Posted on

An Argument for Neighborhood Stores

Specialty retailers – from legacy brands and DTCs to startups – are all facing the same challenge: Declining mall traffic and higher downtown office vacancy rates are making traditional store location decisions far riskier. Brands are wondering if neighborhood stores are the next frontier. If Target, Macy’s, Starbucks, Faherty, Lululemon, Vineyard Vines and others can do it, why can’t we?

Local Incubators

In fact, neighborhood locations have always played an important role as incubators of new specialty retail concepts. Notable brands, including The Limited, Gap, Anthropologie, and Lululemon all began as neighborhood locals. To grow fast and scale, however, they chose regional malls as their primary channel.

The rationale was that mall stores, with their larger trade areas and “cookie cutter” formulas, were generally more productive and less risky. Neighborhood stores, with their smaller trade areas, had lower revenue potential, didn’t fit the cookie cutter size and assortment models that drove mall store operations. They also often required a different store design due to local architectural standards, odd space configurations and a different customer journey. The mall prototype model did not work for neighborhood stores and vice versa. Traditional wisdom believed there were too few opportunities to be worth the effort required to build a different financial and operating model for small, local stores.

That calculus, however, may be shifting.

Think Local

With 20+ percent of a brand’s revenue now coming from ecommerce, neighborhood stores can play an important role as ship-from, pick-up and return-to depots. Having these services much closer to home adds huge value for customers. It increases in-store visits, which increases conversion. Data confirm that physical stores in a market can improve the brand’s ecommerce sales by 25 percent or more.

And there’s more in favor of local stores. The insights from mobility data and AI can significantly improve the predictability of local site selection, with related improvement in productivity. Merchandise assortments can be matched to neighborhood customers using data analytics. From a practical perspective, the normalization of WFH and hybrid work have created a renaissance in neighborhood store traffic and access to local talent as a workforce that represents the community.

In many markets, the neighborhood center/district can beat the mall on occupancy costs by offsetting the higher capital cost of customized store design. Such local centers can also give the retailer more flexibility on operating hours, reducing labor costs.

Lastly, local stores can bring intensity and intimacy to the brand’s value proposition. They strengthen community bonds and can develop longer-term customer relationships. As part of a unified commerce strategy, going local brings the brand into the neighborhood in a valuable way, increasing customer lifetime value (CLV) and total market profitability.

Location, Location, Location

Strategically, building a fleet of stores has always been the art and science of identifying, on a market-by-market basis, the right number of stores to efficiently serve all potential customers in that market. Physical retail stores are expensive to build and operate, and mistakes are costly. Spacing is important – attractive opportunities may lie in the shadow of more current or future productive locations. Geo-analytics can help optimize markets. The investment against return can be daunting if you get the basics wrong.

Regional shopping centers, as the name implies were developed to reach a broad swath of the [population. There are more than a few markets where shopping center developers literally built centers called Northland, Eastland, Westland, and Southland, explicitly and geographically describing market coverage. But by whatever naming convention, by the mid-1990s the regional mall coverage map was becoming overbuilt.

For the last two decades the regional mall market share has been in a steep decline. Today, roughly half of the once 1,100 regional enclosed mall shopping centers have closed or are the walking dead. Let’s face it, the U.S. has been over-stored for several decades and declining mall locations have more than replaced the growth of outlet centers, big box power centers, specialty, and hybrid lifestyle centers, and by the rebirth of metro neighborhood strip centers and street districts.

While these local locations may not have the trade area draw of the large regional malls they replaced, they may well have a higher concentration of core customers. These are locations that are destinations, not accidental retail. When customers come to a center intentionally, the chances are good that their expectations will be met with purchases that matter.

A Unique Role in the Portfolio

Mature specialty retailers sell across multiple real estate channels — workhorse mall stores, high-street flagships, outlet stores, and online. What role do neighborhood stores play?

Mall stores may continue to dominate for some time, but the neighborhood channel has inherent advantages of its own: convenience, novelty, intimacy, personal connection, and being part of the community. The timing could not be better to play into the hands of local retailers. In a fractious world, consumers value these qualities more than ever.

Here’s a playbook to maximize going local:

  • Originality and intimacy of the store environment, including visual merchandising.
  • Product displays that are novel and diverse.
  • A high level of personal service, combined with full-service, omni-capable tech.
  • Engagement with the local community.

Field Reports

There is a P4 formula to getting the big-picture playbook right.

Place

  • Create an engaging sub-brand, e.g., Nordstrom Local, Market by Macy’s, Express Edit, Starbuck’s Roastery, etc.
  • Embody a warmer, more accessible interior design.
  • Make the décor authentic, relevant, and contextual to the neighborhood.
  • Revitalize the local area with an infusion of energy and promise.

Product

  • Showcase more variety with style/color choices in tune with local customers.
  • Create demand through merchandise scarcity rather than inventory depth with lookalike merchandise.
  • Focus on the “sizzle” (quickens the pulse) and not so much the “steak” (fulfills a utilitarian need).
  • Curate an assortment tailored to the local trade area and maybe sprinkle in local-themed merchandise and local artists/designers/artisans/craftspeople.
  • Focus more on services (e.g., sales, styling, alterations, and omni — the Nordstrom Local model)

People and Tech

  • Build a staffing model that allows for high-quality, one-on-one service.
  • Hire influential local residents with a service orientation and personal connections in the community.
  • Make sure the systems delivering omni options are integrated.
  • Empower the store manager to act as store owner (P&L), who will:
    • Play a direct role in product selection and ordering.
    • Lead or direct the store’s visual merchandising.
    • Manage the P&L of controllable items.

Projection

  • Create robust local social media inviting customers to contribute.
  • Advertise to customers in digital and local media.
  • Host periodic store events, featuring locals, to draw in local traffic.
  • Participate in commercial district/association and events.
  • Celebrate employees and local customers with recognition.
  • Give back to the community.

Back to Basics

Neighborhood stores can more deeply connect with and “wow” customers, focusing less on product sales within the four walls and more on creating brand converts and loyalists. Think of it as a store where everyone knows your name. Deeply personal, relevant to local lifestyles and interests, and committed to improving the quality of life as a mantra, not a motto.

Posted on

The Empress’s New-ish Clothes

The value propositions of Rent the Runway, The RealReal and Stitch Fix are indisputable. As these concepts grew quickly through the 2010s, the digitally-driven rental, resale and subscription business models induced dopamine rushes in the fashionista set and strategic anxiety among fashion industry execs.

Yet RENT and REAL gush red ink – arterially. Even pre-pandemic. SFIX was nominally profitable until the pandemic and is now back to profitability in its most recent quarter, but the company’s multiple growth initiatives, I believe, will likely not add much more to the bottom line.

So, why don’t these fabulous concepts also make fabulous money?

The RealReal

Buy gently used upscale and designer fashion at a fraction of retail? What’s not to like? Consign your least joy-sparking items for a quick buck? Ditto. The RealReal, while experiencing a dip during the pandemic’s depths, continues to grow revenue and customers significantly over 2019 levels.

The company will never make serious money if any at all. Its accumulated deficit in retained earnings last quarter summed $659 million. The major problem is the high variable cost of receiving, processing, and inventorying individual items for resale. Think: Opening the consignor’s box, inspecting, authenticating, photographing, retouching, pricing, describing, posting, and warehousing each item. Then add on consignor acquisition cost, CAC, fulfillment and, in many cases, reprocessing the return. The contribution profit per order in 2019 was a record high $20 per order, while the fixed cost per order was $53. I estimate they’ll need to sell four times their 2020 revenue before they make a decent return to investors.

That won’t be easy. Fashion resale is a huge business offline, where the intake and selling processes are less labor and fulfillment intensive; and even then, judging by the lack of corporate chains in resale and the predominance of nonprofits, it’s not a big, per-store moneymaker. There’s also plenty of online competition: think Vestiare and ThredUp (a more mass model but also burning cash) and the platforms Poshmark and eBay, among other formats. You might be surprised where the largest number of authenticated Birkin bags are offered.  

Rent the Runway

My wife founded and ran a nonprofit. During her 10-year anniversary campaign (in the Before Covid Times), she pitched big money donors and attended many events. Her wardrobe solution was, of course, Rent the Runway. Given her exquisite taste, even her for-profit husband was thrilled at the selection and flexibility the service afforded – for a perfectly reasonable, subscription price.

Reasonable prices for customers, yes, but not for shareholders. Like REAL, RENT’s business model is operationally complex. Returns are built into the model. After wearing, each garment is shipped back, received, cleaned, and returned to inventory. And depreciated. Even in its last pre-pandemic fiscal year, investors would have been better off if, for every dollar a customer spent, the company simply rebated $1.50.

RENT has been in business for over 10 years, and still filed its S-1 as an “Emergent Growth Company” entailing a “high degree of risk” for future buyers of its common stock. Another sign that the business model is inherently problematic is RENT’s lack of peers. LeTote filed for Chapter 11 and seems a shell of its former self. CaaStle supplies a rental platform for other brands to use. Who did I miss? Who’s killing it in clothing rental?

Stitch Fix

SFIX has a different value proposition than REAL and RENT, and a business model architected to make money. The company’s clients subscribe to receive personal style advice and periodic outfit selections, in return for buying, at full ticket, items mostly in the better and contemporary price segments. Healthy gross margins, check. If a client returns everything and purchases nothing that period, they still pay a $20 styling fee.

The company further utilizes an array of 140 data scientists who match purchase behavior with customer demos and product characteristics to model and maximize conversion and AOV and minimize returns. Check, check and check. The company also uses the data to guide development and selling of higher-margin private brands. Finally, the business continues to grow its topline, even through the pandemic by expanding into new customer segments (plus, kids, men’s) and geographies (the U.K. so far).

SFIX returned to nominal profitability in its latest quarter, but implicit in its reporting of outsize growth in and emphasis on non-core growth strategies is that the core women’s business – its largest and likely most profitable segment — has matured, despite a ~$250 billion TAM. (What keeps an articial lid on their women’s business, it seems to me, is that their brand imaging is too literal and practical rather than aspirational and emotional.)

The Business Back Story

These three businesses are all 10+ years old. Why haven’t they yet figured out their profit models? I have a few thoughts.

All three of these concepts were/are venture financed. These tech entrepreneurs and financiers are willing to take on substantial risk to play the long game, solve for complex business models, invest until they completely dominate their sector, and figure that’s approximately where “scale” will begin to deliver an ROI.

It’s worked before. High fixed cost creates a barrier to entry; low variable costs create a steep and predictable glide to profit. But when variable costs are also high (and contribution margin low), as in the cases of RENT and REAL, the path is longer, and the expected error dilates. What happens if the market ends up being smaller than you thought, becomes very competitive, or the model is just inherently unprofitable at any scale? Well, maybe the public markets will be frothy enough to bail you out.

In SFIX’s case, I believe founder and former CEO, Katrina Lake, always had the company’s profit model guide its decisions. However, I think she and company shareholders may have overestimated the ultimate appeal, and peak SOM, of subscription clothing for all.

A wild card in these models is stock-based compensation, which applies to SFIX currently and may affect the others’ future P&Ls — if they should be so lucky. For the top-tier executives living in San Francisco (SFIX, REAL) and NYC (RENT), they accept relatively “modest” salaries and finance their Model S Plaids with stock grants and options. SFIX traded largely flat after its debut four years ago, mostly in the $30s, until this winter, when prices briefly rose over $100. Stock- based compensation this last fiscal year blew a $100 million hole in its P&L.

There’s always the pivot. In recent earnings calls, REAL mentioned that they are opening more stores – because they are more profitable; RENT now encourages you to buy its clothes; and SFIX is strongly promoting its new, “Freestyle” non-subscription platform. Less dopamine, but more real.

Posted on

Target’s New Business Model is Still a Work in Progress

No retail segment is more competitive than the mass segment, where retailers sell many of the same SKUs and must therefore compete based on differentiated consumer perceptions of value, access, convenience and customer experience. In 2016, the Target Corporation — facing scorching competition from Amazon and Walmart and saddled with negative comps — decided to check “all the above,” including product selection. In early 2017 the company launched a major, multi-year set of initiatives to remodel stores, improve store operations, expand omnichannel capabilities, increase the number of small-format and campus stores, and introduce dozens of new owned brands. A year ago, the company decided to accelerate these investments, and given their more recent operating results, they seem to be paying off.

It’s a difficult trick. A superior customer experience in a store often adds expense. Offering the complete suite of omnichannel options (including same-day to home or curbside pick-up) also adds expense. With these added costs, how will Target also excel in delivering value? Will this business model foot?

The New Customer Experience: A Great Start but Missing Basic Elements

The digital look and feel of the brand strongly reflect the company’s new direction. My www.target.com landing page featured three new brands in all their inclusive splendor, the day’s most pressing shopping occasions, and new omni-enabled ways to “get your Target Run done.” A very different approach than Amazon or Walmart. It seems to be working, and Target’s e-commerce, facilitated by its many omnichannel options, was up 36 percent in 2018.

Based on recent store visits I made in Columbus, Ohio, the in-store customer experience was a big change and represents a new business model. The new, remodeled, and re-fixtured stores, all with new marketing and visual merchandising, are a big improvement over the “old” Target packages. The company is essentially applying the techniques used for decades in better department, specialty and upscale grocery stores. Several departments are introduced with low tables and stands for displays, folded product or forms; varied fixture heights and types allow for good visibility and provide visual interest. Many of the aisles are now shorter in height and length and not all are parallel. Moreover, the displays and décor often showed enough sass to make you smile. I had never noticed the music before in Target, but the tracks had me “boppin” in the aisles. The total effect is that the store is more attractive, more fun, and easier to shop. The discrete sections, when merchandised well, suck you in to spend more time and money. Store traffic and comps were up 5 percent over the past year.

While the new format has raised the aesthetic bar, not all aspects of execution reached it. Several displays of folded product were askew or unkempt, and several bays read conspicuously empty or low on inventory. The swim trunks on one young mannequin rested around the boy’s ankles. There scurried no hawk-eyed associate nearby to fix any of these issues, even on a busy Saturday. Luxury-inspired displays will always feel less upscale, too, when bathed in Target’s fluorescent bulb temperatures. The company has selectively mounted halogen spots in the high ceilings, but the warmth added from those is often not sufficient.

Target says they are improving backroom operations to allow associates to spend more time on the floor for “customer-facing” activities. Let’s hope its end-state business model will allocate enough resources to fix the merchandising and inventory issues.

A potentially bigger miss, in my opinion, is the stores’ failure to change its associate engagement with customers. In a bright, happy, engaging store, we shoppers expect bright, happy, engaging associates providing great service. One consistently gets energy from Costco, Container Store, and Crate & Barrel employees. At Target, my engagement with the associates was unchanged from the many years I’ve been shopping there. And is still uninspiring.

Finally, there were still longer-than-necessary lines at checkout, queued next to several unmanned lanes – with the longest line at self-checkout. I actually like to shop in stores but am always anxious when I’m not sure if I’m in the quickest line. Why not train a camera with some AI to direct me to the shortest wait? Or, more old school, open up a lane or two so there is less of an annoying wait.

The Key to the New Business Model Lies in the Merchandise Strategy

In Target’s more recent public reporting and analyst coverage, all referenced the growth and success of its new omnichannel efforts and its impact on sales and store traffic. But how profitable can having associates pick, pack, and stage-for-pickup or deliver really be?

In fact, the unlock in this business model is in the merchandise strategy. I walk through the store and see upgraded product and presentations in apparel, intimates, baby, toys, home, and beauty — all designed to evoke emotion. And let’s not forget wine. The wine used to be stacked on regular grocery shelves. Now it’s merchandised like an upscale wine shop. Momma is going to notice and she’s going to smile. The math is: more emotion equals less commodity equals more spend and more margin. The company’s curation of private brands is also an integral component. The product may not add incrementally to sales if they replace a major national brand, but they definitely add margin, probably a net of 10 percentage points worth (after subtracting cost of design and development and co-op advertising dollars from the vendors).

In short, even with its recent innovations, Target still needs to spend more dollars on visual merchandising, checkout, and upgrading associate engagement. The company needs to fund this and further differentiate itself by de-commoditizing key departments. If they succeed, mass will never be the same.

Posted on

Make the Most of Speed — A Nimble Supply Chain is Just the Start

L Brand’s speed-to-market program has delivered a virtuous cycle of positive benefits to the Victoria’s Secret and Bath & Body Works businesses, resulting in lower inventory, faster turns, lower markdowns, higher operating margins and increased sales — extraordinary progress that has set them apart from their mall-based peers.

Continue reading “Make the Most of Speed — A Nimble Supply Chain is Just the Start”