On this episode of Industry Focus: Consumer Goods, the team looks at how retailers are changing the face of brick-and-mortar storefronts. Experimentation is the name of the game, and whether you're a big-box store looking to tap into urban markets or a digital player hoping to give consumers hands-on experience with your product, it's clear that physical stores are far from fading away.
A full transcript follows the video.
This video was recorded on Dec. 21, 2017.
Vincent Shen: This one is closely related to everything else we've talked about so far, and that's the idea that brick-and-mortar retail comes in all shapes and sizes. This one I'm separating from the examples we already discussed in terms of the retail showcases, because the end goal is a little bit more of a sustainable means of geographic expansion. If you're a company with, for example, over 90% penetration in the U.S., you have massive stores in every major metropolitan area, your next goal might be to go small and try to establish a presence in more dense urban markets where your big box store is not feasible. How is this playing out in terms of companies playing with different formats for their stores?
Dan Kline: It's kind of a holy grail, and it hasn't always worked. Wal-Mart tried this a couple of years ago with Wal-Mart Express. And the idea was, if there's a Wal-Mart every five miles, the Express stores would fill in the middle, so you wouldn't go to CVS or the local grocery store. And it wasn't a big enough game, and they closed them. They sold a lot of them off to Dollar General. But Target (NYSE:TGT) is now using, call it a micro-store even though it's a 20,000 to 25,000 square foot store. They're opening locations in cities, in places that identify with the Target brand but weren't going to be able to or be that willing to get in a car to drive out to a full-size Target. And they're tailoring the merchandise for people who live there.
So if you live in Manhattan, you're probably not buying 64 rolls of toilet paper at a time. You don't have any place to put them. So in terms of inventory, that store is probably stocking four-packs and six-packs and single rolls of paper towels, and smaller amounts of trash bags. And these stores are being organized so grab-and-go items, or the things people are most likely to need quickly, are at the front. So maybe in New York, umbrellas would be included in that mix or something else you might just quickly want to get -- get in, get out. These smaller store models are going to work, but you see, a lot of people are testing them. Whole Foods, which is now owned by Amazon, had its Whole Foods 365, which was a smaller, lower-frills store meant to go in a more dense, urban environment. And some of them have worked, some of them haven't.
Amazon is using small, call them bookstores, but really, they're Amazon experience stores. Yes, you may buy a book, but you're just as likely to play with a device or get exposed to the new Echo, and it's not so much about retail sales. I will say, the one advantage all these chains have right now is, even the successful malls have vacancies. So there's a lot of ability for an Amazon, a Wal-Mart, a Target, whoever it is, to go into a mall company or a retail development and say, "I want that space, but I want a short-term lease. I'm not going to commit to 20 years, because this is an experiment and I don't know if it's going to work."
Shen: Yeah. If we can jump back to the Target example, in the latest earnings call, COO John Mulligan actually talked about how adaptable they need to be when they're designing these new locations. He says, "We're also investing to reach guests in new neighborhoods and elevate the experience in all of our stores. To reach new, densely populated neighborhoods, we've completely changed our approach to choosing the location for our small-format stores. In the past, we had a relatively rigid prototype for store size and layout, and our real estate team focused on finding sites that would accommodate that prototype. Today, when we find space available in an attractive neighborhood, we custom design a store that can fit the available space. These stores generate high sales productivity and higher than average gross margin rates, driving strong returns on investment. And for the smaller group of these stores that have now been operating for more than a year, we continue to see very healthy growth in both traffic and comparable sales." Another example I have here, a huge underdog, Sears -- they're hoping for a miracle. The company is testing new locations focused solely on two of their stronger departments, mattresses and appliances. They've been opening these in the past six months and hoping this will maybe help right the ship for them, but they're pretty far down the road already.
Last couple of minutes here, to recap, our picks for 2018 trends -- the consumer convenience and how omnichannel is growing in scale, the brick-and-mortar retailers showcasing their products, and also how their store formats are taking new forms. Looking at this list, including a lot of the other trends that have been discussed elsewhere -- for example, likely to be more M&A activity, more acquisitions and deals between online and traditional retailers in 2018. We saw a lot of that activity last year. What I see connecting everything that you mentioned earlier as well is experimentation.
Kline: Yeah. We don't know, and I think that's the important thing. I don't think there's anyone who believes we're going to move to a storeless society, where at least in the next 20 years, we won't grocery shop out, we won't buy clothes out, there won't be malls. I don't think that's what's happening. I think we're seeing a retail contraction, where some chains had too many locations, some had too big. But I do think there's still a place for physical stores. And that might be varied concepts, like Best Buy has revived itself largely through store within a store. You walk into a Best Buy and there's more than just Best Buy -- you can get your cable, you can see an Apple store. You're going to see a lot more of that. And it's not all going to work. And it's not all going to work in every market. I live in a downtown walking market where some of your retail choices are limited. So if a Target came in, it would probably do very well, even though there's a Target a few miles away. That might not be true where the Fool office is, where there's a Whole Foods and other things you can walk to all within that area. So you're going to see a lot of experimentation, a lot of different ideas, and some stores that open and go away pretty quickly.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Daniel B. Kline owns shares of Apple. Vincent Shen has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon and Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool recommends CVS Health. The Motley Fool has a disclosure policy.