The Trouble with Retail
The BMW Method

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By captainccs
May 18, 2007

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Quite a few moons ago BuildMWell said that he did not particularly like retail but, as far as I remember, he gave no details. I do like retail but I have a hard time fitting retail into the BMW Method style of investing. If a retail establishment has a 30 year price history and if it is still the same business after 30 years, it is likely in trouble. Let me explain.

The history of retailing is very interesting and each success story is quite thrilling. But demographics change and if a business does not keep up, it is in trouble. For example, the Sears' success story is embodied in catalog mail order sales.

In 1888, Richard Sears first used a printed mailer to advertise watches and jewelry. Under the banner "The R.W. Sears Watch Co." Sears promised his customers that, "we warrant every American watch sold by us, with fair usage, an accurate time keeper for six years - during which time, under our written guarantee we are compelled to keep it in perfect order free of charge."

The time was right for mail order merchandise. Fueled by the Homestead Act of 1862, America's westward expansion followed the growth of the railroads. The postal system aided the mail order business by permitting the classification of mail order publications as aids in the dissemination of knowledge entitling these catalogs the postage rate of one cent per pound. The advent of Rural Free Delivery in 1896 also made distribution of the catalog economical.

But as cities became populated and stores sprang up all over the place, you could go to the corner store to get what you need instead of sending a mail order to Sears. The great urban retail success story is The Great Atlantic & Pacific Tea Company (A&P):

In 1870 the Company was renamed the Great Atlantic & Pacific Tea Company, in honor of the first transcontinental railroad and hopes of expanding across the continent.

America's Grocery Store
A&P did extend its operations to the West Coast and became the first national supermarket chain in the United States. Over the years, the Company pioneered many innovative concepts that set trends and satisfied customers.

A&P Lead the Way
In 1880, A&P introduced the first private label product - baking powder. As the Company grew, private manufacturing became an important aspect of its business and by the 1920s, A&P had opened its own factory, packing plant and bakery with private brands such as Sunnyfield (bacon, butter, flour and cereals) and Sultana (canned goods, peanut butter and jams).

A&P did great until people decided that moving out of decadent down-town to the suburbs was a good idea. Down-town most people walk or use urban transportation which means that a lot of small stores all over town is a good idea. Since people would only buy what they could carry, purchases were small and focused. In the suburbs the great malls sprang up with large parking spaces. When going to the mall you could buy a lot more items as you had your car to take them home with. All of a sudden impulse buying was in. To accommodate the suburban shoppers, the stores had to be larger and better stocked. Eventually this led to the gigantic warehouse sized retailers. Urban blight eventually killed A&P.

Curiously, Walgreens prospered down-town possibly because they are a much more focused retailer than A&P:

We're America's premier pharmacy
How did a neighborhood drugstore, founded in 1901 and measuring just 50 feet by 20 feet, become the pharmacy all others are measured by and one of the most respected American corporations?

Eventually Sam Walton notices that small towns could use discount general stores:

Many trace discount retailing's birth to 1962, the first year of operation for Kmart, Target and Wal-Mart. But by that time, Sam Walton's tiny chain of variety stores in Arkansas and Kansas was already facing competition from regional discount chains. Sam traveled the country to study this radical, new retailing concept and was convinced it was the wave of the future. He and his wife, Helen, put up 95 percent of the money for the first Wal-Mart store in Rogers, Arkansas, borrowing heavily on Sam's vision that the American consumer was shifting to a different type of general store.

There are a great many other fascinating retailing stories but these four should suffice to point out how changing demographics forces most of them to change over time. If you compare retailing to staples like tooth paste, soap, drugs, linen and so on, you can see that companies like P&G and Colgate-Palmolive are in much steadier businesses than the retailers. What is good for one is not good for the other. Any retailer that has not changed over the last 30 years is very likely to be on the way out of business.

You will continue to use tooth paste, soap, drugs, and linen but your buying habits are likely to change drastically.

The second issue is the growth pattern in retailing. I think Peter Lynch describes it best, I paraphrase: "Open a store and, if it works, replicate it elsewhere. If the concept can be replicated successfully, you have the beginning of a great retail chain." Initially a one store chain will get no Wall Street following. As success mounts, the analysts flock to recommend it. But eventually all the markets have one or more of your stores so there is no further place to expand to and growth slows. This pattern will create great "S" shaped price charts. I particularly like Wal-Marts two "Ss"

or look at Target:

While bad news can deflate the stock price of any company driving it to low CAGR, with retailers it is almost a foregone conclusion that when the "S" forms the top, you will be seeing low CAGR. When a retailer hits the top of the "S" curve, doing more of the same does not help much. For a retailer the top of the "S" curve implies some kind of radical action. Wal-Mart tried Sam's Club and from what I hear that is not a great solution. Sears imploded, KMart imploded, A&P imploded, Pier 1 might be on the way.

Retail needs a Lynchian style of investing, catch it at the bottom of the "S" curve and you might be good for 10, 20 or 30 years. Then the BMW Methodites will come along and buy it from you if they have not learned this lesson. :))

Denny Schlesinger

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