The Future of Brick-and-Mortar Retail
Is brick-and-mortar retail going the way of the dodo? Well, it’s a fallacy that brick-and-mortar retail is going away, but it is evolving. That’s obvious, but how is it evolving? Let’s discuss “clicks vs. bricks,” the differing retail formats, the retailers they serve, and how the retail formats are evolving.
Ten years ago, e-commerce made up five percent of retail sales. By 2020, that number had exploded to 15 percent, and forecasts indicate that In 2021 it will go to 15.5. E-commerce is steadily whittling away at traditional retailers—that’s not news to anyone—but is the triumph of online retailing obvious?
I say no. E-commerce will level off at some point, but to understand what that means, we have to peel back the layers of data.
The first thing to note is that the overall penetration is significantly higher when excluding “auto and parts” and “food and beverage.” Instead of 15.5 percent penetration, it’s more like 23. This indicates we’re closer to leveling off than we think.
We can see electronics, toys, books, music, video, and office supplies are significantly penetrated by e-commerce, but my guess is they do not have much further to go. I estimate 50 to 60 percent of total retail sales is where these categories will max out (excepting books and music, where online retailing could almost completely replace brick-and-mortar, as those categories are so conducive to e-commerce). For even these highly penetrated categories, a certain amount of commerce will continue in brick-and-mortar. Why? Some people don’t have credit/debit cards, some are unable to receive goods where they live (i.e., their front porch is not secure), and others simply prefer shopping in a store.
Apparel, home furnishings, pet products, and beauty have not hit their maximum penetration and have a way to go. A big challenge for online apparel is returns, but as the technology improves–like avatars to virtually try on clothes–returns will go down. With the extra margin from fewer returns, brands will spend more money on customer acquisition, accelerating market share. Through innovation we will see the gap close on these categories at an exponential rate; we’re closer to these categories’ e-commerce growth leveling off than it may seem.
Auto, auto parts, home improvement (not mentioned as a category in the table above), crafts (also not mentioned), grocery, dollar stores and restaurants are less affected by e-commerce. The barriers to e-commerce penetration into auto and restaurant are apparent. Some internet-only car concepts and ghost kitchens seek market share, but people need to “kick tires” and love going out to eat. Home Improvement, craft, and grocery sell components to projects, which consumers are most comfortable gathering in person, touching, feeling, smelling and comparing.
The next piece to the puzzle in a discussion about the future of brick and mortar is retail formats.
- Malls, outlet centers, lifestyle centers (best described as outdoor malls with a movie theater and more restaurants), and high street make up a format that mainly serves specialty retail, which is mostly apparel/fashion, home furnishings, decorative accessory, with books, music, food and beverage, and electronics sprinkled in.
- Grocery/Drug Anchored and neighborhood shopping districts are another format, which harbors all things daily needs; grocery, drugs, convenience, services, food and beverage.
- Power centers are characterized by large format retailers mainly promoting and selling comparison goods like electronics, home improvement, home furnishings, mass apparel merchants, and discount department stores.
The first prognostication I’ll offer regarding brick-and-mortar’s future is how many square feet of retail per capita the US will adjust to. Here is how the US compares to other countries.
The US has more money for consumers to spend than most other countries, but clearly, we are over retailed and probably will need to adjust to between 10 and 15 square feet per capita in the next ten years to correct over saturation and make US brick-and-mortar retail sustainable.
I predict half of retail is going away in the next ten years, but I will be more specific and break it down by format.
Specialty (mostly malls) is the most vulnerable. There are 1100 malls in the US, and I estimate in 10 years, we will have closer to 400 pure malls and maybe another 200 partially redeveloped or mixed-use assets. The top third of malls (assets where the non-anchor sales per square foot are $800 or more) will survive, the bottom third will go away completely (i.e., redeveloped), and about half of the middle third will figure out a way to survive. The other half of that middle third will go away. While mall-based retail chains–including department stores that survive this culling of malls–will suffer a fifty-percent reduction in their store count, they will become stronger companies as sales per square foot, e-commerce and operations/logistic efficiencies increase.
Daily Needs (mostly market/drug centers) will not contract much, maybe 15 percent. The most vulnerable market/drug centers in the asset class are those that are “over-shopped,” meaning, if you have a 40,000 square foot grocer, and a 15, 000 square foot drug store (55,000 square feet total), you should not have more than half of that in shop space (27,500 square feet ). Centers with too much shop space are most likely to struggle.
Power Centers are more complicated, because specific retail categories in this format are vulnerable while others are very strong. You also see the most innovation and adaptation in these categories as retailers figure out the synergistic universe where e-commerce and brick and mortar meet. WalMart and Target (and of course Whole Foods) are leaders in leveraging their brick-and-mortar footprint with a robust e-commerce business. Retailers like Home Depot, Lowes, and Hobby Lobby are also going very strong, benefiting from the “shopping for projects” dynamic that hedges against the threat of e-commerce.
You also have remainder/overrun apparel discounters (i.e., Ross, TJ Maxx), which are e-commerce proof, because hunting through racks of products can’t be duplicated at that kind of scale on a website. A more significant issue for power centers is the fact that the US is over-retailed, and by nature, these centers are very large. Many retailers have been “right-sizing” their formats, reducing their footprints by as much as 50 to 60 percent. There is also pressure from logistics users pushing retail users out as warehouse space and big-box space rents reach parity. Governments will need to assess zoning and balance community needs against asset value. My prediction for power centers is a 30 to 40 percent reduction in square footage over the next 10 years.
Aside from significant culling of retail space, there are big trends like rideshare, curbside pick-up, last-mile delivery (think drones) that are changing the demands on the physical plant. Many retailers will require free-standing locations to utilize all four sides of a building for their operational needs as opposed to the front and back only.
As I already noted, as retail space per capita reduces, sales per square foot will rise, and rents along with it, which shines a bright light on the prospects of profitable brick-and-mortar retail business models (especially the ones who can grow their own e-commerce businesses) and owners of those surviving retail formats. Retail is not doomed: it is simply evolving.