Much of my past corporate life was focused on using technology to maximize some of the most valuable real estate in the world. I am not talking about Malibu beachfront or secluded sea side property in Maui. On a per cubic foot basis shelf space within high volume retail stores is more precious than beach property. Not surprisingly, retailers micromanage the utility of this space. During my corporate tenure, we were able to analyze and measure a product's "true costs" throughout the distribution chain. This wasn't an easy process,often involving identifying and quantifying hundreds of discrete activities.
In many instances, a group of seemingly similar products had strikingly different cost components. A loaf of bread produced and distributed by wholly owned bakery and transportation group often sits on a retail shelf next to another loaf of bread which has been delivered directly to the store by a third party vendor on a privately owned company truck. In the latter case, store employees may never touch the bread until it is scanned at a register at the time of sale, in the former example, dozens of company paid employees may touch the product during its creation, transit, shelf positioning and ultimate sale.
This single example highlights some of the variables required to understand a product's "true cost" and ultimately, "real profitability" to the retailer. Multiply these issues by tens and perhaps hundreds of thousands of items and you have a perfect storm of complexity; a problem seemingly perfect for modern computational software and hardware to help us resolve. This exercise is of great value even for companies not focused on traditional retail sales. Analyzing every aspect of delivering value to your company's customers can be quite eye opening. Many business fail due to a lack of true understanding of underlying fixed and variable costs.
Of course, identifying and measuring all the elements of the supply process is very different from the even more complex task of determining an optimal outcome (i.e. cash flow, net profit, total retail sales) and managing the variables to maximize the desired result. If nothing else, this conversation should disavow you of the notion that "profit" can be measured by simply subtracting retail from cost!
Back to the grains of sand on the beach, or should I say, nearly priceless store shelf space..... When analyzing a product's costs, and therefore profit contribution, the single greatest determining factor is how much "rent" a given product pays while sitting on a store shelf. Other inputs, while important, pale in relation to this charge. How do you determine a product's rental bill? Well, it is a function of volume (how many cubic inches) of actual shelf space an item consumes. And turns... How long does that tube of toothpaste sit on a shelf with the "meter running!?" This makes intuitive sense but it can create surprising results.
Seemingly profitable goods can become "loss leaders' simply by sitting too long and/or taking up too much precious real estate before you, your spouse, or your kids, are willing to trade cool cash for the right to own the product.
Why am I asking you to read this brief tutorial on modern product profitability? While this article may well make you look at your local supermarket or department store in a different light, I want you to reflect on changes taking place in traditional and virtual shopping arenas!
|Apple is #1! (Credit: Retail Sales)
By most standards, Apple Stores represent the most profitable traditional retail experience in the world at this time. Generating in excess of $5,600/ square foot in sales! Apple leads the world in yet another statistic! The company accomplishes this using an average store footprint of just 7,800 square feet! By way of comparison, Best Buy manages to generate just $831 with an average store square footage of 13,900! Twice the square footage and less than one fifth the sales! (Click on the nearby chart to see how other retailers fare in this key metric.)
It gets worse, or better, depending on your perspective. Apple enjoys relatively high profit margins. The company is, first and foremost, a hardware company. They also sell relatively few SKUs (stock keeping units). There are only so many models of iPhones; iPads, and MacBooks stores must stock and maintain. In contrast, Best Buy must stock a dizzying assortment of items to satisfy its customer base, many of which are generic enough that they must compete on price. Not so Apple, whose products are distributed through a highly controlled distribution chain with virtually no price competition. Generally, fewer SKUs equate to far lower handling costs and most importantly from a true profitability measure, fast inventory turns. It may be "nice" for the consumer to have Best Buy stock twenty different flavors of home routers, consumers love "choice," but Apple handles just one router, and can do so with far greater efficiency online and in store!
The retail road has forked. Online sales through virtual stores-- organizations with no public retail spaces-- the most notable of which is Amazon. Traditional retail stores providing "instant" gratification but encumbered with many costs and distribution challenges making them easy prey for online competitors whose efficiencies allow them to sell more variety at lower prices.
Finally the zebras-- retailers trying to leverage both online and traditional retail presences. This final path has its own challenges not the least of which involves competing with yourself even on pricing. WalMart is experimenting with the "never ending aisle" concept which rewards the nearest local store for online sales (encouraging employees to recommend the web site for products not stocked in-store rather than losing the sale entirely) and next day in-store pick up of online purchases (which is labor intensive and not ideally suited to the retailer's other strengths. Being a zebra may provide cover in the sahara, I am far less sure that this dual focus guarantees survival in the modern retail ecosystem.
One can argue each of these three retail philosophies each has various strengths and weaknesses. I leave this argument for another day. What I do find very interesting, and worth commenting upon, is a trend I see all three general formats adopting-- boutique sales often combined with a deal of the "hour" ever so vaguely reminiscent of K-Marts once iconic blue light specials!
Best Buy has recently announced that it is closing fifty or so "Big Box" stores while at the same time developing a new line of smaller footprint retail outlets which will carry a limited assortment of higher margin electronics. Clearly, Best Buy is being squeezed, becoming a "virtual showroom" for customers who want to view products before ultimately purchasing at the lowest possible price online through Amazon or another online "superstore" and retailers such as Apple Stores (and others) who have a laser focus on select, high demand (aka high margin), items. In many ways Best Buy is in the worst place of all, online and traditional retail locations carrying a wide range of low margin goods many of which still require specialized sales expertise, setup, and maintenance. They must feel like they are captured in a retail Alamo with Indians on every side!
Amazon is the epitome of online genius. Amazon has no expensive retail store real estate. They have arguably mastered the art of suggestive selling using only a web site and your inbox. The company "knows" synergistic items to suggest based on your walking through their virtual aisles. Once purchased, logistics is there business! Moving items from A to B with a minimum of human intervention and maximum efficiency allows the company to offer razor thin pricing undercutting all competition in the majority of cases. The brilliant Amazon Prime membership effectively gets customers to "pre-purchase" a year's worth of second day shipping (which also predisposes these members to look first to Amazon when purchasing). Most importantly, all of that very costly retail shelf space is replaced with highly efficient, inexpensive, warehouse slots. It costs virtually nothing to add another "department" to its web site or online Kindle Fire marketplace.
The biggest trend I see from this company isn't the addition of Netflix like video to its Prime Membership or the promise of color ink e-readers later this year, it is the growing attraction of its online boutique stores! Years ago Amazon acquired Zappos, a shoe store on steriods. Bezos and company decided to continue to run Zappos autonomously rather than roll its business into the larger Amazon organization.
Today, myhabit.com is getting a lot of buzz. This boutique is also an Amazon offshoot. Combining trendy deals with limited supply, myhabit.com has some of the feel of Woot and Groupon, but with the clout and pricing only a company like Amazon can provide. Boutique formats with focus appear to be the direction online and traditional retailers are moving towards. These venues make online shopping "fun." Liberal shipping and return policies makes the risk of online purchase virtually zero. (When was the last time you thought rumbling through your local Walmart or Kroger was "fun?" I know, me either and I helped create some of that "excitement" in another life!) Contrast this with a shopping experience at your local Apple Store. The cash register walks with you-- you can even use a convenient App to check yourself out with certain purchases. Even people walking into an Apple store with a damaged device seem to be smiling! Now that is magic!
Online, myhabit.com and others, give you a sense of urgency--purchase now or forever hold your peace! The genius behind these sites is Amazon (and others) are able to build there very own virtual mall. Amazon's mammoth offerings and backroom efficiencies effectively serve as the mall's anchor. Building boutique specialty shops such as myhabit.com "around" this anchor is easily achieved in cyberspace. In many instances, customers may be wholly unaware as to who "Oz" is behind the curtain. This illusion is far more difficult (and expensive) to achieve under the harsh light of your local shopping center.
How about jewelmint.com? Another boutique online store which offers deep discount shopping with a limited number items. I always thought translating jewelry purchases to the web would be a (very) tough task. Based on how women seem to react to this site, I believe there is a combination of style and value which translates well and provides an exciting experience.
J.C. Penney has hired Ron Johnson as CEO. Johnson is widely credit with many retail innovations at Apple including the Genius Bar. He has a real challenge! An old brand, Penney doesn't evoke excitement, or even a yawn, in my daughter's generation. If he can instill some "Apple magic" at this chain, he will be the CEO of the decade in many people's opinion! I think the days of big box traditional retailers are numbered (or at least their best days are in the rear view mirror). Traditional 50,000 square foot supermarkets are probably a fixture of our retail landscape. They are very efficient in many ways and serve a real, if unexciting, consumer need. I am far less optimistic about selling non-perishable, low volume (i.e. products with long purchase cycles), items in big format stores. The economics aren't there and the wolves are at the door!
How do you feel about the current state of retail? Are you willing to pay a premium for the ability to go down the street, find, and walk away with a purchase or is the convenience of shopping from your easy chair and paying substantially less, worth waiting a couple of days? Other than daily groceries, are there just some things you refuse to buy online? If so, why?
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Companies: Best Buy, Apple, Amazon
I have a long positions in $AMZN, $AAPL
This commentary is not meant as an endorsement of any company or to provide financial advice. If the author has any financial interest in any company mentioned at the time of this article’s posting, it will be explicitly noted. I welcome feedback and comments.