Retail: The Final Frontier?

Historians eventually will look on last year as the beginning of the end for retail stores (aka fixed asset distribution) as we know them. Holiday ’08 retail sales dipped 5.5 percent to 8 percent from the previous year, the most dramatic decline in decades. Few, if any, retailers projected such drama.

Retail operating margins were extremely low coming out of the holiday season. There have been boatloads of red ink, numerous store closings and high-profile bankruptcies. And as we all experienced, merchants practically gave their goods away at heavily discounted prices.

Does this signal the end of the retail model as we know it? Despite the fact it’s been the dominant paradigm since The Crusades, retail is inherently inefficient. It’s all fixed expense (vs. variable). Retailers have to bank a whole set of decisions — including how much inventory to stock, space to lease, sales staff to employ, etc. — on their abilities to stimulate and project demand.

Consider the fate of the now-defunct F.W. Woolworth chain. At its peak, Woolworth’s numbered more than 1,000 retail sites and had become the largest department store chain in the world by 1979. But in the late ’80s, Woolworth’s tried to develop multiple specialty store formats within an enclosed shopping mall, a concept that failed. By 1997, Woolworth’s was gone.

Eleven years later, The Sharper Image, the high-tech gadgets retailer founded as a catalog in 1977 and built into a store chain, met a similar fate. Although The Sharper Image’s life as a cataloger/retailer was considerably shorter, its fate was similar.

Rapidly growing and highly profitable when its focus was on marketing products directly to consumers through its innovative catalogs, an aggressive strategy of retail expansion led to The Sharper Image’s downfall. The company at one point operated 186 retail stores nationwide.

Both these stories expose the vulnerability of fixed asset distribution. In simple terms, the cost of doing business in a traditional retail environment is fixed: It doesn’t vary with volume; it’s independent of the revenue required to support it. Over the years, our retail distribution systems simply have been overbuilt.

Certainly, the sheer cost of leasing real estate is a huge factor contributing to the decline of retail businesses. Inventory management also has been increasingly costly as warehouse space, inventory management systems and personnel expenses have increased.

Dumb Stores
Perhaps the most important criticism of the fixed asset distribution model is that retail stores are just plain dumb. In essence, they treat all comers like strangers, new customers with whom they have no prior history. Similarly, they seem to presume these people have no knowledge of the company, no prior experience with the organization. That’s a huge wasted opportunity.

Consider a major athletic footwear retailer that has spent $130 million on national advertising every year for a number of years. TV and print ads are designed to drive consumers to stores that carry its line of shoes. Its advertising makes the brand look fairly new, but the majority of Americans are familiar with this company and are already customers. Still, the fixed asset distribution model prevents this company, or any other retailer, from developing an interactive, intimate relationship with those customers.

Modern databases are smart — they allow marketers to segment customers and prospects to a fine degree — but database technology outpaces retailers’ ability to exploit it.

In gauging the fate of the dedicated retailer, we can point to three key problems:

1. Economics. It’s prohibitively expensive for merchants to employ traditional media to speak intelligently and intimately to a multitude of tiny market segments.

2. Bandwidth. Even if merchants could afford to communicate effectively with lots of narrowly defined market segments, most wouldn’t know what to say to them. And if they did know what to say, they wouldn’t have the resources to say it.

3. Customer service. Our culture has devalued good customer service. Customer service stalwarts are few and far between. Rapid turnover among sales personnel, the high cost of training and the daunting challenge of maintaining customer service standards across a wide-ranging retail network all have contributed to the problem.

Beware the Bombardment
Take all three of those and compound them with the simple fact that today’s American consumer is bombarded with more than 3,000 advertising messages each day. Consumers have built up greater resistance to advertising and marketing messages. Upward of 60 million households signed up for the National Do Not Call Registry in 2003, five times greater than first projected. DVRs now let us skip the commercials.

Naturally, the Internet has played a key role in retail’s demise. After 10 years “in development,” the Web finally is realizing its potential as the merchandise marketing medium of the near future, allowing merchants to fully anticipate the wants, needs and desires of consumers in real time and with unprecedented flexibility.

Few Adapting to Web Well
But herein lies the problem: Despite the fact that virtually all merchants know they need to make the transition to the Internet, few are doing it well. Even those who’ve jumped into the digital world with both feet tend to apply many retail business conventions to their Web sites.

These companies are failing to recognize inherent differences between their online and offline business models. Consumers have far greater control on the Internet than they do in stores. They can dictate the terms of their shopping patterns.

Above all else, there’s no physicality or other limitation to consumers’ ability to move on to competitive alternatives. What’s more, various digital tools, such as pricing bots, have been developed that provide consumers with great transparency across the Web.

Differentiate or Die
This situation is far more threatening than the competitively insulated confines of a brick-and-mortar store. It’s critical that Internet distributors differentiate themselves and their offerings effectively and precisely to engage customers.

Consider the use of digital wallets. One high-end apparel marketer has increased conversion rates of browsers to buyers, as well as average order size, by incorporating digital wallets. When a visitor looks at a suit, for instance, the wallet pops open to reveal a special offer on shirts and ties to go with it.

Here’s a different kind of example: A marketer of skin care products aimed primarily at teens and young adults populates its wallet with a special offer for an annual “subscription” to the product line with attractive savings.

These merchants are employing the digital wallet to achieve relevance, timeliness and differentiation, three characteristics that set them apart from more generic or less connected competitors.

In the next installment of this series, we’ll discuss how the Internet enables you to know your customers in far greater depth than at the retail level. ROI

Rick Braddock is chairman/CEO of online grocer FreshDirect
(rbraddock@midoceanpartners.com). Donn Rappaport is founder, chairman and CEO of data marketing services provider ALC, and immediate past chairman of the Direct Marketing Association (donn.rappaport@alc.com).