12:17 am
18 June 2018

An Internet Reality Check

An Internet Reality Check

Ask any consumer or industry professional to estimate the impact of the Internet on retail, and you will get wildly divergent responses, each backed by expressions of passionate confidence. What share of retail sales occur on the Internet? Who is the largest retailer in the world? Why are Macy’s and Sears closing stores? If you answer these questions with “60 percent,” “Amazon” and “Internet competition,” your answers would match those of most other respondents—and you would be wrong on all three.

The correct answers are 8.4 percent, Walmart ($500 Billion) and 30 years of “category killer” retail competition. In the world of retail, the growing disparity between market perception and reality has never been greater, representing one of the central issues facing the industry. While dramatic changes in technology routinely occur in one or two years, retail changes occur at a glacial pace by comparison.

Yes, while iPhones change annually, retail formats often change and evolve over years or decades, and understanding the dynamics driving these changes is more important than ever. Getting it right can propel retailers to new heights, while getting it wrong can result in fatal strategic mistakes, differentiating success and failure, winners and losers.

Two fundamental realities lie at the heart of how most retail works today: the commoditization of most retail going all the way to Toys “R” Us in the 1960s and the expanding role of technology in retail. Both are not only misunderstood, but barely understood at all.

Category Killers and the Commoditization of Retail

For department stores like Macy’s and Sears, fundamental change began to take place more than 50 yeas ago with the introduction of Toys “R” Us, the first category killer. Prior to the introduction of Toys “R” Us, full-line department stores, the general stores of modern-day retail, carried virtually all commodity retail products consumed in average American households. However, the undermining of this model began even before the department store and regional mall industries had fully matured.

One by one commodity retail categories once exclusive to department stores and malls, were duplicated in lower cost big box category killer outlets like Staples, Best Buy, Michaels and Bed Bath & Beyond. Thousands of these new discount stores were built by the turn of the century, and the number of malls operating nationwide began contracting from a high of near 3,000 at the peak of the industry to fewer than 1,000 today. By the year 2000, most department stores had been reduced to underused cavernous boxes carrying a bloated supply of overpriced soft goods and housewares, leading to high-low pricing strategies and endless sales.

Today, with T.J. Maxx, Marshalls, Ross Dress for Less and Nordstrom Rack, as well as specialty stores like Bed Bath & Beyond and Home Goods, offering everyday low pricing and still opening hundreds of stores annually, the entire U.S. department store industry is responsible for less than $72 Billion (and shrinking). With the entire department store industry now dwarfed in size by single commodity retailer chains like Target, Home Depot and Costco, we expect that the industry will continue to shrink in annual and market share, with only between 150 to 250 malls surviving as high-end specialty retail mega-hubs when the process is complete.

Technology and Internet Retail

When Macy’s recently announced 100 more store closures and new asset sales, the company cited pressure from online competition as the primary reason for the closures; moreover, Macy’s announced an aggressive Internet expansion strategy to stem the tide. Macy’s explanation, along with its strategy for recovery, couldn’t be further from reality. The department store industry had begun its long slide into obscurity well before the rise of Amazon, and in fact, Internet sales may well have helped slow Macy’s decline. Macy’s itself has reported that when it closed its only Minneapolis Bloomingdale’s unit at the Mall of America two years ago, Internet sales in the market not only failed to pick up the slack, but fell by 75 percent—hardly a saving grace.

The reality is that not only is online competition not a meaningful part of Macy’s (or any other department store’s) basic challenge, it barely plays a role at all. Despite all the hype, total U.S. online retail sales just passed eight percent of last year, 25 years after Amazon’s first sale, and online retail sales models have serious challenges of their own. Even the Internet’s 500-pound online gorilla, Amazon, with $85 billion in annual sales, has struggled to generate any profit on its online sales, making all of its profits to date from its “web services” division.

Make no mistake about the impact of technology and Internet-initiated sales, they are real and most retailers must offer this option. Analysts and retailers now routinely cite Internet sales as both cause of failure and the path to salvation, but they are taking a shortcut in logic that they will eventually pay for dearly. The reason is the high cost of operating online sites and high shipping and handling costs associated with online sales that both dilute margins and limit the Internet as a fulfillment option for the vast majority of commodity retail sales.

While consumers certainly find Amazon’s free two-day shipping for Prime customers appealing, Amazon loses billions of dollars annually shipping to these customers, and they will lose even more on same-day deliveries by ground and by the drone delivery fleet now being touted. And, can you imagine what a large-scale Amazon drone delivery “airport” would look like? Do we really believe this can become a reality, or are we being drawn in by the allure of change and the hype of a seasoned marketing machine? As seasoned retailers know, the cost of over handling merchandise and inefficiencies of shipping are profit killers.

Walmart’s recent $3 billion acquisition of is yet another example of misinformed decision-making. After spending $3 billion to purchase Jet, $500 billion Walmart will now need to fund billions of dollars of additional development costs and absorb annual losses at Jet for as far as the eye can see. In the end, Walmart will almost certainly be forced to realize what Amazon already knows. Developing a large Internet sales platform is very expensive, and shipping costs eat up profits, especially when shipping low cost commodity retail goods like those most often sold by Walmart.

Meanwhile, back in the real world, while Walmart experiments with Jet, Dollar General will open 1,000 stores in 2017 alone, and basics commodity retailers like Aldi, Lidl and Five Below will open hundreds of additional stores. As these more nimble retailers take market share from Walmart, Walmart itself will be racking up billions in losses from its ill-advised foray deeper into Internet retailing, reminiscent of Kmart’s fatal strategic detour into category-killer retail while Walmart zoomed past it in the 1990s. Contrast this strategy to mega-retailer Ikea, which, cognizant of the cost and inefficiency of picking and shipping from a retail warehouse, does not offer free shipping at all, opting instead to charge customers $40 to “pick and pull” an order and another $59 to deliver it.

Compare the Walmart initiative with that of TJX Company, when it purchased Internet darling Sierra Trading Post several years ago. TJX purchased the small, but well-established Internet company to gain Internet sales expertise and experience. Today, however, it is aggressively rolling out the Sierra Trading Post brand as its latest high-growth brick-and-mortar retail brand.

Make no mistake about the fact that most retailers must offer an Internet sales option, especially in apparel where Internet sales account for nearly 30 percent of total industry sales. They must, however, also be realistic about the business model they adopt. In the end, the same shortsighted analysts that encourage poorly thought out and expensive investments in Internet retail infrastructure will be the first to run for the door when the red ink piles up with no end in sight.