Are Retailers Facing a Coming ‘Tsunami’?

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Wharton's Peter Fader and Columbia's Mark A. Cohen discuss the recent spate of retail bankruptcies and closures.

The retail industry seems to be facing one of its worst crises in recent times. When Payless ShoeSource on Tuesday filed for Chapter 11 bankruptcy protection, it became the 10th retailer to do so in roughly the first quarter of this year. That happens to be the highest number of retailer filings for bankruptcy protection since 2009, when 18 retailers did so for the entire year, according to a CNBC report that cited data from consulting firm AlixPartners. Also this week, premium lifestyle goods retailer Ralph Lauren announced that it is closing down its flagship Polo store on Manhattan’s Fifth Avenue.

Wharton marketing professor Peter Fader said the metaphor of a tsunami hitting the retail industry is an apt one to describe the recent spate of bankruptcy filings this year. “You know the tsunami is coming,” he added. “You see the tide going out before that big wave hits.”

Fader said signs of trouble for retailers were visible from multiple directions, including consumers changing their preferences and becoming more demanding; pressure from online retailers like Amazon; uncertainty in the economy; and private equity investors saddling the retail companies they own with too much debt. “Now, will the wave hit and will we recover from it, or is it [going to continue] building and building? That remains to be seen.”

Retail stores haven’t invested sufficiently in improving the shopping experience, rendering it unappealing, said Mark A. Cohen, director of retail studies and adjunct professor at Columbia Business School. He described the latest round of bankruptcy filings in the retail industry as tragic. “That 10 enterprises have gone into [Chapter] 11 just in the first quarter is shocking,” he added.

“You know the tsunami is coming. You see the tide going out before that big wave hits.” –Peter Fader

Fader and Cohen discussed the factors working against retailers on the Knowledge@Wharton show on Wharton Business Radio on SiriusXM channel 111. (Listen to the podcast at the top of this page.)

Overstored and Unfocused

Broadly speaking, “the U.S. has been overstored for decades,” said Cohen. “Now we’re seeing the [inevitable outcome] of that in this increasingly troublesome round of foreclosures and bankruptcies. Of course, the internet is the disruptor of all disruptors.” He noted that while growth in online sales is in the double digits, sales at brick-and-mortar stores are flat at best.

According to Fader, the troubles in the industry go beyond criticism that retailers haven’t kept pace with demographic changes. He traced them to “fundamental issues” such as a lack of focus on the full value that customers represent. Cohen agreed. “There is no lack of customers, regardless of their age or generational standing. There’s no lack of disposable income. The fact is that millennials are spending more on tech than on apparel is just a manifestation of the ever-changing nature of the business.”

At Payless ShoeSource, the problems are “all about the merchandise,” said Cohen. “Payless hasn’t had a compelling assortment for a very long time.” He added that the footwear chain had overextended itself on the number of stores it maintains, and relied far too long on promotions dubbed “BOGO” or “Buy One, Get One,” a strategy which at some point loses its efficacy. “You run yourself out at the end of a plank; at some point it starts to creak. What we’ve just heard is the plank actually cracking.”

Cohen predicted that closing 400 stores is a prelude to closing the entire Payless enterprise. “I don’t know how they are going to remediate their issues simply by reducing the size of their store [footprint].”

“Payless has gotten mindlessly over-large with stores in too many locations that are not productive enough for them to remain viable,” said Cohen. The acquisition of Payless by private equity investors in 2012 may have brought on more woes, he said. Such investors tend to leverage the businesses they back with too much debt, making it difficult for them to adequately service that debt, he added. Blum Capital Partners and Golden Gate Capital along with apparel maker Wolverine Worldwide bought Payless ShoeSource’s parent company, Collective Brands, five years ago in a $2 billion deal.

“This is a business that thrived on getting bigger because scale does work if it is managed in the right context,” Cohen noted. By closing down a number of stores, Payless would lose a lot of that leverage, he added.

Whether it’s because retailers overbuilt their store footprint or took on too much debt, “some of this pulling back is natural, should be expected and isn’t necessarily a calamity,” Fader pointed out.

“That 10 enterprises have gone into [Chapter] 11 just in the first quarter is shocking.” –Mark A. Cohen

Fader agreed with Cohen’s analysis of the outlook for Payless. However, he argued that the problems are not just about the merchandise: Payless has built a loyal franchise of very low-value customers, but not much beyond that. “You just can’t run an enterprise unless there are some whales out there that are going to help keep you afloat.” The company has to develop a base of more valuable customers, he added. “By just bottom-fishing all the time, you can’t sustain yourself.”

The online marketplace has also been particularly problematic for the footwear industry because of the extraordinarily high incidence of returns, said Cohen. Customers typically shop online, buying multiple pairs in multiple sizes, and then return the pairs that don’t fit them, he explained. And while shoe and clothing retailer Zappos.com has succeeded with online sales, although it isn’t clear how profitable that channel is, he added.

A Fifth Avenue Exit

Cohen said he was surprised to hear of Ralph Lauren’s decision to shutter its New York City flagship store, considering that it had opened only in 2014. “It was — typical of Ralph Lauren — a very elaborate, expensive and indulgent expression of his brand,” he added. He noted that retailing on Fifth Avenue in Manhattan is heavily driven by tourists. While the flow of tourists exists, the strength of the U.S. dollar has eroded their spending power, he explained. “The business, generally speaking, in New York, has been tough — and here is Ralph with this $25-million-a-year lease, which apparently had no pathway to success at any time in the future.”

Cohen said Ralph Lauren has been doing “very poorly” for three or four years. “At the end of the day, there is no natural law that suggests that an iconic brand, as iconic as his has been, is guaranteed to be successful forever and always,” he said. “So this retrenchment is painful; it’s humiliating.” He noted that the company has relied heavily on the lower-margin outlet stores that bring in at least half of its total sales and profitability.

Questions at Macy’s

Almost every time the retail industry faces troubling times, all eyes turn to see how the largest among them – Macy’s – is doing. A common thread seems to be an excessive dependence on apparel and accessories. Chains such as Macy’s unwittingly charted their path to tough times years ago when they eliminated most categories they used to offer historically and focused principally on apparel and accessories, said Cohen. That strategy misfired because “apparel and accessories are now off trend,” he added.

“Macy’s has been following a last-man-standing strategy, which served them well until it stopped serving them well,” Cohen said. “Now they are merely a dead man walking.” The company doesn’t have a viable strategy going forward, even as its finances are not exactly in troubled shape currently, he added.

“Customers don’t like shopping in an empty mall any more than they like dining in an empty restaurant.” –Mark A. Cohen

However, Fader said Macy’s does have the opportunity to redirect itself with its “good stores in good locations.” It could try out several options, such as rearranging its merchandise, or investing more in customer relationship management and customer analytics, he added.

Impact on Malls

The slew of retailer bankruptcies will likely bring much collateral damage. Super regional malls that are fully tenanted with multiple anchors will continue to be successful because people will want to shop in a physical setting, said Cohen. However, the malls graded B, C and D will lose stores such as a J.C. Penney or a Macy’s, or others that have filed for bankruptcy, and the feel a disproportionately larger impact, he added. “Customers don’t like shopping in an empty mall any more than they like dining in an empty restaurant.”

About 1,100 malls are at risk, said Cohen. Some of them could reinvent themselves by changing their mix of offerings, but he was pessimistic about the outlook for the majority of those at risk. “The internet just keeps growing, and this represents a new element of convenience, capacity and power on the part of the consumer, who can sit in their underwear in their living room in the middle of the night and shop with abandon without having to make the trip to the ubiquitous mall.”

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