses deep, long term relationships with its suppliers. A traditional retail model will always be more expensive than an online competitor. To compete on price Myer will have to close stores. To compete on service it needs to keep them open and employ more people to work in them.

A smart solution could be launching an equivalent online store under a new brand that matches The Iconic’s functionality and range. In doing so it could leverage its unique strengths—a vast existing customer base and tight supplier relationships—to promote the new store and negotiate low cost prices. By using a new retailing brand Myer could charge different prices online without directly aggravating its in store customers, similar to Qantas’s approach to capturing part of the discount airline market by launching Jetstar. 

Cannibalise or die

Still, it’s unrealistic to expect bold changes from Myer, or any other discretionary retailer for that matter, to combat the online threat. Sass & Bide is a brand partly owned by Myer and yet The Iconic stocks more items on its website than on Myer’s. In fact, Myer’s website deliberately offers a limited product range to drive customers in store.

That’s hardly unusual. Most businesses won’t cannibalise an existing one by expanding into new, competing but uncertain areas. That explains why Kodak went down, and why Fairfax Media is heading in the same direction. Clinging on to an out-dated worldview is far easier than creating a new one. The future is uncertain, the past all too clear.

Online retailing offers a permanent and imminent threat to incumbent retail models. Think of it this way: If you had a brilliant new retail concept, would you open a few stores in a Westfield or build a website? Thought so.

Existing retailers need to adapt, and fast, or face disaster. In part II tomorrow we’ll see which companies are up for the challenge.