Pressures on stores could spell more online retailing

As a strategist in the Internet practice of retail consultants Kurt Salmon Associates, Chad Doiron stays current with how America shops. So when it came time for him to buy a new oven over Labor Day weekend, it wasn’t surprising that he joined the throngs he’s been watching in how he chose to execute that purchase.

Before he got into his car to drive to any home appliance retailer, he already knew from online research which models he would be willing to consider, their features, their prices, and whether they were on the floor for him to view. He ultimately narrowed his target to one store that met all his criteria and made the purchase there.

“We went to one location because driving to one store after another all over town all afternoon would not benefit us. In fact, it would cost far too much. We could have spent $75 on gas,” Doiron says.

Anecdotes such as Doiron’s abound. And that’s not the only trend in the larger economy that stands to change both consumers’ shopping patterns and how retailers serve up the shopping experience. The healthy profits enjoyed by many big-box chains are built in part on inexpensive labor, but there’s growing pressure on chains to improve workers’ compensation. And some business analysts also wonder if creeping interest rates and rising capital construction costs could be enough to put aggressive store expansion strategies on pause.

The bottom line is that rising costs on both sides of the cash register are putting pressure on consumers and retailers to be more efficient in their approach to commerce—and that the Internet channel is in line to be a chief beneficiary of that convergence. “The one area that really hasn’t felt much of a slowdown in spending happens to be Internet sales,” says economist Bernard Baumohl, director of The Economic Outlook Group. “When you look at the annual growth of retail sales, year over year, it’s been around 7%. But Internet sales have consistently been growing at three to four times that. It appears that Internet sales are somewhat impervious to the stresses and strains we are seeing in the household sector.”

The most visible factor affecting retail sales both online and offline is the rising price of a gallon of gasoline. A survey about shopping intentions conducted by online shopping engine Shopzilla at the end of July found that a third of consumers were planning to shop more online as a way to spend less on gasoline. That confirmed the results of a Shopzilla survey as gas prices rose following Hurricane Katrina last year and a similar survey by consultants Retail Forward Inc. earlier this year.

“Higher energy costs will be a factor that will help the online retailer,” says David Wyss, chief economist at Standard & Poor’s. While cautioning that the fourth quarter’s seasonal peak in online shopping could partially obscure the true effect of gas prices on web vs. store sales, he notes, “The money that people spend at the gas pump is money they don’t have to spend at the mall or online. But online is a more convenient way to shop and save gas. When people feel squeezed, they want to find a bargain. It’s a lot easier to find bargains on the Internet than by driving to the store.”

Rising labor costs
In addition to consumers’ desire to spend less on gas, Wyss and others note online and web-to-store sales will continue to get a boost from the increasing penetration of broadband connectivity into U.S. households. “As more people purchase more computers, as high-speed Internet access becomes more available around the country, and as wireless systems are set up, it’s natural to conclude that even as the economy slows, we are really not going to see the Internet show a comparable slowdown,” says Baumohl.

Consumer’s increasing adoption of the channel is just one advantage favoring the future of online retail. Another is that it’s little affected by another issue big-box stores have managed to hold at bay for years but are now being forced to grapple with: rising labor costs.

Federal efforts to increase the minimum wage would take it above $7, while some municipalities are passing ordinances requiring big-box retailers to pay at an hourly rate that’s even higher; in the case of Chicago, $10 an hour. Even though Mayor Richard Daley vetoed the City Council’s bill, observers say that’s not the end of the pay debate.

Baumohl cites second quarter Commerce Department figures showing that average weekly earnings—a figure that represents the earning of 80% of U.S. workers—were up 4.2% over a year earlier, but that adjusted for inflation, that’s an increase of only about 1.1%. While small, “It’s long overdue that households are beginning to earn more than inflation,” he says. He notes that one element driving the increase is “widespread criticism of companies that have been making huge profits, largely on the backs of workers who have been more productive, but are not getting their fair share of these profits.”

The expansion question
Rising labor costs have little direct impact on online retail, giving it a development advantage over the offline channel. Neither does another issue facing stores—how are they to approach a store expansion strategy at a time when consumers want to shop more online and spend less on gasoline and stores are facing rising construction costs?

The short answer is, it depends. While some retailers pursue store expansion on the basis of such factors as population density in a target market or even a gut feeling that it’s time to move into or expand in a particular region, larger retail chains more often have a very sophisticated formula for making those decisions. Store expansion strategies with such retailers typically evolve from annual revenue growth goals established at the top corporate level.

“If the corporation says it wants to grow 10% this year and figures it can get 50% of that from sales in existing stores, they know they have to add this many more stores to achieve their plans. Then they go looking for locations,” says Bob Antall, CEO of LakeWest Group.

Partly art, partly science, a sophisticated store expansion strategy at that point factors in demographics, market penetration, competition and real estate cost and availability, according to different recipes for success plotted out by different retailers, which in turn depend on the level of data about all of those areas available to the retailer. Home Depot, for example, spent its early years determining exactly what characteristics surrounding a piece of land would make it ideal for rolling out another store. “So early on, there was modest expansion, but once they had it figured out, they could literally roll out hundreds of stores,” says Jim Okamura, senior partner at J.C. Williams Research Group.

To their store expansion strategy, some retailers are now beginning to factor in the cost of achieving the targeted growth goal via the online channel versus store expansion alone. For some retailers, a business case can be made that if the retailer has hit a critical mass in the online channel, the same several million dollars to build a store could go toward a serious upgrade of its web capabilities, whether it’s a new platform, supply chain system, or other need, says Okamura.

More selective consumers
He adds that J.C. Williams already has conducted such modeling on behalf of retailer clients. “If the percentage of boost you get from the e-commerce value exceeds on an absolute basis what you would get in another store, at that point, you should think about decelerating the store growth strategy investment and investing on the e-commerce side, if you believe that growth will continue,” he says.

Okamura adds that’s a valid consideration for regional multi-channel retailers, or specialty lifestyle retailers whose stores are especially expensive to build, such as BassPro’s huge Outdoor World stores, for example. However, the math is much different for mass merchants and big box retailers, where a single Wal-Mart Super Center, for example, may bring in $100 million a year. “You’d have to have a lot more online business to offset what comes in from a store of that size,” he notes.

IRCE 2008 Conference Multi-Media CD-ROM

Consumers aren’t about to stop shopping. But given pressures on the household budget, they’re going to be more selective about how they go about it. Retailers can continue to grow sales and stay profitable—if they adapt to the new realities with a considered multi-channel strategy. “The retailers who are going to win are the ones that have visibility online and product in the store,” says Doiron. “We are helping our clients understand the value of the multi-channel shopping experience and trying to coach them on what that means in terms of merchandising strategy, logistics strategy and how they integrate online and in-store so it’s one presence to the customer.”

How that multi-channel experience translates will vary by retailer. A customer shopping at REI, for example, may be looking for technically detailed product information, with the expectation he can find it readily in whatever channel he uses. A Macy’s customer might place a higher value on broad assortment or inventory status—and consistency across channels, in the channel of her choice.

The web in the store
Forward-thinking retailers are getting added utility out of consumers’ increasing propensity to look on and shop the web by not only making it easier to research or close the transaction online, but also by offering in-store features and functionality similar to what consumers are becoming accustomed to online. In August, for example, The Container Store introduced shop-and-scan technology in its Manhattan store. Store customers using the GoShop Scan and Deliver service get a hand-held device they can use to scan from store shelves the bar codes of items they want to purchase.

Scanning the bar code brings up on the device’s screen a photo of the item (when available) and additional price and product information. The customer can select the items she wants, build a shopping cart visible on the screen, and carry the device to a special check-out area to complete the sale. An associate confirms the order and sets up delivery for a $15 charge. Because the system’s integrated with the store’s inventory database, the associate also can inform the customer of inventory status and delivery times at the point of checkout. Macy’s Manhattan store has a shoe locator service that uses handheld devices allowing the associates on the floor to call for and check the inventory status of shoe models and sizes without leaving the customer’s side.

Elsewhere, that sort of visibility into price, product and inventory information so readily available on the web interface is moving even deeper into a customer’s experience in the store. Doiron cites a Japanese apparel retailer that uses voice over Internet protocol in fitting rooms that leverages the sort of content available online. With a screen in fitting rooms, customers can see what the retailer has in stock in which colors, and using VOIP, have an associate bring it to them without leaving the fitting room.

Doing what it takes
Not only are such applications more efficient for shoppers, they’re potentially a better use of labor for stores as well. With a store associate only a touch of a button away, managers can more efficiently address the customer’s needs. That takes fewer associates on the floor. Store managers could put those associates to better use in tasks such as store recovery until they are called. In the case of applications such as Macy’s shoe locator, the technology puts more product information and sales power into the hands of associates while they stay with the customer, rather than forcing them to go in back to hunt down a shoe.

Does the success of such initiatives—or not—suggest that more multi-channel merchants will be weighing investment in store infrastructure against investment in Internet infrastructure and other technologies to which the web has accustomed shoppers, if current trends continue? As always, merchants will do whatever it takes to keep selling. “Clearly, they are going to be making sure that money is being spent to ensure they are driving customers into the stores and maintaining share,” Doiron says. “And increasingly, a percentage of that has got to be dedicated to online.”

mary@verticalwebmedia.com

E-retailing faces its own challenges

While e-retail is benefiting from some economic and consumer trends, it’s not impervious to the potentially adverse effects of others. For starters, with a larger portion of consumer spending shifting online, states will become even more eager to collect sales tax from online merchants, which would end an advantage banked on by many. And the flip side of rising gas prices causing more shoppers to buy online instead of driving to the mall is that fuel costs are going up for the shippers online retail depends on as well. For some online retailers, the sales tax and shipping cost issues are linked, with an imbalance between the two having potential negative impact on their margins.

Carriers such as United Parcel Service, feeling the pinch of higher fuel costs, have added surcharges for deliveries into certain areas, and some retailers are considering or implementing them as well. That leaves retailers with a choice: absorb those higher costs, or pass them on to consumers, which could make them less competitive with offline stores that don’t have to add shipping charges to the bill.

As a New York City resident, for example, David Wyss, chief economist for Standard & Poor’s, says that in addition to the retailer’s shipping cost, built into the overall delivery charge, he now pays a 95-cent surcharge on deliveries from online grocer FreshDirect. “95 cents on a $75 grocery order is not a big deal,” he says. “But at some point, maybe you start to think otherwise. Part of why we buy there is convenience, but part of it’s price also.”

Wyss adds that while shippers’ costs are rising with energy costs, it’s unclear as yet where the trade-off to be made among the consumer, the shipper and the retailer will settle. “There’s a cost to the individual of driving on the one hand, and the cost of distribution on the other. To some extent, it’s going to depend on the kind of goods involved,” he says.

Bernard Baumohl, director of The Economic Outlook Group, notes that online retailers and shippers have contractual arrangements that offer more flexibility on shipping charges. “Internet retailers may have to be concerned about the fact that shippers are gong to raise prices but they don’t have to be concerned with rising labor costs or higher real estate costs, so that makes them more flexible in their pricing strategy,” he says. “We haven’t yet seen to any significant degree higher energy costs showing up in Internet sales.”

Yet the issue is surfacing among individual online retailers, particularly in view of increasing pressure among states to collect taxes on online sales where they don’t already. Gary Imig, executive vice president of Sierra Trading Post Inc., in July told a U.S. Senate subcommittee hearing on the Sales Tax Fairness and Simplification Act that shipping costs paid by Internet retailers are in most cases bigger than the state sales tax charged by stores, and that having to charge state sales tax on top of shipping would make online retailers less competitive with offline stores. “In this day and age of ever rising fuel charges and postal rates, this will substantially impact our bottom line,” Imig said.

To the extent that consumer spending moves online, states will push harder to collect sales tax from online retailers. SB 2152—the Sales Tax Fairness and Simplification Act—would allow states adopting a streamlined sales tax structure to require out-of-state merchants—including online retailers—to collect sales tax on merchandise sold to residents of their states. And that would end an advantage enjoyed by online retailers and catalogers who can currently ship to out-of-state customers without collecting and paying sales tax to the state where the customer resides.

“It varies from state to state,” says Wyss. “You can ship to New York if you don’t have a physical presence in that state without having to charge the customer in that state sales tax. But states are becoming much more aggressive in defining what constitutes nexus.” That effort is supported by some multi-channel merchants forced to charge state sales taxes under laws governing nexus, and opposed by other online merchants that don’t have to charge state sales tax under current law.

Amid these sometime-conflicting trends, one thing already seems clear. “The rising cost of shopping will shift who the winners and losers are in retail,” says Chad Doiron, strategist in the Internet practice of retail consultants Kurt Salmon Associates.