The middle of the retail market continues to evaporate. Two articles recently summed up this transformation: Big-Box Retailers Have Two Options If They Want to Survive, in the Harvard Business Review, and The Macy's factor in Politico. Big-box retailers—Macy's, Walmart, Target, Kohl's, JC Penny, you name it—are suffering as the internet, and more precisely Amazon, continues to devour the middle of the market.
The fall of General Merchandise
One line in the Politico piece acutely sums up the entire problem with these retailers: "Macy’s helps lead a category called General Merchandise." When I think of "general merchandise," Amazon is the first thing that comes to mind. Tens of millions of consumers agree. The only way to differentiate with general merchandise, which are mostly commodity items, is by winning on price and convenience. Amazon continues to win on both counts, which is highly concerning for big-box retailers.
Traditional big-box retailers have a cost structure problem that is directly tied to their past success. First, they occupy millions of square feet of real estate in malls and shopping centers all over the country. Second, their business is significantly driven by advertising, specifically newspaper ads. Third, they were often the cheapest alternative to any other local store. Forth, they were often more convenient than the alternative. And fifth, the scale of these stores required them to be a mile wide and an inch deep with selection—they had a little something for everyone.
Amazon has obliterated all five of big-box retailers' one-time advantages and turned them into troubling disadvantages. The massive footprint of these retailers in malls has been destructive—just ask Sears, whose real estate holdings are worth more than the company's entire market cap. As print advertising continues to recede, stores like Macy's, which are built on the very success of newspapers, are faltering. Macy's is trying to recover by slashing its print budget by 50% and upping its digital budget by 23%, but a business built on newspapers doesn't translate identically to digital, just as newspapers moving online don't automatically succeed. The trend is crystallizing, with sales at Macy's stores open at least a year down 6.1%, a 7.4% fall in sales in 2015, and guidence for 2016 down 3-4%.
This leaves price, convenience and personalization, three categories where Amazon will usually beat any big-box retailer. Amazon will often have the cheapest or an equally cheap price on millions of items. Even if Amazon's price is the same as Walmart's, a customer will still buy from Amazon, since she probably is a member of Prime and enjoys Amazon's super fast and hassle free shipping, which can sometimes arrive in as little as an hour with Prime Now, and only a day or two with normal Prime. More importantly, Amazon always wins on personalization, since it has near endless selection, outnumbering every big-box retailer with its diversity and depth of selection. Amazon can offer this unparalleled selection thanks to the internet, which allows it to scale infinitely while keeping distribution costs very low.
The success of Amazon compared to big-box retailers is even more striking when realizing that Amazon rarely advertises for its core retail business. Amazon has such a strong relationship with customers that it doesn't need to. Big-box retailers, on the other hand, are so addicted to advertising that when newspapers and TV, the channels that these companies built their businesses on, are faltering and evolving respectively, the big-box retailers will falter as well. As Ben Thompson pointed out in this week's Exponent, it's not that the internet is casuing money to move from one channel to another, such as the shift in print ad dollars to digital ad dollars. The real impact of the internet is that it allows entirely new businesses—such as Amazon—to exist, where infinite selection and the lowest prices can scale infinitely.
Are there any solutions?
The HBR article offers two solutions to the problems big-box retailers are encountering. Big-box retailers "need to leverage their scale to offer what e-tailers and specialty players can’t — big experiences, big discounts, or both."
It's unclear how big-box retailers can beat Amazon on price with "big discounts" while maintaining a healthy business. It's very easy to beat Amazon on price and bleed money, just ask JC Penny. But it's much harder to compete on price while maintaining a successful business.
It also isn't a fair game. Given Amazon's scale, it's able to skim a small percentage off of each transaction, which translates to billions of dollars at scale. Amazon's focus on free cash flow and scale over margin gives them a very different mindset and cost structure than their big-box competitors, who are stuck trying to extract a much higher margin to support their burdensome cost structure and retail footprint. Amazon is simply competing on a beautiful, new and nimble playing field, while big-box retailers are stuck on their old and expensive turf. It's unclear how traditional retailers have any chance to compete with Amazon on price while keeping their long term prospects healthy.
This brings us to "big experiences." It's an interesting idea, but I'm unsure how successful it will be. The article cites sporting goods stores putting in archery ranges to try out different equipment as an example of a "big experience." This is intriguing, but I'm unsure I would hinge a comeback strategy on better ways to fill up space that retailers are stuck with—the underlying space is the issue.
Look at what Amazon has done with its bookstores. They are intentionally small with limited selection. They are self-admittedly really bad places to go if a customer knows exactly what she wants. Amazon.com is the perfect place for that. The bookstores, conversely, are great places to go if a customer doesn't know what she wants and is open-minded. Amazon uses its unparalleled data operation to pick around 5,000 titles that people might like and rarely stocks the obvious choices.
The inherent problem with "big experiences" is the "big" part. Amazon, by having a vastly different cost structure and data operation, can open stores that have excellent sales per square foot by tailoring the real estate to the experience they want to offer. The problem with big-box stores is the opposite: they are forced to build experiences for the real estate they already have, not the real estate they actually need.
This undoubtedly leaves a very grim outlook for big-box retailers. I'm unsure if there is any way around it besides changing the underlying cost structure of the business, which is nearly impossible. Pumping more money into ecommerce, digital advertising or social media is only a shallow and short-term fix to a very long term problem: Amazon has rendered the purpose of a big-box store nearly irrelevant. Big-box retailers exact success—the big box part—is exactly what is taking them down.