April 01, 2004

Musing on the Future of Retail

by Alan Beatts

For years the news has been full of material about the way that the internet will change (and has changed) shopping habits.  Within the bookselling industry, Amazon.com is the second most often mentioned cause for independent store closures (the most cited cause are the national chains, most notably Borders and Barnes and Noble).  In the wake of Avenue Victor Hugo Bookshop's announcement that they are closing their doors (1), I've been musing on the probable future of retail quite a bit.  This musing is partly in self-defense but is also motivated by a curiosity about what the world of retail may be like in ten or twenty years.

As I'm sure most of our readers know, the overall prognosis for independent retail businesses is poor.  The combination of chain stores (i.e. Borders Books, Walmart, and Home Depot), bulk retailers (i.e. Costco and Sam's Club), and internet sales (i.e. Amazon) have been taking larger and larger pieces of retail sales, resulting in rashes of store closures.  Consider that in 1950, chain stores captured 30% of retail sales nationwide.  In 2000, chain stores accounted for 60% of sales.  One sector particularly hard hit is hardware and lumber, where chain stores have gone from having 26.5% of sales in 1990 to 42% in 1997.  In a similar 7 year period (1991 to 1998) the sales income for indi bookstores dropped from 32.5% of retail sales to 17%. (2)  Conventional wisdom suggests that this trend will continue until the only independently owned retail business left will be in specialty fields so small that they are unprofitable for chains.

However, there is another trend taking place which, if it continues, may save independent retail.  The beginnings of this can be seen in the recent troubles that Blockbuster Video and its parent company, Viacom, have been having.  The short version of the story is that Viacom is unhappy with Blockbuster's slowing sales (only an 8% increase in revenue for quarters 1-3 of 2003) despite Blockbuster providing 22.5% of Viacom's revenue (for the same period) (3).

And what's being blamed for slowing the sales growth?  Netflix, an internet based rental service, and WalMart (4).  Leaving WalMart out of the picture for now, consider Netflix's business model.  There are no rental fees nor are there late fees.  However, there is a monthly membership fee of around $20.  For that fee you can use any number of DVDs.  But, the catch is that you can only have three DVDs at any time.  When you return one, Netflix sends you another.  DVDs are mailed out to the customer and include a postage paid return envelope.  It's a great system and I'm a member myself.  But, it lacks the convenience of just running down to the local video store, browsing and then grabbing the movie you want.

In short, Netflix isn't going to replace my local video store (Lost Weekend Video on Valencia St., if you're keeping track).  If one evening I decide that I want to go see The Wind and The Lion, I'm going to have to head down the street to get it.  So, will Netflix put them out of business?  If Blockbuster hasn't done it already then it's likely that Lost Weekend's business model and expenses are such that they are relatively stable.  Netflix might hurt them at first but probably won't kill them.

But, will it kill Blockbuster?  It might.

And, if Netflix does kill Blockbuster,what happens to Lost Weekend's business?  I'm betting it will improve.  Granted, Netflix is cheaper and has a bigger selection but you have to plan in advance and there's no personal interaction.  Essentially what is happening is a shift in the retail equation where two very similar businesses competed head to head (Lost Weekend vs. Blockbuster) to a situation where the businesses competing are actually quite different.  Lost Weekend gives you convenience, spontaneity, and a social outlet and Netflix provides low price and a different kind of convenience.  My bet is that there is room for both types of business.  But is there room for Blockbuster and their demanding sales goals?  I don't think so.

Though it is arguably a big step, this model can be extended to retail in general.  In the past, one of the main ways that national chains have competed with independent businesses is in the area of price and selection.  Because of greater buying power and other economies of scale (centralized ordering and administration, for example) national chains have been able to offer a greater selection of merchandise and lower prices than independent retailers.  But, due to their size, national chains tend to be less efficient and less responsive to changes in the market.  Finally, national chains tend to have much higher employee turnover and pay entry-level employees less than independent operations.  As a result, customer service suffers and national chain staff are often less knowledgeable.

Finally, due to most chains being publicly traded corporations, there is a significant pressure on them to show significant sales increases every year and even every quarter.  Failure to do so can result in dropping stock prices and serious financial troubles.  This pressure does not exist for independent stores.  If I am making a comfortable living, the only sales growth I need is enough to keep up with inflation.  I might like more growth but I can plug along indefinitely with what I have.  Thus far the preceding considerations have balanced in favor of national chains, hence the steady attrition in independent retail.

But increasingly now, internet retail is supplanting chain stores in the very areas where they have the advantage.  Consider, an internet business has all the potential advantages of a national chain, plus it doesn't have the massive expense of maintaining large storefront locations and a huge pool of employees.  Granted, internet retail offers even less customer service than chain stores and there is the pesky shipping delay.  But both of those problems can be alleviated.  Telephone customer service for internet retail has been, in my experience, far better than I have come to expect from chain stores.  And, though delivery time for internet orders is an inconvenience, it must be balanced against the convenience of being able to shop anytime you want, day or night, and having one's purchase arrive at one's doorstep without dealing with driving to, parking at and searching around a huge store.

It would be ridiculous to suggest that internet sales will take all the business away from chain stores.  But, remember why Blockbuster is in trouble -- it's not that they aren't making money, it's that they aren't making _enough_ money and more importantly, their sales growth isn't high enough.  As internet sales increase those sales will come at the cost of physical retail sales.  Independent stores are very familiar with ways of dealing with shrinking sales.  But national chains are not and that may mean serious problems for them as internet sales grow.  As internet businesses start showing the sales growth that investors want to see and chain sales slow, the money will move towards internet business.  Chains may pay attention to this trend and move more and more vigorously onto the net but even this tactic clears the field for independent stores.

It's possible that some chains that deal in bulky and heavy items (lumber and other building materials, for example) may be able to retain their physical stores in the face of internet encroachment but even the high shipping costs for internet orders of these goods may be offset in lower warehousing costs and centralized shipping and logistics.

In summation, the growth of internet retail has changed the equation in a profound way.  No longer are chain stores the lower price, bigger selection alternative to independents.  Now they are the compromise between independents and the internet.  They can't beat the prices, selection and convenience of buying on the net and they can't give the social outlet, customer service and depth of knowledge of a well run independent.  As my dad used to say, "It's like all-purpose flour -- some good for everything and no good for anything".

So what happens over the next ten years?  My guess is that the chain stores start to dry up, initially in areas that are marginal markets and then generally.  They probably won't vanish but they'll fade.  And as they do, the customers who either _want_ to get out of the house and shop or must have what-ever-it-is RIGHT NOW or just need some solid customer service will go to their only alternative -- the independent stores who have weathered the current storm.

(1) Full information at http://www.avenuevictorhugobooks.com/

(2) The Fight for Survival by Independent Retailers (USA Today (Magazine), July, 2000) by James R. Lowry ( http://www.findarticles.com/cf_dls/m1272/2662_129/63668115/p1/article.jhtml )

(3) A Blockbuster spinoff for Viacom? (New York Times, February 2, 2004) by Geraldine Fabrikant and Andrew Ross Sorkin ( http://www.iht.com/articles/127680.html )

(4) Video for Sale: Viacom rumored eager to spin off Blockbuster (VisualStore on-line, February 2, 2004) by staff. ( http://www.visualstore.com/index.php/channel/39/id/7155 )

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