COLUMN-The bricks-and-mortar albatross: James Saft

Tue Nov 27, 2012 8:00am EST

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(James Saft is a Reuters columnist. The opinions expressed are his own)

By James Saft

Nov 27 (Reuters) - To understand why the retail sector will continue to be such an investment minefield consider just two phrases: Black Friday and Cyber Monday.

The latter, the mock tradition of buying stuff online when the boss isn't watching on the Monday after Thanksgiving, is emblematic of the forces challenging a retail industry much of which was built for a U.S-centered cars, parking lots and box store paradigm which makes less and less sense every day.

Black Friday began to be so called in the 1980s because it marks the kick-off of the holiday shopping season during which retailers are thought to move from the red ink of annual loss into the black of profit.

That such an insider term, the kind of language favored by analysts and investors, came into general use says a lot about the age of consumption and speculation which began in the 1980s. After all why should a shopper, other than one who thinks we can all get rich by buying things and investing in stocks, care about when a store moves to profitability?

But underlying the term Black Friday is a business model reality, which, once examined, poses real problems, especially given the impact of the Internet. Physical stores are not simply a combination of assets, labor and merchandise, they are systems, ones with a lot of sunk costs.

Why after all do stores even stay open during slack periods if in fact they only are truly profitable during the holiday rush and other peak periods? They do so because there are huge upfront costs to setting up a physical retail outlet and once you've made those investments in people, facilities and everything else, the economics dictate that you sweat those assets, work them as hard as possible in order to gain as much revenue as you can to recoup fixed costs.

Just as airplanes on the ground are hemorrhaging money for their owners, so are shuttered stores. And, to the extent that retail has an advantage over internet distribution, and there are real ones, it is in part speed and availability. If J.C. Penney starts closing on Tuesdays, or in September, they are training their customers to use the Internet, a bad thing for a retailer with a big physical investment.

As sales via the Internet grow and steal market share from physical retailing those fixed costs will only hang more heavily on businesses with large existing retail networks.

A GROWING SHARE

Black Friday and Cyber Monday made quite a contrast this year, and the data clearly points to a growing market share for virtual retailing. While footfall on Black Friday rose by 3.5 percent, according to ShopperTrak actual sales decreased by 1.8 percent to $11.2 billion. This may in part reflect the way in which mobile Internet access allows shoppers to use stores as display galleries, viewing merchandise in person but nabbing the lowest price available on the Internet.

In contrast to the retail till shrinking, online sales surged 26 percent to $1.04 billion, a record for the day. Tracker ComScore expects Cyber Monday online sales to hit a record of about $1.5 billion.

And it is not just over the holidays that online growth is outpacing physical retail. Data from the Census Bureau shows that online sales rose 11.8 percent this year through October, against a 5.5 percent gain in physical retail sales. With online comprising 8.6 percent of all sales that's significant, but as the sector grows the pain for retailers will become more acute.

Forrester Research predicts that U.S. consumers will increase online spending to $1,738 each by 2016, a 44 percent increase over 2011. Some of that surely will come from a growing pie, but much will come out of physical retail's market share.

Physical shopping won't ever end, and will always probably comprise a majority of retail sales. But the journey from the current cost structure and approach to one which is profitable and sustainable will be difficult. Managing decline is never fun and investing in it, with the rare but inevitable value bargains excepted, is even worse.

The growth of "pop-up" stores, which open in empty retail space for a short time, is emblematic of the industry's attempt to get in front of this curve. So too are companies such as Apple which have moved into vertical integration of distribution. If you both manufacture and distribute you can capture more of the profits, benefit from the exposure and advertising that a retail outlet represents and be in a better position to bear the fixed costs.

It works a lot better, though, if you can charge premium prices, as opposed to selling coats or books.

This is a big and long-running trend, and as such there will be huge variation of outcomes. Many will do well in physical retail but those who do will be beating the odds. (At the time of publication, Reuters columnist James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. For previous columns by James Saft, click on ) (Editing by James Dalgleish)

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