Are Retailers Making a Big Mistake in Small Stores?

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If you feel like the walls are closing in around you, you're not imagining things. Retailers from Wal-Mart (NYSE: WMT  ) to Office Depot (NYSE: ODP  ) are abandoning the big-box concept in favor of stores with a smaller footprint. Where once the thinking was to wring as many sales as possible out of a given space, now managers are trying to squeeze every bit of margin they can out of just the most profitable parts of their business.

Dialing for dollars
This phenomenon might be best exemplified by consumer electronics giant Best Buy (NYSE: BBY  ) , which has seen sales of big-screen TVs falter while smaller, more profitable handsets soar. By focusing on what's keeping it going these days and opening up stand-alone stores to sell mobile devices, the retailer is hoping to reverse a decline in its operations.

At around just 1,500 square feet, Best Buy Mobile shops are significantly smaller than the 38,000-square-foot stores the electronics king previously preferred. At the end of 2009, Best Buy had 74 stand-alone Mobile stores accounting for 112,000 square feet; its big-box namesake stores number more than 1,000 in the U.S., and take up more than 41 million square feet. According to the analysts at Trefis, revenue per square foot for these stores has fallen from about $953 in 2006 to about $885 in 2010. It will be opening 150 new Mobile stores this year while keeping big-box square footage growth to less than 1%.

More paper, less clips
Office Depot is finding it necessary to scale back, too. It's shrinking from an average of 24,000 square feet down to 15,000-17,000, a 30% to 38% decrease. More dramatic is the 5,000-square-foot concept store it's also trying out. Rival and industry leader Staples (Nasdaq: SPLS  ) is also opening up smaller-format stores, and, taking a page from Best Buy, is expanding the selection of mobile phones it carries.

The ever-shrinking store is not limited to consumer product retailers. Restaurants are going smaller, too. Chipotle Mexican Grill (NYSE: CMG  ) , for example, expects 30% of its new store openings to be "A-Model" type, believing the smaller store will allow the restaurant chain to cut occupancy costs as well as development expenses. Cheesecake Factory (Nasdaq: CAKE  ) is lopping 20% off its restaurants, going from 10,000 square feet to 8,000, while Texas Roadhouse is trying a new format that is 10% smaller.

Two for the price of one
Darden Restaurants
(NYSE: DRI  ) is trying a novel way of saving space: It's combining the kitchens at its Red Lobster and Olive Garden eateries. A joint kitchen accessing two separate dining rooms lets the restaurateur cut the footprint in half.

But there's no guarantee for success by going small. Home Depot (NYSE: HD  ) has experimented with small format stores several times over the years. There's a reason it keeps going back to its big orange boxes.

And while it didn't change its square footage, Wal-Mart experimented with fewer products and a less cluttered appearance. The drop-off in sales that followed sent Wal-Mart scurrying to restock its shelves. It remains to be seen whether it's cutting its nose off again by committing to opening smaller stores this year that clock in at just 20,000 square feet, one-seventh the size of its supercenters. But rarely has Wal-Mart performed well when it's deviated from its standard formula.

Bubbles are forming everywhere, from social media to cupcakes. Getting small could be just another example. Good things may come in small packages, but if consumers still aren't willing to open up their pocketbooks and spend, investors are likely to get a big, unhappy surprise come earnings time.

Fool contributor Rich Duprey owns shares of Best Buy but does not have a financial position in any of the other stocks mentioned in this article. You can see his holdings here. Office Depot is a Motley Fool Big Short short-sale recommendation. Best Buy, Home Depot, and Wal-Mart are Motley Fool Inside Value selections. Chipotle is a Motley Fool Rule Breakers recommendation. Best Buy and Staples are Motley Fool Stock Advisor selections. Wal-Mart is a Motley Fool Global Gains pick. Chipotle is a Motley Fool Hidden Gems choice. Wal-Mart is a Motley Fool Income Investor pick. Motley Fool Alpha LLC has opened a short position on Office Depot. Motley Fool Options has recommended a diagonal call position on Wal-Mart. The Fool owns shares of Best Buy, Chipotle, and Wal-Mart. 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.

Read/Post Comments (2) | Recommend This Article (3)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 12, 2011, at 5:33 PM, JMM11b wrote:

    Menards, Eau Claire WI isn't looking to build smaller stores ... they are going even larger. Recently they announced they were adding 100,000 sq ft. to a store in the Chicago metro area that was 200,000 sq ft. already. This chain of approx 300 stores isn't publicly traded but they give home depot and lowe’s fits. What do they do that is succeeding …. They have honest to goodness real value sales on products that people want everyday and they advertise out the wazoo … The only shoppers they don’t attract are those with their noses up in the air. Ckeck them out you will be surprised!

  • Report this Comment On April 13, 2011, at 9:24 AM, iccds wrote:

    I think this is a case of less is more. From a consumer's standpoint there is always a little "Paradox of Choice" ...we think having more will make us happy; it actually does the opposite. Retailers will find they are more profitable (less inventory, less rent, less people, less equipment) by focusing on the 80% of the stuff people really need. This approach will not work across the board, but in many locations another superstore may not be the solution (for the retailer or customer)

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