HAS EXPANSION BOOM FINALLY BROUGHT RETAIL TO SATURATION POINT?
Byline: Dick Silverman
NEW YORK — What happens when sales per square foot tumble, yet retail square footage skyrockets?
Analysts and observers say retailers across the nation soon will find out. And the results may be ugly.
American retailers, after some retrenching in the early Nineties in the wake of retail bankruptcies and closures, have been on an expansion binge the last few years, opening new sites ferociously. But many question whether market conditions really warrant such growth.
As Bob Mettler, president of merchandising at Sears, asserted, “The oversaturation of retail space outstripping demand continues to plague the industry.” Mettler said retailers always pay the price for oversaturation.
Wall Street analysts were also keeping their eye on how Monday’s big drop in the stock market might affect retail expansion plans.
Allison Malkin, director of SBC Warburg Dillon Read, said in the worst case, it might curtail buying by upscale consumers who had fueled the pickup in purchases. She said the marketplace may be overstored, but with unemployment low and wages up, consumers still should remain confident, unless there is a sustained downturn.
Malkin added some U.S. manufacturers could benefit from the Asia currency decline and pass along savings in production to consumers.
Susan Silverstein, vice president of Nation’s Bank Montgomery Securities, claimed reverberations from Asia could affect consumer spending and retail activity. She said if the stock market fall is a precursor to an economic slowdown, “then we’re in for a lighter 1998, and we’d position ourselves as such.”
“Retail should keep in mind both inventory positioning as well as the stores they want to open up that are in the pipeline, and just be conservative in their outlook,” Silverstein said.
Meanwhile, a survey conducted earlier this year by Ernst & Young revealed that while retailers are embroiled in oversaturated markets and struggling with tightening margins, they still plan to open five times as many new stores as they will close.
“While recent sales figures have been encouraging, consumer spending patterns don’t favor retailers,” Ernst & Young wrote in its survey analysis. “Store expansion will continue despite the economic warning signs.”
“It does not come as a shock to us that the growth in surplus retail space has been countered by an increase in the number of retail failures,” Bear Stearns analysts Dana Telsey and Donna Leong stated. “Consumers only have a finite number of retail dollars to spend in an increasing number of retail stores.”
A Bear Sterns report, which came out before this week’s U.S. financial market reaction to the Asian currency problems, also contends retailers will regret the rush to expand, stating: “We believe there is a glut of domestic retail space.”
The study reveals there is almost 19 square feet of retail space for each person in the U.S. today, a dramatic increase from just 5.3 square feet per capita in 1964.
F.W. Dodge, which tracks new construction, reported retail startups hit a new high in 1995, representing a whopping 263.2 million square feet of new space. And last year brought another 233.2 million square feet, much more than in 1992 or 1993.
“Retail formats succeed or fail much more rapidly than in the past, increasing the chance that stores will have to be closed or altered to survive,” said Bob Untracht, Ernst & Young’s national director of retail and consumer products industry services.
The Ernst & Young study showed serious skepticism about future results. While 90 percent of respondents said they felt the five-year outlook for their own firms was bright, only half predicted a positive future for retailing overall. And they also expect occupancy costs to rise over the next five years.
The respondents, who averaged 230 locations with leases of 25,000 square feet per site, revealed:
Five times as many stores will open as close in 1997.
Apparel and accessories retailers plan above-average expansion.
Sixty-seven percent of retailers plan “significant” store expansion in the next two to three years.
While new stores continue to sprout, dark clouds hang on the horizon. Studies show consumers have changed their buying habits and are concerned about inflation, rising interest rates and debt, while personal bankruptcies and credit card delinquencies have soared to record heights.
While retail square footage has galloped along at an astonishing pace, sales per square foot have plummeted. According to Management Horizons, a consulting division of Price Waterhouse LLP, sales ratios have slid dramatically in the last 20 years, from as high as $197 a square foot in 1978, down to $181.34 in 1988, to approximately $160 last year.
Apparel’s share of consumer spending also has declined steadily. In 1980, it represented as much as 5.2 percent of consumer spending, but by last year, had dipped to a low of 4.4 percent.
Irwin Cohen, chairman of Deloitte Touche’s Trade Retail Group, claimed the significant decrease in sales as retailers expand poses a strategic dilemma.
“On a macro basis, there’s too much square footage; on a micro basis, it’s grow or die,” Cohen said.
The National Retail Institute’s 1996 edition of “Retailing: A Mirror on America” noted more than 77,000 stores have closed since 1991. After dropping 24 percent to 12,602 in 1994, the overall number of retail failures rose 3 percent to 12,945 in 1995 and increased 3.7 percent to 13,426 failures in 1996.
New apparel stores are a particular risk, Leong and Telsey warned. The apparel and accessories markets had 2,224 failures in 1991, 2,419 in 1992, 1,990 in 1993, 1,491 in 1994 and 1,631 in 1995. All in all, the apparel industry suffered through 125 failures per 10,000 businesses in 1995, 67 percent higher than the overall average retail failure rate.
The NRI noted that despite pessimistic market conditions, retail expansion rolls on. An average of 10 new regional malls will open each year for the rest of the Nineties, compared with an average of just seven new malls during the decade’s first half, NRI stated.
“With the scarce availability of underdeveloped prime retail space, malls are being built within a 30-minute drive of each other in areas where the population is not large enough to support multiple malls,” the NRI report said.
As more malls open, bigger chains feel compelled to have a presence and are swayed by attractive rent and lease terms. But the addition of more shops cuts into comp-store sales.
“With new stores cannibalizing sales from old stores, is there any wonder that sales trends are weak?” Bear Stearns analysts asked.
“Not only are malls being built at an accelerated pace, but planned project size also is increasing to 800,000-plus square feet, or 98,000 square feet more than the average size over the past four years. We do not believe that mall sales, which have been increasing at an average of 5 percent per annum since 1990, can maintain this space for the remainder of the decade.”
They predicted sales gains would slow to just 3 percent.
Doug Eldridge, principal consultant with Management Horizons, observed retail expansion has run somewhat unchecked.
“It’s not unusual to see a closed supercenter because someone went out of business, and right across the street you have a brand new one,” said Eldridge, noting it often costs companies less to build new sites than to renovate old ones.
Part of the urge to grow is to keep in step with competitors’ new locations, he said.
“It’s not unusual to drive down a strip and see three competitors in a row,” Eldridge said. “They’re sort of thinking, ‘If they’re there, we have to be there, and we have to slug it out!’ If you’re going to grow, you need to get out there and show how you can compete.”
He said the result will be clear winners and losers, and the losers will leave a trail of empty buildings.
Mettler said Sears chooses to examine opportunities in urban centers, many ones that other retailers have vacated, “and we’ve been very successful in what we’ve opened.” He said Sears maintains a well-planned expansion strategy that considers both sales potential and community response.
“It’s a strategy that’s aggressive, but that has a point of view about where we are and how we compete,” Mettler explained. “We’re not interested in opening stores just for store count. We’re going to build where we make money; we’re not interested just in volume.”
Mettler said Sears plans a second store in Brooklyn, where one of its best-performing sites in the nation is located, and said the chain has found “tremendous success” with new stores in Queens, N.Y., and Oakland, Calif.
The pressing expansion issue will be a focus of the 1997 International Council of Shopping Centers conference in Atlanta, Nov. 3, which will examine “Overcapacity in retail space: What are the issues and answers?”
Discussing the topic will be Michael Giliberto, vice president of J.P. Morgan Investment Management; Leslie Oringer of F.W. Dodge Market Analysis Group, and Walter Salmon of the Harvard Business School.
Giliberto, an economist who heads real estate research for J.P. Morgan, said investors always like to see more supply.
“There are a lot of places in the U.S. where there is very rapid economic growth and they need shopping centers,” he said. “The problem is, you can’t lift them up from where they are now and move them someplace else.”
The Ernst & Young 1997 retail survey found many retailers had no retail strategies, even though they planned to open more sites.
“Although real estate historically represents one of the retail industry’s highest fixed costs, it apparently receives less-aggressive oversight and management than most other businesses,” the survey reported. “Retailers are needlessly exposing their businesses to serious financial risk by failing to adequately manage existing retail estate assets or strategically plan for future real estate needs.”
The study stressed that while most retailers believe real estate plans are viable for only up to five years, 73 percent of locations have leases of an average 13 years.
Most retailers said they intend to increase store formats and expand territorially, despite reports of declining consumer purchasing power.
In the Retailing 2005 study issued by Management Horizons, projections about retail overdevelopment were pessimistic.
“The era of green-field expansion is long gone, replaced by an era of market-share battle,” the study said. “We will see slow or negative growth in most channels. Above-average rates of growth will of necessity come at the expense of another competitor. The development of retail space has long outpaced the growth of consumer demand. We now have significantly more retail square footage than is needed to service the population profitably.”
Management Horizons said there just is too much square footage chasing too few customer dollars. It predicted, in years to come, “many more stores will close to bring supply back into equilibrium with demand.”
Department stores, it noted, had been “reinvented, reengineered, reinvigorated and re-formed,” yet they are “not growing and probably won’t for the foreseeable future.”
Retailing 2005 projected department store sales would rise only 0.8 percent annually, which would represent only 0.5 percent after accounting for almost no inflation. That compares with 2.4 percent growth, or 2.2 percent after inflation, for the past several years.
Management Horizons stated that while apparel and accessories store sales rose slightly during the last half of 1996, “the overall trend for the last several years has been dismal — not just in terms of sales growth, but especially profitability.”
In 1986, stores specializing in either women’s or men’s apparel accounted for 25.8 percent of all consumer spending on apparel. Today, it stands at 18.6 percent. By 2001, Management Horizons believes it will dip to 15.1 percent.
“Over the next two years, a slower-growing economy will play the primary role in restraining demand for apparel,” the study stated. “In addition, apparel retailers will find themselves competing not simply with other retailers, but with various lifestyle-oriented goods and services.”
Eldridge of Management Horizons stressed much of the expansion glut is created by publicly traded firms pushed by shareholders.
“With public companies, growth is an imperative,” he said. “If you look at them, they can be successful by growing without accumulating a lot of debt. Public companies’ growth covers a multitude of sins, particularly on Wall Street, and the demand to grow is driving a lot of expansion.”
Dana Eisman Cohen, vice president and research analyst at Donaldson, Lufkin & Jenrette, said, “There’s tremendous pressure on the publicly traded companies to continue to grow. In sectors like apparel, where there’s been much more difficulty, there’s less focus today than three to four years ago.”
Lee Backus, senior vice president of Buckingham Research Group, contended that while expansion continues, many retailers, particularly privately owned firms, are closing doors and consolidating. Publicly traded companies are compelled to show growth, “and they are certainly opening a lot of stores, but there are a lot of private companies going out of business.”
“Even outlet store growth has slowed dramatically,” Backus said. “The only ones you hear about are the ones expanding; you don’t hear about the ones that are closing. Everybody looks at what the public companies are doing. But to get the whole picture, you have to look at the private companies as well. The information just isn’t available.”
Backus said expansion and store closings have resulted in survival of the fittest:
“It’s kicking out the weak players, and I think that’s good for the marketplace.”
This article is part of a continuing series from Strategic Information Services (SIS), a division of Fairchild Publications that provides research-based information to the apparel industry.