E-commerce has been a force to reckon with in recent years. The proliferation of smartphones and the rise of 4G networks (with faster download and browsing speeds) have led to a strong surge in online shopping, with global e-commerce sales rising from $1.34 trillion in 2014 to $3.5 trillion in 2019 for a stunning compound annual growth rate (CAGR) of 21%. Statista predicts that e-commerce sales will continue to grow at a CAGR of 16.6%, hitting $6.5 trillion by 2023. Top e-commerce retailers like Amazon, JD.com, and Apple have been performing superbly. These are the three largest online store operators by revenue for 2018, each clocking revenue of more than $20 billion.
The huge success of some of these online stores stands in sharp contrast to what's happening to many familiar brick-and-mortar retailers. Toys R Us, an international retailer of toys and baby products (and one of the first modern category killers), closed all of its U.S. stores in June 2018 after filing for Chapter 11 bankruptcy in September 2017. Macy's, a department store chain founded in 1858, has seen its stock fall by as much as 50% this year alone, due to huge markdowns on products that didn't sit well with customers. These consumer discretionary stocks previously did very well during economic boom times, but due to company-specific reasons, they have fallen on hard times in recent years.
Does such downbeat news for physical retailers spell the end of an era for bricks and mortar?
Problems with large-format stores
First off, we need to drill down into the exact problems that caused these retail giants to stumble and fall. Toys R Us, before its downfall, operated huge stores spanning 40,000 square feet. These were stuffed with toys (i.e. inventory) from top to bottom, resulting in a big drain on working capital. Such large retail stores are frequently understaffed, resulting in customers not being able to locate sales help. Furthermore, large stores create an environment for shoplifting as it's tough to police the entire store.
Sears, which was bought by billionaire Eddie Lampert in a $5.2 billion deal back in February, is still struggling to reinject life into the business. It reportedly hired investment bankers to explore additional asset sales just eight months after being bought out of bankruptcy. The storied retail chain, founded 127 years ago in 1892, lost its focus over the years as it relentlessly cut costs. It eliminated its iconic catalog and put restrictions and time limits on product returns in order to prevent a small proportion of customers from abusing what had been a very generous returns policy. This practice ended up hurting the company as it became "just another retailer", rather than one that engendered fierce loyalty.
In contrast, Walmart (NYSE:WMT) continues to do well: It raised its annual profit guidance last month after reporting strong Q3 results, boosted by its grocery business. The key reason for Walmart's success is that it continues to focus on its timeless mission to help customers save both time and money. Walmart does this by looking for ways to make life easier for the customer, such as reducing delivery time (for online purchases) and making improvements in merchandise selection.
Brick-and-mortar works for bulky items
Retail stores that stock bulky items also continue to do well in the brick-and-mortar space. One example is The Home Depot (NYSE:HD), the largest home-improvement retailer in the U.S.
Home Depot supplies tools, building materials, and construction products and services. In its recent Q3 2019 earnings report, the company reported a 3.5% year-over-year rise in revenue, while sales per square foot increased to $449 from $434. Most people still buy bulky items from physical stores like Home Depot and transport them on their own, as these items are tough or costly to ship.
Retail stores are also increasingly embracing a new business model known as omnichannel retailing. This involves a mix of both online and offline (i.e. physical) stores, where customers can see, feel, and try out new products and then proceed to buy those items online. Retailers that use this strategy can enjoy the best of both worlds -- high footfall in their physical stores and a growing online presence, driven by the same customer base. However, omnichannel success depends on shoppers continuing to prefer to browse the physical stores before buying online.
Toys R Us may have learned this lesson, too. It opened its first next-generation experiential toy store in New Jersey last month. These stores are a mere 6,000 square feet and are stocked with just 1,500 items. They are equipped with technology and digital innovations that help to connect with modern-day kids. The new Toys R Us website also allows customers to order toys online, through a partnership with Target. So, it seems that Toys R Us has managed to downsize its working capital requirements while working with a partner (probably on a profit-sharing basis) to ensure that customers can also order online.
It seems physical stores do have their place after all. Retailers that constantly strive to understand customers' needs and focus on a smaller yet targeted range of inventory can continue to thrive. Stores selling bulky items also still require a physical presence, as transportation costs and logistics for pure e-commerce business models may not be cost-effective. Omni-channel retailing, if done right, can drive higher store traffic while also boosting e-commerce sales. Investors, therefore, need to be selective in evaluating different retailers' strategies to see which work and which are flops.