News & Trends

The tipping-point: Brick-and-mortar vs. Amazon

Posted by: Conor Flynn Conor Flynn
on June 6, 2016

Retail is an extremely fluid industry, constantly shape shifting as a reflection of our changing culture and economy. Style trends, eating habits, health and wellness, and thought leaders can heavily influence the success and failure of the close to 4 million retail establishments in the United States. But, in recent years, we’ve seen the industry rattled and disrupted from one especially outstanding force – technology.

The retail industry employs 29 million people in the U.S. and consumer expenditures make up two-thirds of the U.S. GDP. This fact is often overlooked, especially when we dream about the future, and what our country and economy will look like. We are nearing a technological revolution that may have as big of an impact as the Industrial Revolution, with the rapid development of artificial intelligence, e-commerce, tablets, robots, kiosks, drones, autonomous cars, virtual reality, and smart phones. All of these technologies will reshape retail, the economy, the workforce, and our lives.

One thing is certain, you can’t fight technology and win; each new generation embraces technology and has a thirst to adopt innovations that will most certainly impact future generations. Out with the old, in with the new. How will this impact the labor force, consumer spending, and the future of retail? Only time will tell, but first let’s take a quick look back at the rapid ascension of the biggest retail disruptor in our world today.

Amazon draws “Advance to GO, collect $200”

When e-commerce took off in the early 2000s, it presented a unique challenge for many companies faced with a new medium to compete with. Amazon reared its head and quickly became a king in retail, focusing first on the books and electronics sectors. Taking advantage of tax loopholes with online purchases exempt from sales tax – thanks to the 1992 Quill Corp. v. North Dakota ruling – Amazon was able to undercut brick-and-mortar stores’ pricing across multiple consumer goods categories. Amazon focused on eliminating competition and abandoned near-term profits, with a long-term view of raising prices once that goal was achieved. Some might call it a move out of the Monopoly playbook. In attempts not to be swallowed by the shift to online, major publishing houses even raised their e-book prices to discourage consumers from making the print-to-digital switch. The unlawful play recently caught up to them in the form of a lawsuit that’s costing the publishing houses $166 million in settlements.

Amazon could offer goods that didn’t require an additional sales tax and were priced at razor thin margins. The end product for customers could not be matched by any brick-and-mortar competitor. Retailers like Borders and Circuit City went bankrupt and fell to the wayside as a result, and Barnes & Noble and Best Buy were brought to the brink of extinction. Amazon nearly eliminated two entire categories from the retail landscape before these retailers were able to pivot and compete.

Change is inevitable…and necessary

One lesson the e-commerce revolution has taught retailers is that the ability to be malleable is essential to continued success. Some brick-and-mortars have stayed afloat by implementing new tactics in customer service, competitive pricing, and shipping services to be resilient and stay relevant in the ever-changing landscape of retail.

A prime example of this is Best Buy. In 2013, the company was still teetering on the cusp of financial demise, having seen its stock drop from $48 a share in 2010 to $11 a share at the end of 2012, and considering a significant downsizing of its big box stores. At a pivotal time, Best Buy brought on a new CEO, Hubert Joly, who believed price-competitiveness and customer service could be its big differentiators. Instead of consumers entering the store as a “showroom” to see the product, then purchasing online at a cheaper price, Best Buy’s prices gave Amazon a run for its money and their customer service was so helpful, that it was hard for customers to leave without a product in hand. As a result, Best Buy’s stock tripled in 2013 and fiscal 2016 marks the second year in a row the company increased domestic revenue and expanded its operating margins.

Best Buy also developed a store-within-a-store business model, where it leases out square footage inside its big boxes to Apple, Samsung, and Google. Gone are the DVD and CD racks, and in their place are appliances, a Samsung Experience, Apple kiosks, or a Sony display that showcases their products. Customers can take devices for a test drive, something they still can’t enjoy online. At one point Best Buy was looking to downsize, but recently, demand has actually outweighed the current supply that its 45,000-square-foot prototypical boxes can handle.

Best Buy’s latest endeavor to stay on the cutting edge is same-day delivery. Joining other retailers like Kohl’s and Macy’s, Best Buy has partnered with independent delivery service provider, Deliv, to enhance its capabilities and offer the fastest service for customers. Competing with the likes of Amazon is not easy, and Best Buy will have to continue to evolve with new technology and take advantage of its physical presence and customer service.

Barnes & Noble is another retailer that was forced to transform in an uneven playing field. After releasing the Amazon Kindle in 2007, Barnes & Noble followed up with its own e-reader, NOOK, in 2010. In addition to its in-store cafes, the book retailer partnered with AT&T in 2009 to give all customers access to free Wi-Fi while in its stores and further drive not only its e-book business, but also increase time spent by customers in-store. The Nook never was able to compete with the Kindle and was recently written off almost entirely by Barnes & Noble. The company has instead focused on its four-wall profits by changing out its merchandizing mix. For the first time since the emergence of the e-reader, physical book sales actually outpaced e-reader sales this past quarter in the U.K. Is this trend evidence that we are nearing an inflection point in the U.S. also? With plans to open a new prototype store in late-summer 2016, Barnes & Noble continues to evolve with focus on the in-store experience and providing a welcoming environment that customers enjoy.

Government involvement

Brick-and-mortar retailers are not the only institutions stepping into the ring with Amazon. In response to the unfair playing field ushered in with e-commerce, the Marketplace Fairness Act was introduced in 2013. The proposed legislation gives states the authority to collect sales tax from online retailers, but has yet to garner bi-partisan support.

One state that has spearheaded this action is South Dakota, who in March passed a law requiring numerous online and catalog retailers to implement the state’s sales tax in their pricing. Enacted earlier this month, out-of-state retailers with more than $100,000 in sales or 200 remote transactions in South Dakota annually are obligated to register with the state and collect its 4 percent (soon to be 4.5 percent) sales tax.

Despite progress on Capitol Hill and the business innovations experimented with by brick-and-mortars, the online retailer advantage still remains present today.

A fork in the road

Amazon certainly continues to disrupt the retail world, and now has an eye on fashion and private-label goods. Department stores beware, as there is no competitor quite like Amazon. In the open air shopping center sector, Amazon opened its first brick-and-mortar bookstore in Seattle in November of last year and has plans to open a second in San Diego this summer. Perhaps this opening of physical stores by the pure play giant is the single most important signal that there will always be a need for brick-and-mortar.

There appears to be a fork in the road, where retailers can choose to compete with Amazon and invest heavily in e-commerce and delivery, or focus on goods and services that are “un-Amazonable.” TJX Companies and Home Depot just had better-than-expected quarterly earnings, standing out as star retail stocks this month. TJX reported same store sales of 7 percent and the retailer is expanding with store openings across the world. TJX is cashing in on the “treasure hunt” trend and outpricing Amazon by purchasing goods from vendors with too much inventory. Home Depot reported same store sales for U.S. stores of 7.4 percent. Both companies raised their guidance for the year. Home Depot’s stock is near an all-time high and its integrated in-store and online retail approach, Buy Online, Ship to Store (BOSS), has positioned it as one of the 10 largest e-commerce businesses in the U.S.

Clearly, recent negative same store sales trends in department stores vs. the positive same store sales produced by TJX Companies (Kimco’s largest tenant) and Home Depot (Kimco’s second largest tenant) illustrates why we believe we are in the sweet spot of retail at Kimco.

While nobody can predict the future, at Kimco we are focused on high-quality real estate in our top 20 markets that will continue to bear fruit over the long term via redevelopment opportunities. The demand for high-quality real estate allows Kimco to transform assets to meet the everyday needs of the shopper today, and in the future. Competition is a good thing for every industry, and disruption is a natural step in evolution. Amazon and other disruptors will continue to challenge the status quo, and retail will continue to evolve.

In the near term, consumers can take advantage of all forms of omni-channel retail and continue to enjoy a deflationary environment where discounting is the new normal. However, in the long term, technology will disrupt many landscapes, not just retail. In our sector, we see a tipping point where Amazon is opening physical stores in open air centers, our top retailers are thriving in a competitive landscape, and even some watch list retailers are finding their footing.

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