sears

Recent store closures involving major retailers like Sears and Macy’s are adding to the belief among some that the days of going to a store to do your shopping are numbered and that most shopping will be done from your home computer or cell device.

But the reality is that the traditional brick-and-mortar retailer is not going away anytime soon. Annual e-commerce sales growth has been averaging around 15 percent for some time now, currently representing around 20 percent of total retail sales (excluding low online penetration categories like auto, gas, food service and food retail). And while e-commerce growth could continue at a similar rate over the next several years, total penetration is expected to trend to around 30 percent over the next few years. In other words, 70 percent of sales will still be made in a physical store.

Click here to see the chart, “Online Sales Penetration”

Customers like to shop in brick-and-mortar stores for a variety of reasons. They may need their products immediately, they may appreciate the store’s service, or they may prefer making their shopping selections by seeing or touching the product in-person. They may also not want to risk getting the wrong product, damaged goods or a shipping delay from an e-commerce order. Finally, shopping, to some extent, also remains a desirable leisure activity for many consumers.

However, even if e-commerce demand growth accelerated significantly from current growth rates, distribution infrastructure may not be able to handle increased volumes. Fulfillment and shipping logistics are much more complex when considering sending boxes with just a few items to individual homes, versus larger amounts to centrally located stores. These limitations will impact e-commerce growth rates, especially in more logistically challenging categories like grocery and large-scale consumer electronics and home improvement.

Beyond Amazon, much of the e-commerce share gains have been made by chains with a physical presence, like Wal-Mart, Macy’s and Best Buy. These companies have been able to leverage their existing brand identity, inventory position and free cash-flow generation to develop robust online businesses. Companies with the ability to invest are developing omnichannel models, which provide customers with multiple channels through which to shop and receive inventory. Sales for businesses with good omnichannel models can stay within the company’s ecosystem; however, the cost to operate these models is greater than operating a successful brick-and-mortar business. As a result, profitability has declined at even the largest companies.

While brick-and-mortar retailers are not going away, you’re not likely to see more new stores pop up either. Virtually no categories of retail are expanding square footage, while some segments, like mall-based department stores and specialty apparel retailers, are seeing the opposite take place. In fact, we expect square footage in many categories to decline. We’ve seen this in areas like consumer electronics and office supply, with more recent aggressive closures by department stores. The pace of closures is likely to accelerate over the next few years.

In addition to the cost of omnichannel models and the lack of square-footage expansion opportunities, retailers face the challenge of price transparency, which has resulted from the rise of e-commerce models. Customers in a store can easily price-compare goods with their smartphone, which limits physical retailers’ ability to increases prices.

Insulated Retailers

E-commerce is not likely to penetrate in-store sales for home improvement retailers. Neither Home Depot and Lowe’s, for example, derive much of their sales from online and will not likely do so for the foreseeable future for the simple reality that customers still have to come into the store for large nondeliverables like lumber and big-screen TVs. (No one wants a washer-dryer left under the welcome mat).

Food retailers, despite the advent of services such as Peapod and Fresh Direct, are also not likely to see their sales dramatically eaten into by e-commerce for a host of different reasons, among them the temperature-specific issues inherent with cold items. And while drug retailers have seen a significant change in growth outside the internet with 15 to 20 percent mail order penetration, this penetration seems to have peaked a few years ago and may actually be on the decline.

Discount dollar stores are another segment that will continue to see a sizable number of customers peruse their aisles because they enjoy the treasure hunt appeal of visiting a discount store. What’s more, this is another model that cannot afford the supply infrastructure to move over to e-commerce. Another insulated segment is auto parts retailing. Simply put, if your car breaks down, you need a new part now and can’t afford to wait for one to be shipped to you in the mail. Some categories, like crafting and party supplies, sell products that the customer wants to see in person, limiting online penetration.

Vulnerable Retailers

Not surprisingly, the largest category of focus has been the traditional mall. But it should be noted that for department stores and specialty retailers, their challenges extend well beyond the advent of online incursion. They are also grappling with lack of fashion excitement and momentum, the divergence of discretionary spending toward services like travel, while the customer’s “quest for value” has driven significant market share to off-price retailers like TJ Maxx, Ross Stores and Burlington — and fast channel retailers such as H&M and Zara.

Office-products retailers, which have seen market share shift online in addition to weakness stemming from the reduced use of traditional office products from technological innovations, are likely to continue to close stores and concentrate on other selling channels. The consumer electronics category has already experienced a significant reduction in store count through bankruptcies by RadioShack and Circuit City in recent years, leaving Best Buy as the only remaining national player.

What Retailers Could be Next?

Vitamin retailers such as GNC appear to be losing resilience to the e-commerce channel due to a proliferation of information about the category online, and increased product supply in the online channel as well as from brick-and-mortar competitors like supermarkets and discounters. The sporting-goods and pet categories may be ripe for a reduction in square footage given e-commerce encroachment. We’ve already seen several large sporting-goods retailers declare bankruptcy and close stores.

Conclusion

While e-commerce continues to take share of overall retail sales, there is still a place for brick-and-mortar retailers. In fact, the vast majority of purchases are expected to be made in-person for the foreseeable future. The best protected retailers are those in more insulated categories and those with the cash flow and liquidity to invest in robust omnichannel models.

David Silverman is senior director at Fitch Ratings.

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