10 Mar 2015 Research & Ideas
The Surprising Winners and Losers in the Retail
Revolution
The growth of ecommerce is
creating new leaders in retail
while putting many famous
brands at risk. Professors Rajiv
Lal and Jose Alvarez pick the
winners and losers in part two of
our series on the new book, Retail
Revolution. PLUS: An excerpt on
the future of grocery stores.
by Sean Silverthorne
The new book Retail Revolution:
Will Your Brick-and-Mortar Store
Survive? lays out the thesis that
traditional store-front retailing is
at an inflection point, under
tremendous pressure from
ecommerce and the changing
wants and needs of a new
generation of shoppers—the
millennials.
In Part 2 of our three-part
interview with Harvard Business
School Marketing professors Rajiv
Lal and Jose B. Alvarez, they
discuss who is winning this
revolution and which brands
appear to be losing ground.
Sean Silverthorne: Among the
retailers you have found to be most
successful in striking a balance
between brick and clicks are Home
Depot and Pet Smart. What did
Home Depot do right?
Rajiv Lal: Home Depot thought
about the challenges facing their
business very strategically. They've
gone category by category and
asked: What is the best way to
service the customer in this
category? Does it makes sense to
sell these products online, in the
store, or both, and how? Take
lighting as an example. Home
Depot asked: How do we best help
customers with their lighting
needs? What knowledge, products,
and services do they need and in
what form? What should we do
with lighting in the stores? Should
we eliminate it, sell it only online?
If not, what is the requisite
assortment we should carry?
What's the appropriate pricing in
the store? They decided on a
limited assortment in-store, that is
mostly private label and where
price comparison is not possible.
Jose Alvarez: This approach to
categories is seminal to what
they've done to reinvigorate their
business. They looked strategically
at all aspects of their offering
across the various channels they
have at their disposal to maximize
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customer satisfaction and the return
they get on their TIPS
(Technology, Inventory, People,
Space) assets. For example, if your
toilet blows up, you aren't going to
wait two days for delivery for a
part from (competitor) Amazon
Prime. You need that part right
now. You need it to be in stock,
and you need somebody to help
you understand what to do, what
kind of silicon sealer you
need—Home Depot does a great
job of that. They make sure they
carry enough inventory so you can
get that job done immediately.
Lighting fixtures, on the other
hand, are a different animal. There
are hundreds of thousands of
options to choose from and
generally the need is not an
immediate one. They carry a
selection of good, better, and best
options in-store along with the
electrical supplies and tools you
will need to install the fixture.
Online they carry an endless aisle
of products and they provide
videos and expert advice to help
with installation. They do not
deploy their TIPS assets in a
one-size-fits-all manner. Home
Depot has studied deeply how to
best deploy their assets in order to
satisfy the customer in a way that
allows for an excellent return on
invested capital.
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They have also paid very close
attention to what is likely their
most profitable customer segment,
professionals. They have created
wonderful technology and
processes to support customers that
align with their entrepreneurial
culture. If you are a professional
today buying from Home Depot, an
app on your phone lets you order
directly from the job site and gives
you the option to get delivery to
the site based on urgency of your
need and willingness to pay.
Lal: They've created new sources
of value for their customers that
did not exist before.
Q: And PetSmart. What's made
them so successful?
Lal: PetSmart saw the online threat
early and built a strategy to insulate
themselves from the damage that
ecommerce could inflict. They saw
what was coming, and entered
services. If you look at the store
today, almost a third of PetSmart's
sales are in services, things like
grooming or hoteling—those sales
aren't going away, they are not
threatened by the Internet. And
while the pet parent waits for the
services to be completed, PetSmart
provides a wide array of in-aisle
treats and accessories to drive
impulse purchases. At the same
time, they've maintained a strategy
of exclusivity with pet food so that
they are not stocking all of the
same items that Walmart and the
supermarket carry.
Alvarez: PetSmart saw the Internet
challenge back in 1999 and 2000
when Pets.com came along; they
dreamed up this strategy very early
on. To me, it's a lesson on just
smart strategic leadership. They
saw the threat and came up with a
smart strategy that placed them
where the puck was going.
Q: Those are two winners; which
businesses do you think are at risk?
Alvarez: In the worst shape are the
stores that said: I can fix that.
Maybe it's not fixable—maybe 80
percent of your products are now
going to be sold online or in a
digital format, like books. Barnes
& Noble and Staples are two
companies in great peril because,
not only is the Internet more
efficient at what those stores sell,
what they sell may no longer
needed by the customer!
Those are the easier ones to see in
decline. But there are some
businesses that at first glance look
to be OK but on close inspection
are in trouble. A company that's
going to be in trouble over the next
few years is Kroger in the food
space. They are a very large
company. They have all this
leverage against suppliers. They
have huge cash flow, customer
counts are fine, they've crushed the
competition. But I think they are at
an inflection point. Is the typical
Kroger store going to be where the
average person is going to want to
shop in a few years? I don't think
so. This is true for the supermarket
space in general; it's really not
about Kroger as an organization.
Supermarkets are these very large,
impersonal, and inefficient spaces
for customers. Grocery shopping is
one of the most unappealing chores
for a large swath of customers. The
supermarket space is ripe for
disruption by ecommerce.
But it's not just about the
ecommerce. Other changes are
COPYRIGHT 2013 PRESIDENT AND FELLOWS OF HARVARD COLLEGE
going on in the environment.
People don't know how or don't
have the time to cook, so they are
eating pre-prepared meals more
often. There is also the fact that if
you go to a CVS or a Home Depot,
there is a panoply of products that
were once the sole domain of
supermarkets. Twenty-five years
ago supermarkets had more than 80
percent of the consumables market
share; today that number is in the
low 40s. Now it appears that
everybody sells consumables
including the 30,000 or so dollar
stores in the United States. You
only have to take a look at the UK
supermarket space to see what is
ahead for the US supermarket
industry in this regard.
Q: The book makes the case that
even Walmart is under threat by
the changing environment.
Lal: Look at the business model.
Walmart catapulted into a
$400-billion-plus company by
luring customers into stores with
groceries at very low margins,
reaping the benefits of additional
trips, which generated increased
sales of higher-margin general
merchandise items. But if you look
at what has happened to that
model, it is challenged on all
fronts. On the general merchandise
side, Walmart has competition
from the Amazons of the world. So
their ability to make money with
general merchandise has become
compromised because ecommerce
forces prices down. Amazon's cost
structure and their formula for
deploying assets is superior to
Walmart's. At the same time, the
traffic that was being generated by
lower food prices is being
threatened by much leaner and
more competitive grocery stores.
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The icing on the cake is that the
lower-income customer has
another choice in the form of dollar
stores. So, on all counts, you have
a model that is under significant
pressure.
Alvarez: What's fascinating is that
the model has worked for Walmart
for a very long time and looked
like a juggernaut that nobody
believed could be stopped. You
had this strategy of
drive-traffic-with-food and make
money with everything else—but
everything else is really under a lot
of pressure.
With dollar stores you have this
shopping trip interrupter that
dissuades you from going to
Walmart—they have paper, milk,
frozen food, bread. The Walmart
machine was driven by traffic; now
they've lost the traffic, lost the
margins, and you say, holy cow.
That's the conundrum that Walmart
is in.
Think about this. There are more
than 30,000 dollar stores in the US,
you can find one everywhere: in
rural regions you find Dollar
General and in the urban settings
you have companies like Family
Dollar. The Walmart machine is no
longer printing dollars, it's minting
quarters. It's very, very
problematic. Walmart has a new
strategy that uses smaller stores,
supercenters, and their warehouses
in an ecosystem that includes
ecommerce, but it's going to be a
lot of work for them to make that
happen. The investments will be
enormous and they will have to
shift their very strong culture in
ways that will be uncomfortable if
not impossible. I believe this may
push Walmart to make their first
major acquisition in the US.
Q: For what companies will 2015
be a make-or-break year?
Lal: The thing about retail is that
no year is a make-or-break year.
Every retailer has nine lives. A&P,
still alive. Sears Roebuck, which
has been on its deathbed for Lord
knows how long, still alive.
JCPenney. Even though the
business is sick, the patient fights
on. Retailers always find a way to
repurpose the real estate.
Alvarez: We have seen a huge
number of store closings but not a
concomitant number of store
brands dying. The concept the
brand represents may be dead to
the consumer but the stores are still
there generating cash flow. In retail
location is still critically important.
book excerpt
Will the Internet Push
Grocery Retailers Over the
Edge?
From Retail Revolution: Will Your
Brick-and-Mortar Store Survive?
By Rajiv Lal, Jose Alvarez and
Dan Greenberg
Supermarkets, much like
department stores, mass
merchandisers, supercenters, and
other broad-assortment retailers are
facing impacts across almost every
category in their stores. Reading
the commentary of equity analysts,
one is impressed by the extent to
which supercenters like Walmart
and warehouse clubs like Costco
have stolen supermarket customers
and taken over categories that were
previously the sole domain of
COPYRIGHT 2013 PRESIDENT AND FELLOWS OF HARVARD COLLEGE
supermarkets. But the assault on
supermarkets is actually much
more widespread, and comes not
just from traditional competitors
like supercenters and warehouse
clubs, but also from new entrants
like dollar stores and online
retailers, and from shifts in
consumer habits. We believe that
there are several key issues that
will effect a dramatic change in the
supermarket industry over the next
five years.
First, eCommerce will shift
significant dollars out of the
industry. Although home delivery
does not seem to be a viable
alternative in the supermarket
space today, a combination of
fragmentation in consumer
shopping behavior and emerging
alternatives to home delivery will
change how Americans buy
consumables. The inexorable
march of internet technology will
create significant changes in the
expectations and behavior of
supermarket shoppers that will
open up opportunities for new and
creative concepts. Related to this,
the consumer need for convenience
will continue to explode and
retailers will need to find solutions
that solve problems for
time-starved customers. While
online retail of groceries doesn't
generally have cost advantages,
some segments of consumers are
more than willing to pay for
convenience.
Second, the bifurcation of income
in the US will accelerate and lead
to an even greater need for
supermarkets to provide value.
Supermarkets have long relied on a
high-volume, low-margin model,
and the large, vibrant middle class
that characterized
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mid-twentieth-century America
was essential to supermarket
success. However, the supermarket
sweet spot in the middle of the
income distribution has been
shrinking for decades. As income
inequality accelerates, the ability of
supermarkets to remain
competitive will diminish as
volume flees for Walmart or
migrates to higher-end retailers like
Whole Foods. Supermarkets have
already reduced costs dramatically
in order to compete with much
more efficient competitors, and
they can no longer generate price
savings by cutting heads. Now too
they lack the residual store-level
talent to shift strategy and provide
service. Consequently, these
downward trends create an
unstable situation for supermarket
retailers.
Third, the bifurcation of consumer
shopping trips will continue
unabated with consumers looking
for meal solutions on an almost
nightly basis (trips that have been
going disproportionately to Quick
Serve Restaurants [QSRs]) and
filling in their non-perishable needs
(household items, canned goods,
health and beauty care) on separate
store-based trips. These
non-perishable trips are a place
where eCommerce and other
non-traditional competitors like
dollar stores will shine, and the
winners of the past two decades,
supercenters, will fail. This trend
will continue to shrink the freedom
supermarkets have to manage
pricing, service, and product
assortment. While beautiful
perishables departments have been
a cornerstone of many
supermarkets' strategies and
formats, Americans have greatly
simplified their meals over the past
three decades, and many have
either forgotten or never learned
how to pull these raw ingredients
into a meal. Because of this,
demand for the core perishables
category is declining.
This will lead to a fourth
significant issue: the amount of
excess space that supermarkets will
have on hand. This will manifest
itself not just in the number of
excess stores in a chain's network
that will need to close but, more
importantly, the excess space in
every individual location that a
chain operates. As we will show,
supermarket store size has risen
dramatically over the last 30 years
yet consumer behavior indicates a
need for this space to shrink
dramatically. Space will become an
albatross around the necks of most
supermarket chains as they struggle
to figure out how to productively
deploy or shrink the space in what
has become a very inflexible
format.
Finally, the wave of human health
concerns (especially relative to
obesity) will cause supermarkets to
COPYRIGHT 2013 PRESIDENT AND FELLOWS OF HARVARD COLLEGE
rethink some of their core
strategies.
We are currently in the midst of
many of these changes, and
because of them, the past two
decades have been challenging for
supermarket companies. The recent
recession has made things worse.
Store closures have become
increasingly common, household
names like A&P and Winn-Dixie
(now part of Lone Star owned
Bi-Lo) have entered (and emerged
from) bankruptcy, and supermarket
giant Supervalu is laying off
workers, closing stores and selling
assets to Cerberus Capital
Management in a bid to stay afloat.
Even large chains, like Safeway,
have struggled with generating
high returns on invested capital,
and Safeway has also been
purchased by Cerberus Capital
Management. Kroger, for its part,
has done very well and improved
its operations significantly, as seen
in its falling SG&A Expense Ratio.
However, it is focused on
improving a box and a style of
retailing that, as we will see later in
the chapter, may face an existential
crisis if European-style,
purpose-built Drive stores (small
warehouse formats where
customers order online and pick up
orders) come to America. These
Drive stores are apt examples of
the "Shrink and Transform the
Format" strategy.
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