Navigating The Retail Maze...

The 2016 Holiday season did bring some good cheer. Retail sales for the November-December period increased 4% when compared to 2015. In many respects, this result was not surprising considering the recent positive data on job gains, average hourly earnings and household net worth.

But a look behind these optimistic numbers shows that the negative forces buffeting the retail industry of late are only gaining steam. Back in June, an annual survey by United Parcel Service Inc. found that for the first time consumers in the U.S. bought more online than in stores (see chart below). In last year’s third quarter, total retail sales inched ahead 2.2%. But online sales, which now represent just over 8% of total sales, advanced at an almost 16% rate.

Walk through any mall and it is not hard to see who is losing out in the battle for consumer wallets. Department store chains are having the hardest time with same store sales often down in the high single to low double digit range. To offset the weakness, executives are slashing headcount, closing stores and selling real estate. Macy’s recently announced plans to close an additional 100 stores and lay-off up to 10,000 employees. Sears, meanwhile, is closing another 10% of its store base and selling its Craftsman brand. Even Walmart, one of the strongest players in the group, recently announced a major reshuffling of talent aimed at boosting online operations. In total, over 14 major retailers announced closing at least 100 stores each in 2016.

Despite the recent closures, the U.S. remains the leader in retail space with approximately 23.5 square feet of retail space per person. The next two countries are Canada with 16.4 square feet and Australia with 11.1 square feet.

China, which only began aggressively building malls in the late 1990s, is also experiencing a glut of retail space. Developers throughout much of China underestimated the shift to online spending – a trend which is even stronger in China than in the U.S. The Wall Street Journal recently highlighted the case of Chongqing, a city of approximately 30 million people on the Yangtze River. In 2015, Chongqing had almost 22 square feet of shopping mall stock per urban consumer or almost four times the amount of first tier cities like Shanghai and Beijing. In that year alone, approximately 40 million square feet of shopping center space was under construction - - a level almost 10 times the pipeline in New York and more than anywhere else in the world (see chart above).

The retail industry’s challenges will not be resolved anytime soon. The cost savings and convenience of online shopping will continue to drive many traditional retailers out of business. Survival will depend on at least three factors. Scale, or the ability to spread the costs associated with branding and technology, will be key. Amazon is probably the best example here. Second, clean finances or an unleveraged balance sheet is a major advantage for firms undergoing major restructuring. Many of the firms that went bust last year did so under the weight of crippling debt levels. Finally, in many markets, the firms that figure out how to balance efficiently-run online operations with a carefully honed (though likely more limited) physical store strategy will have a strong competitive advantage.