• Retail

Wanna Go Private?

Week of June 17, 2019.
By Garrick Brown

The last few weeks have been full of news from the monthly blips of May retail sales (up) to consumer sentiment (down) to more closures (Francesca’s, Gap, Williams-Sonoma, J. Crew, TopShop, etc.) and a few openings (Michael’s, Versace, Burlington, et al). But I believe the most significant stories come from two publicly traded companies going private (Barnes & Noble and Hudson’s Bay Company).

With retail stock prices down almost universally, I anticipate more retailers to take advantage of this situation and go private. For example, in the case of Barnes & Noble, though their stock surged 30% upon rumors of going private, the deal price of $6.50 per share was still a far cry from their peak pricing of $30 in 2006. At $638 million, private equity firm Elliott Management got a deal. On the other hand, the Hudson’s Bay deal is less a sale and more a reclamation — with current shareholders and former CEO Richard Baker looking to take the company private. I see both types of transactions ramping up in the next year or so, but the former demonstrates something that I have been saying for the last few years: publicly traded retailers have been caught between a rock and a hard place by investor focus on the short-term.

First off, there is the challenge of the “retail apocalypse” storyline that has permeated the marketplace over the last four years. Clearly there are real challenges in the retail space, but this simplified narrative ultimately tells a dumbed-down story of eCommerce dominating bricks and mortar retail.

The reality is far more complex, and understanding that it is actually the convergence of multiple trends is key to explaining how we got here. It. Is also critical to understanding what works and pointing the way forward, especially for some of the brands that are currently in the crosshairs of these trends.

There are actually five trends at play in the challenges facing the retail marketplace today:

  1. Acceleration of newCommerce (eCommerce and omnichannel).
  2. Over-retailed marketplace.
  3. The rise of the discounters.
  4. Shifting consumer patterns (millennials spending differently than past generations).
  5. Outdated financial growth models from Wall Street and private equity.

Five challenges as opposed to just one may sound worse than just the newCommerce imperative. But some of these challenges are, in fact, major growth drivers, from the rise of clicks-to-bricks retailers to the strength of discounters to a new breed of chains focused on experience. While all of these trends are interrelated, the issue of an over-retailed marketplace came about as a direct result of the final trend on this list: outdated financial growth models. It’s this last one that I would argue is likely a bigger threat than eCommerce in the short term. But it is also the trend that was the most preventable, is the most correctable and holds the greatest number of lessons for retailers going forward.

We may be in the midst of a perfect storm of all of these trends, but the reality is that eCommerce alone is not necessarily the “lights out” threat it has been made out to be. And I don’t just mean to the categories it either can’t, or hasn’t, disrupted yet. This isn’t to diminish its power now or going forward. But the reality is that many retailers inadvertently helped to make it easy for online concepts to disrupt.

Unfortunately, it is the “retail apocalypse” narrative that the public has embraced as the truth and that includes the average investor. The result has been a black cloud hanging over nearly every retail category and most publicly traded retailers and REITs, whether or not their actual performance warrants it.

Dozens of retailers have experienced the same phenomenon in recent years. Shrinking market share and declining sales lead to falling stock prices, “smart money” investors and top analysts calling for fleet rationalizations (closure of underperforming stores), retailers responding appropriately and making closure announcements… and then, stock prices falling even further as the average investor gets even more skittish. It’s a damned if you do, damned if you don’t environment.

Retail CEOs have been trapped between these forces. Worse yet, this is all transpiring against a backdrop of operating in an environment of reduced profitability and greater stock market volatility at a time in which greater investment into building eCommerce infrastructure AND elevating the consumer in-store experience are EQUALLY imperative.

Going private means CEOs can navigate this minefield with much more flexibility and stability. They can make the hard choices and bold moves that, while being imperative to the long-term survival of their companies, likely would not be stomached by the average stock investor looking for short-term rewards.

The only problem with going private is that it likely means taking on a significant amount of debt to buy back stock. For already highly leveraged chains, such a move in and of itself may simply not be possible. For others, it could create a whole new set of problems in servicing that debt.

But this all highlights the issue of outdated financial models that I would argue are actually a greater threat to retailers today than eCommerce itself and that have been responsible for more damage. To understand why, all we have to do is look back 25 years. Retail was on a roll in the 1990s. Once the 1991 recession was out of the way, the economy entered a decade-long, tech-fueled expansion that was among the strongest in U.S. history. Consumers were on a buying spree — they also were on a debt binge (often refinancing homes they thought would never reverse in value in order to fuel even more spending). Developers couldn’t build power and lifestyle centers fast enough. Most malls were still packed.

While eCommerce was a new phenomenon, at the time it shared more in common with the existing channel of catalog sales. Still, most in the business knew that this channel was going to grow and it would be distinctly different. The power of online “catalogs” promised to reach far more consumers far more quickly and cheaply in the internet era. But delivery times still ranged either from a few days, at best, to multiple weeks. The emerging channel of eCommerce wasn’t about convenience yet. The value proposition to consumers for digital retailers was one of value. Cheaper industrial rents, reduced labor costs and fulfillment centers located in sales tax advantaged states meant online retailers could undercut the prices of their bricks and mortar competitors. But consumers still couldn’t beat the convenience of heading to the local mall.

Very few traditional bricks and mortar retailers began investing heavily in eCommerce infrastructure before the 2000s. And, those that did rarely invested more than a fraction as much as what they continued to spend opening additional stores.

The threat at that time to most publicly traded mall-based retailers was the rise of big box discounters. Walmart, Target, Costco, BJs, Sam’s Club and dozens of other low-price retailers were popping up in big boxes across the country. Their value proposition to consumers was simple; value. Remember this; convenience, value or experience are the three things that drive consumers to a store or shopping center. It’s not a purely “one or the other” choice. But this is where so many of the retailers that have suffered most in recent years made their biggest mistake.

At the height of the big box era, many mid-priced retailers made the mistake of confusing who their real competitors were and what their own value offering to consumers was. Instead, they got lured into the trap of deep discounting and going head-to-head on value against competitors they couldn’t possibly beat.

Discounting is about size and scale. Low prices are about immense buying power, tighter margins and greater “efficiencies.” The challenge of competing against discounters is that unless you have similar economies of scale, you are almost certain to lose in a price war. Even smaller discounters often lose the battle of economies of scale with larger fish, so how could service-based models in the middle hope to compete?

Remember, while upscale and luxury retailers haven’t been without some challenges in the current era, they have almost universally performed better than their mid-priced competitors by sticking to their service and experience focus. Meanwhile, the challenge of value-oriented consumers is that their loyalty is to low prices. Retailers focused on the consumer experience build more loyalty and greater prestige for their brands, even if their sales volumes may be dwarfed by the biggest value brands.

This is where mid-price retail made its biggest errors. At the time, too many stuck with the convenience part of their model (huge store fleets) and, rather than focus on that which differentiated them from the onslaught of discounters (experience), they chose to compete on value.

In the race to compete on price, the consumer experience ended up suffering. Reinvestment in stores fell. Retailers centralized buying — leading to more homogenized offerings, commoditization and more disconnect at the local level with consumers. Homogenization meant the same store windows and the same goods from coast to coast. Stores became boring.

Worse yet, investment in workers fell. Customer service is the first, and most important, form of experiential retail. Staff in retail stores were never going to get rich, but retail used to offer livable wages to workers. Commission salespeople at some chains used to be able to earn a comfortable middle-class living. But most retailers got rid of commission sales — despite the fact that those were usually among their best and most knowledgeable salespeople. Most chains flattened wages. Through “synergies,” they cut staff; resulting in fewer opportunities for promotion. Talent suffered, worker motivation faltered. Retailers that once had a strong service offering to consumers now increasingly seemed to offer no service, bad service or self-service.

As the in-store retail experience suffered, shoppers tempted by value became less loyal to brands that were now barely distinguishable against discounters, save for the fact that their prices were still higher. It was a battle that the middle was never going to win, and by engaging in it, mid-priced players eroded what had made them popular.

And, as to that other primary offering… convenience? It’s pretty hard to find anything more convenient than ordering goods while sitting on your couch and receiving them by the next day, if not sooner. It varies by category, but convenience is now the domain of eCommerce. The answer then, as it is now, was not direct warfare with discounters but asymmetrical warfare focusing on building their strengths. The answer then, as it is now, would be to focus on experience and to magnify and exploit those differences. But most chains did the opposite.

I don’t want to underplay the challenge mid-priced retailers were facing from discounters at the time. Value retailers were undoubtedly going to seize considerable market share. While the trends of rising income disparity and a middle class shrinking at the fringes were not as clearly visible as they are today, they were already starting to impact consumer decisions. The middle ground, even then, was beginning to shrink.

A few smart retailers realized that the way to continue to grow would be to open or expand value oriented banners that were clearly differentiated from their main brands. Nordstrom Rack is a huge success story, as is the Gap’s Old Navy. Some luxury brands made the mistake of not clearly differentiating these lower price banners. Expanding factory outlet stores made sense, but when these outlets began to rival their own primary banners in numbers and also didn’t clearly differentiate the goods they offered, they ended up cannibalizing their full-line stores and training their core consumers to never pay full price.

Here is the challenge. If you were a retail CEO in the mid 1990s — when retail sales growth was exploding — would you be able to implement the moves that would have prepared your chain to not just survive, but thrive, a couple of decades later? Especially when the old model was still working? Remember that the mandate from investors is always one of growth; with the short-term, sadly, almost always beating out the long-term.

Imagine going to a board meeting as a retail CEO in the 1990s and, instead of laying out a strategy for aggressive expansion in a strong economy, you felt that shrinking retail footprints would be the best move for long term viability.

Imagine that, instead of advocating for the “efficiencies” needed to cut prices and compete with the discounters, you did the opposite. That you suggested increasing reinvestment in stores, hiring the best talent and not chasing value-oriented consumers. Imagine telling those investors to accept losing a certain amount of market share to discounters. That it was more important to maintain your core consumer and focus on the upper end of the economic spectrum where growth was modest in comparison.

And, lastly, imagine the reaction if you suggested that instead of adding new stores in one of the most robust economies on record, that you wanted to reduce your store fleet and invest heavily in the emerging new channel of eCommerce?

You get the picture. You probably would have not retained that retail CEO position for very long after that meeting. That said, even though much of the writing was already on the wall, you’d have had to been a bit of a visionary to have seen that far ahead in the mid- or late-1990s. The real question is why so many companies continued to make those same choices well into the 2000s? By then, it was already clear that retailers in the middle were losing on the value side. And, eCommerce was only gaining momentum. You were already struggling on the value side and your offering of convenience to consumers was about to be disrupted. This meant that the way to remain competitive in the future was to focus on experience.

To do this, you would have to reinvest in stores, personnel and the consumer experience in a big way. And, you would have to start rationalizing your store fleets, IE closing locations. But, even until the financial meltdown of September 2008, investors still demanded expansion — not contraction and reinvention.

There are a lot of brilliant people on Wall Street and in private equity who understand these challenges. The real problem is that the model for the average investor tends to look only at the immediate term — especially if current models seem to be working, even if they may be sowing the seeds of destruction for later.

So what does it mean? It’s not enough for publicly traded retail CEOs today to be extremely talented and competent. They also need to be visionary, evangelical in their message and extremely lucky in being able to change the mindset of investors. And so, it’s no wonder retailers would want to go private. Let’s just hope that the amount of debt they have to incur to do it doesn’t prove just as challenging as the limitations of investors whose focus on the future is limited to the next quarterly report.

This post is commentary from the latest edition of our Cushman & Wakefield Retail Newsline, which you can subscribe to for free by emailing garrick.brown@cushwake.com.

Garrick Brown serves as Vice President, Retail Intelligence for Cushman & Wakefield throughout the Americas. He is one of the leading retail real estate analysts in the United States; speaking frequently at industry events and regularly quoted on retail matters by the Wall Street Journal, the CBS Evening News, NBC News, CNBC, National Public Radio, Women’s Wear Daily and dozens of Business Journals and other industry publications.

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