Digital Kills The Retailing Stars (A retrospective from 2011)

Written 3 years ago - "Digital Kills the Retailing Stars" was written in the aftermath of the collapse of Woolworths in the UK. Given all the changes kicking around at the moment, I thought it was worth dusting off and sharing. No apologies for the length....have a coffee...
Two things I didn't foresee: Tesco Hudl - an undoubted product success and the rise of pound stores.....Let me know what you think, all comments appreciated....enjoy!


Digital Kills the Retailing Stars
The future of retail as we know it is hanging in the balance. From Cheshunt to China, digital is reshaping the course of retail developments.  There are particular dynamics in emerging economies with little historic exposure to Western retailing norms and the questioning logic is “to what extent will they need and/or acquire them? “ It is different in mature economies where big box is the common retail denominator, isn’t it?

4 connected ideas are emerging and joining up the dots creates some fascinating pictures. Of course this won’t be a universal pattern but it provides a coherent sense of retailing in the post-modern phase and it is a future that is rapidly approaching.

1.    Digital Tsunami

There appears to be a digital tsunami inexorably moving, albeit at different paces, throughout the retail universe.  Plausibly, the forces inhibiting big box development in China will simultaneously sweep away irrelevant, non-value adding retail in mature markets. 

Picture a huge tidal wave overwhelming all that stands in its path. Two groups of mature retailers are already feeling the full force of this surging power: 

• Retailers whose businesses have an easy propensity to be purchased on-line. We have already experienced and/or are in the midst of witnessing a fundamental reshaping of retail categories including Music & Entertainment, Books, Gambling, Insurance, Consumer Electronics, Travel, Property, Greetings Cards and Banking etc
• Retailers whose business model was so fragile that any material loss of revenue was sufficient to push them over the edge. In the UK, perhaps the earliest casualty was the Woolworth’s group that collapsed in 2008/09 as their Music and Entertainment sales evaporated under the Apple / Amazon revolution, disrupting their total commerciality. And we know there are many lining up to join them like Jane Norman, Comet, Carpetright et al

This is a hungry tide and no one knows where its path will lead and how much land will be 

consumed.  But as with all seismic shifts, the landscape is being irrevocably resculpted.

2.    What happens when your greatest strength becomes your Achilles heel?#

The seeds of this question are sown in the post-apocalyptic fall-out that follows the demise of these early casualties and it comes with the realization that retailing is, de-facto, a fragile model.

For many years, major suppliers have invested time in training their own people and developing presentations to justify why manufacturers’ margins are justifiably so much stronger than retailers. Manufacturers invest in new technologies they need to fund R&D; major retailing is a scale cash business – so focus on cash generation, GMROII etc and be satisfied with low single digit margins.

The trouble is, no one considered what might happen when business starts flowing from mature big boxes? How much contraction can be tolerated before even the best retailers hit  Gladwellian “Tipping Points?”  The best worst-case scenario, sees retailers like Tesco build strong on-line propositions – but this doesn’t necessarily help.

Retailing is a “Stock, Pack, Pick, Pay, Ship” business. It moves products from suppliers to retail distribution centres (Stock) on onwards to store shelves (Pack); from shelves to shopping baskets (Pick); through the tills (Pay) and to the shoppers home (Ship).  Conventionally, off-line retailers absorb the larger part of the Stock, Pack and Pay activities; whilst shoppers bear the burden of Pick and Ship. In recent years, a good deal of technology has been applied by retailers to bring their costs down – e.g. Cross-docking, Shelf Ready Packaging, Ship to Display Pallets and Self-Serve Tills help bring down significant chunks of the cost model. ”

With on-line retailing, major grocers have to take on Pack, Pick and Ship with decreasing ability, in the face of rising competition, to pass any of the cost increases back. (Initiatives like Tesco’s “Click and Collect” – dressed as a shopper benefit, are really just attempts to put the “Ship” costs back into the shoppers pocket).  Under such conditions, even growing sales from competitors is likely to be margin dilutive. Once you start including the spiralling costs of promotions into the retailers economics, it becomes quickly evident how, even profitable, business models can be undermined by relatively small  on-line volume shifts.

And there’s another problem. Where to do the picking? If it’s a store pick based model, it is cost-additive and margin dilutive. If you go the dark-store route, it drives sales out of existing outlets. Either way, it is bad news.

Second, many major retailers expanded their businesses by entering non-grocery categories – many of which are in the previous list of digitally transformed businesses.  Whilst they looked opportunistic in pre-tsunami times, they are part of the risk to be contained from now on – and will be the first areas where business loss will be experienced.

All these factors are concerning but the real “aha moment” centres on the historic strength of major retailers; the real estate footprint. Millions of retail square footage and with it the ability to serve millions of shoppers every day from prime retail locations. 

Having spent decades building land-banks and property portfolios, it is common practice for major retailers to leverage the value of these assets by entering into sale and leaseback agreements with property developers. This takes assets off the retail balance sheets, provides investment capital and commits the retailers to long term leases with guaranteed annual rental escalation formulas.

Here is a recent example from January 2011

Prupim has completed the £125m purchase of three supermarkets on a sale-and-leaseback basis for M&G’s Secured Property Income Fund. The real estate fund manager has bought three Sainsbury’s superstores in Worcester, Truro and Huddersfield. The leases at stores are for 25 years, with RPI-linked rent reviews. Source:  PropertyWeek.com

But it’s not a new phenomenon. A similar article in 2004 noted

Tesco yesterday raised more cash for acquisitions by selling off 33 of its UK stores for £650m. The stores, which range in size, have been sold to a joint venture that is half owned by Tesco and real estate firm Topland. Tesco has also sold two distribution centres in the deal. Tesco's £650m cash will come from issuing bond debt, which will be secured on the rent that it will begin to pay for the properties. Tesco will rent the stores on a long leasehold and carry on running the operations, so customers will not see any change.  Topland, has done similar sale and leaseback deals with retailers Marks & Spencer, Littlewoods and Budgens. The Guardian, Tuesday 23 March 2004

Taking the UK as an example, the implication of a significant retail contraction  and the exodus of household brands from the high street, may well be falling commercial retail property value and rental costs. With commodity prices still having the potential to fuel cost price inflation, this is not a great moment to find yourself with long-leases, large stores, lots of them, increasing on-line competition and guaranteed inflation-linked rental increases.

It creates a toxic mix where major retailers may find themselves unable to operate stores profitably and unable to affordably close them. They could try and renegotiate the rents – but why would property companies who bought the assets in a much stronger climate want to deal?  Their only dependable asset is the rental income.

Suddenly, retailers’  biggest assets become a major headache, underpinning a structural erosion of the competitive model and reducing their abilities to respond to newer, trimmer more agile competitors unencumbered by these legacy challenges.

Put simply:  Big box retail in mature markets is under threat.

3.      The end of Tesco?

Really? Tesco? Game Over?? Accepting this is a rather extreme proposition, it’s worth considering what Philip Clarke, the new Tesco CEO, said to the British Retail Consortium in his key note address last month (June 2011)

“….in this digital world, great service, value, convenience, price – these things are no longer enough to win customers’ loyalty. More than ever before, customers’ decisions about what they buy are likely to be influenced by the power of brands”

This could have come straight from the mouths of AG Laffley  or Paul Polman. But it didn’t. It came from a top global retailer and its conclusions are far reaching. First, Clarke implicitly acknowledges some of the retail challenges we set out above. Second, if you follow through with this stream of consciousness, it has the potential to destabilize the Tesco model as we currently understand it.

Even aspiring to be the best retailer in the world, is not enough for Clarke. Tesco’s future is as a brand builder and he goes on to reference, by example, the importance of the Technika house brand as a lead play in Tesco’s consumer electronics business. Clarke goes further:  his new strategy for Tesco includes the expansion of Tesco services to more parts of its footprint.

So brand building for Clarke means building the Tesco retail brand, stretching it further and wider across more services and markets, whilst developing and supporting Category specific sub-brand propositions. Tesco already has its fair share of critics, uneasy about its UK market strength and others who believe that its ubiquity and utilitarian ambitions, trying to be all things to all people, risks mushing it into a mire of muddled mediocrity.

As if to push the point harder, days after Clarke’s speech, Tesco committed a major faux pas in mishandling the transfer of Tesco Bank Accounts from RBS, leaving thousands of customers without access to their funds. BBC Radio 4s Money Box programme featured the problem and despite Tesco’s best attempts to front up and downplay the issues, there was no mistaking the customer anger. Many vocalised their intention to cease banking with Tesco.

And here’s the rub. The broader your brand, the more equity management required and the more potential for fowl ups. Once your PR starts turning negative it’s hard to recover. Ask Gordon Brown.  Long before we consider the real prospects of success of Tesco taking on the likes of Samsung and LG and winning the consumer electronics war with their house brand, Tesco’s ubiquity may yet turn out to be their Achilles heel and Philip Clarke’s brand build plans, one stretch too far. So whilst, I am only half serious in sounding the death knell for the folks at Cheshunt – they have more challenges ahead of them, and tougher ones, than they’ve encountered in the last twenty years.

4.      Brands reclaiming ownership of the consumer/shopper relationship

Don’t get me wrong, I might disagree with Philip Clarke’s response, but he has put his finger on another massive challenge for today’s retail giants: “Who owns the shopper?” For the last fifteen years we have all been working with a simple governing dynamic : “retailers, having become more powerful, can and do exercise a great deal of influence over shoppers and act as,  crucial and not necessarily benign, interlocutors, in the parley between brands and consumers”.

Across the globe, major manufacturers engage with customers to protect their brand positions. P&G have long-since made an art of this and way before concepts like “shopper based value creation” were born, Tom Muccio was leading the first WalMart/P&G Global team with 140+ P&G associates based in Bentonville.  P&G decided to excel in this space out of necessity, not desire – their hearts were and will always be with the brands, consumers and shoppers.  Customers were recognized as critical arbiters of brand success. Put simply: engage or die. And if you are going to engage: engage and win.

Digital presents opportunities to stimulate fundamental shifts in the power balance in the battle for ownership of consumer and shopper relationships, enabling brand owners to reach shoppers and consumers with more precision than ever before and reclaiming a bigger stake of the profit pool.  Digital media and social networks Where historic brand communications were broad-brush and one directional, today they can be ongoing, multi-layered sets of intimate dialogues. Retail hegemony is no longer a given. The rules are there to be rewritten and P&G is keen to author them.

The shifting of vast amounts of money into digital advertising and communications is no surprise. Their desire to invest in more forward looking rather than rear view research is instructive; but it is their eagerness to understand all things retail - on-line retail via, initially Ocado in the UK , the e-store in the USA, Tide Launderettes, The Amazing Shave stores, Branded Car Washes - that represents something of a qualitatively different order.  

It is widely rumoured,  P&G would like to see c15% of their global sales operating on a direct to consumer model within a medium term span - (and why not, after all, two of their global competitors, Avon* and Amway**  have never put their products anywhere near a Walmart store). This is no thirty-minute diversionary tactic – this is game changing for the next thirty years

If Philip Clarke thinks Tesco needs to be a brand builder, perhaps P&G reckons they can regain control of their own destiny by mastering on-line retail and capturing consumer/shopper relationships in ways previously undreamed of. You don’t need the square footage – you just need great product , effective ongoing consumer / shopper relationships, backed up with stunning fulfillment. Amazon began with books and today they sell.....

The consumer relationship renaissance, commercial opportunities for suppliers and the value implications for shoppers could prove an irresistible combination as economies downshift and consumers seek ever improved value. Such innovations will suck more volume out of the established retail environment and even retailing goliaths may be toppled by digital slingshots.

Digital may not have quite killed the retailing stars yet, it has claimed an increasing number of b-listed actors, and the waters are still rising.  In 10 years we might be asking “Do you remember when Tesco had superstores? In 20 years, “Do you remember Tesco?”  And, as with all tsunami’s, by the time you see it for sure, it’s way too late.