By Cari Bunch and Madison Riley
The line on retailing in this ravaging recession is that the winners are the discounters, warehouse clubs and other price choppers while the losers are the full-price chains and sellers of luxury goods. For sure, it’s a nice, tidy story with numbers that appear to confirm it. Just compare Wal-Mart’s same-store December sales (up nearly 2%) to Neiman Marcus’s (down 27%) and the logic seems evident. At the very least, it has the major department store chains, upscale apparel shops, high-end grocery stores and other merchants of “extravagance” wondering if they have a future.
But the tale on retailing’s winners and losers is not as simple as that, and merchants that act on this logic will put themselves at risk. Based on Kurt Salmon Associates’ new study on the performance of more than 100 major U.S. retailers over the last 10 years, we believe there’s a much different story at work here. The moral is this: If all a retailer does is cut costs and throttle back expansion, it won’t emerge from the recession any stronger and perhaps even survive. While cutting waste is indeed more essential than ever, it is hardly sufficient.
That’s because the recession has only deepened a fault line that has been fracturing U.S. retailers since the mid-1990s. That’s when the Internet began giving consumers a powerful tool for finding the best bargains in seconds, whether online or in a store. While Internet sales were only 3.4% of the total U.S. retail pie in 2007, 15% of Americans go online every day to research products before they buy them. In fact, 55% of Americans with Internet access at work (73 million) planned to shop online for the 2008 holiday, according to Shop.org.
This means consumers are much more efficient in their shopping than they were 15 years ago. By researching more of their purchases online, they make far fewer store trips that force them to settle for the price at hand because they don’t have the time to find a better deal. Increasingly, this trend has been spelling disaster for retailers selling national product brands at or near full retail price. Their customers — particular in this recession — have been flocking to the discounters, off-price outlets, warehouse stores and Internet shops where they can purchase these items for far less. All to say, the prevailing business model for retailers that largely sell national product brands at or near full price — and which don’t have the scale and cost structure to compete on price — is rapidly becoming obsolete. And while the current recession didn’t start this trend, it has certainly accelerated it.
What does this mean for retailers that can’t go toe-to-toe on price against the Wal-Marts, Costcos and Amazon.coms of the world? Our research found they will have no choice but to compete on the opposite end of the spectrum from the price players (i.e., by offering truly distinctive and compelling products and customer experiences.) To understand this spectrum, consider mapping the retailing landscape on two axes: the uniqueness of a merchant’s products and how engaging their customer experience is (i.e., the environment in which its shoppers learn about, sample, purchase and use its products.) Retailers on the low end of the uniqueness and experience scales are most discounters, warehouse stores, off-price sellers, and convenience store chains. The most successful of these (e.g., Wal-Mart, Costco, TJX) stock national product brands, buy them in huge quantities, and sell them at rock-bottom prices. To keep their prices low, they provide a bare-bones customer experience: efficient but no-frills. You are not likely to get a personal shopper at Wal-Mart, Costco or Marshalls anytime soon.
On the opposite end of the spectrum are the retailers offering distinctive products and experiences. These merchants are playing a quite different game, and even in a debilitating recession they are doing well. They don’t compete on the basis of rock-bottom prices and transactional customer experiences. Instead, they sell a multitude of compelling products that can’t be found at most other retailers (exclusive national brands or their own brands). As important, they provide an engaging customer experience, one that highlights the distinctiveness of their offering and makes customers feel special. Aeropostale is one such retailer (same-store sales up 8% in 2008, including a 12% increase in December). Others include: PetSmart (double-digit revenue and profit growth over the last five years); Coach (a nearly 40-fold increase in earnings in the last 10 years and a 36% operating margin in the last quarter of 2008); Apple (from zero to $6 billion in annual sales in the last seven years); Best Buy (a $40 billion giant that has steadily taken share from arch-competitor Circuit City, which is now in liquidation); and Trader Joe’s (whose sales have more than tripled to $6.5 billion since 2003, according to grocery-industry estimates).
All of these retailers have gotten serious about designing compelling products that can’t be found at other retailers. In other words, they have “vertically integrated” themselves by getting into the product business. However, none of them owns manufacturing plants; they contract that out (even computer and electronics “maker” Apple). They are retailers that “act vertical” rather than “are vertical.” But that’s just the first big way they differ from the price and convenience players. Act-vertical retailers don’t stop at designing their own products. Some of the most unique and profitable “products” sold by PetSmart, Best Buy, Apple and Walgreens are not hard goods at all. They are services that help customers use the retailer’s products and simplify their lives. PetSmart, for instance, generates 10% of its revenue from pet hotels, vet clinics, pet grooming and other services. Six percent of Best Buy’s sales come from installation and computer repair. Walgreens has been fast expanding into health clinics. In addition, these retailers provide truly distinctive customer experiences, ones that go far beyond efficient checkout or helpful store associates. Those experiences help demonstrate the superiority of these retailers’ offerings.
Acting vertically, as these merchants do, is becoming the fundamental way for retailers to avoid getting sucked into the black hole of price competition. It is how Target has been able to thrive in the same segment as Wal-Mart over the last decade while numerous other discounters have disappeared. Target offers an upscale twist to the typical mass-merchandising offering and experience. We believe it must raise the bar even higher on product uniqueness and experience to escape falling in the black hole of price that Wal-Mart and the warehouse stores have spawned.
Thriving as an act-vertical retailer is not easy. It demands capabilities that most retailers do not have – particularly retailers that have focused on selling national product brands or private-label knockoffs. Here are some capabilities retailers need to act vertically:
1. Market research that defines emerging customer needs and product opportunities. Research that PetSmart conducted in the late 1990s opened its eyes about how critical pet services were to pet owners. Aeropostale employees travel extensively to see what its core young teen segment is wearing.
2. Extensive consumer testing that reduces the risk of product innovation. Coach spends $5 million annually on such consumer research, including 70,000 in-depth interviews.
3. Product design and development that balances creativity and commercial appeal. Coach and Aeropostale make sure the quants don’t dominate the design creatives.
4. Tight relationships with sourcing vendors that enable manufacturing to scale up quickly and quality to be maintained. Coach works directly with leather suppliers to ensure its handbags meet its exacting standards.
5. The design and execution of a consistently engaging brand experience across shopping channels — stores, catalogs, and the Web. Apple organized its stores (which have the highest per square foot sales in retailing) not by technology categories but rather by how customers use them. Its 247 stores group hardware, software, accessories in sections such as music, movies, photos and children.
6. Inventory-management capabilities that can shift products to the places of greater demand. That maximizes prices.
7. Marketing must showcase how the retailer’s offering is truly different and show why it’s fundamental to the customer’s lifestyle.
The recession has not decimated these retailers. They are more than holding their own — despite not being the biggest bargains in town. Their secret — how to create truly distinctive offerings and customer experiences that consumers cannot find anywhere else — is one that many other retailers must learn quickly.
Cari Bunch and Madison Riley are partners with Kurt Salmon Associates, a premier retailing, consumer products and healthcare consulting firm.