There have been quite a few “retail apocalypse” stories in recent months that make it sound like every traditional retailer is on their deathbed and Amazon is going to rule the world. As is frequently the case, the headlines are exaggerated and reality is not going to be as dire as many journalists would lead you to believe. However, the world of retail is changing and it is in the best interests of cities to understand and prepare for those changes because retailing in 2025 will be substantially different than it was 2005.
This post is the first of a two-part series. This initial part will focus primarily on what is happening to retailers -- particularly the physical (“brick and mortar”) stores that fill the commercial centers in every city. I will try not to bore you with too many numbers, but it is important to understand the scale of what is happening. The second part will focus more on the impact of these changes on cities. My goal, as always, is to help cities be prepared for what is coming so that they can develop a strategy to not only survive, but prosper in the future.
Many of the gloom-and-doom stories about retail have focused on the impact of the COVID-19 pandemic, as if retail would have remained unchanged without the coronavirus. The more accurate assessment, in my opinion, is that the pandemic simply accelerated trends that were already well underway. Amazon and other online retailers have been eroding sales from traditional brick and mortar retailers for years, but the pandemic convinced many people to either try online shopping for the first time or to significantly expand the amount of their online shopping. The net impact is that the percentage of all retail sales done online in 2020 will probably reach levels that would otherwise not have been reached until 2022 or 2023. (1)
One final caveat: retailing is not monolithic. There are a variety of retail businesses that have very different products and very different customer bases. They will not all be impacted in the same way. Nor is human behavior monolithic. The shopping patterns of some people will change far faster than others. The impacts of retail change discussed below are happening at the margins so to some civic leaders they may seem almost trivial, particularly for midwestern cities that are not exactly known for being “cutting edge.” But they will spread eventually and they will end up affecting every city in the relatively near future.
The first key point to understand about retail development in the United States is that we arguably have way more retail floor area than is really needed. Our country has over 8 billion square feet of retail space, or roughly 24 square feet per person. By comparison, the amount of retail space per person in Europe is roughly 5 square feet. (2) Much of that difference is because our country is much more spread out than the countries of Europe, but it also reflects the fact that we have a lot of retail floor area that is less productive than it should be.
The pattern of rapid outward growth common in this country has resulted in large commercial developments on the outskirts of nearly every city, which in turn has left core areas in the older parts of town oversupplied with commercial space that is aging and obsolescent. It is generally cheaper to build new retail on the edge of town (where new housing is also being built) rather than remodel existing retail centers. Add to this the common practice of retail chains opting to grow too quickly in an effort to capture market share, and you end up with a lot of retail stores that are only marginally productive.
The second key point to understand is that as people’s shopping habits evolve, the format of retail centers will evolve to match. This is not abnormal, but it does cause problems for cities because the physical structures built for one type of retailing are often hard to adapt to new trends. For example, the enclosed shopping mall has been a fixture in the retailing world for the past 50 years. In the mid 90s, roughly 140 new malls were being opened every year and they typically were the hub of retail activity for most mid-sized cities. Now, shopping and social habits have changed and enclosed malls are quickly dying.
Roughly a quarter of all enclosed malls have either closed already or are nearly vacant. That number is expected to reach 50 percent by 2030. Many of those that remain open have been (or soon will be) forced to make major changes to their physical form and their list of tenants. Medical, educational, and public service tenants were nearly non-existent inside malls 25 years ago but are now common as replacements for department stores or other major retailers that have closed down. Unfortunately, these non-retail tenants are not particularly helpful to the remaining retailers so their struggles intensify and the entire mall starts circling the drain.
Third, the COVID-19 pandemic has had a major impact on brick-and-mortar retail with a large number of bankruptcies and store closings in 2020 and more to come in 2021. Most of these stores were struggling pre-pandemic, but the lockdowns and general fear of public places has been the final nail in the coffin. Just this year, well known brands such as JC Penny, Lord & Taylor, Stein Mart, Ascena Retail Group (Ann Taylor, Lane Bryant), Tailored Brands (Mens Warehouse, Joseph A Banks), Brooks Brothers, GNC, and numerous others have filed for bankruptcy and started closing stores. Forbes estimates that over 14,000 retail stores have closed for good in 2020, while the Wall Street Journal puts the number at a slightly less scary 11,100. (3) (4)
To be clear, many of the companies that declared bankruptcy will re-emerge in a slimmed-down form, and some retail chains are doing so well that they are adding stores. But the net effect is negative and the pain will be particularly acute in areas that have struggling economies or that are particularly dependent on tourism or convention traffic.
Finally, retail store closures mean lost rent for commercial property owners which will ultimately affect their ability to make mortgage payments and pay property taxes. As of the end of September, only 82% of shopping center tenants were current in paying their rent. (4) As of October, roughly 14 percent of all retail loans (and 20% of all hotel loans) that were originated by commercial real estate lenders and packaged into securities are delinquent. (5) This is not expected to be a repeat of the residential mortgage meltdown of 10 years ago, but it will hurt many real estate investors and will put financial pressure on some cities.
In particular, it will be interesting to see if the rising number of store closings and commercial defaults increases the success rate of retailers challenging property tax assessments using the “dark store” argument. Property tax assessments can be calculated several different ways and local governments often use a combination of methods to determine the appropriate valuation of retail stores for tax purposes. Big retail chains, however, are arguing that the most appropriate method should be based on the market value of comparable stores, including those that are vacant (or “dark”). This approach can reduce valuations (and hence tax payments) by 30 to 60 percent. If vacant commercial property becomes more common, will this form of tax challenge become more successful and widespread? It is too soon to tell but it certainly seems possible, and that could have a substantial impact on local property tax receipts.
Adapting to a New Retail Future
Fortunately, people (and the retail stores they run) are amazingly adaptable. Retail entrepreneurs and companies have already implemented changes in response to the rise in online shopping and the financial aftershocks of COVID-19. These adaptations vary widely mainly because any given strategy will work for some retailers but not for all. To make sense of these various ways of adapting -- particularly to the challenges of online retailers -- I have grouped retail transactions into three different types that I think help explain which stores have the best chance of survival and which adaptations are likely to be most effective. Retail stores, of course, are likely to accommodate all three types of transactions, but most will focus on one type of shopper:
I know exactly what I want and my primary concern is price and convenience;
I know generally what I want but I need help in finalizing my decision; and
I didn’t really need anything but I’m purchasing for social or emotional reasons.
I know what I want. Many of the things we buy are basically staples of our day-to-day life and we pretty much know exactly what we want. For these items, the key considerations tend to be 1. how much effort does it take to get it, 2. how cheaply can I get it, and 3. how quickly can I get it. These transactions are highly susceptible to disruption by online shopping platforms because ordering something from my phone and having it delivered to my door is about as easy as shopping is likely to get. The stores that focus on transactions of this type better have a compelling online presence and fulfilment process or they won’t be around much longer.
Many companies are implementing a strategy known as “bricks and clicks” which combines local stores with a strong online platform. This allows them to cater to shoppers who prefer online shopping as well as those who prefer traditional in-person shopping. It also allows people to order online and pick up at a local store to avoid the time and expense of shipping, and it allows retailers to ship their goods from a local store rather than a regional warehouse. Witness for example, the tremendous rise in curb-side pickup during the pandemic. WalMart and Target are both good examples, but numerous smaller stores are finding success with the bricks and clicks approach as well. The primary challenge for small businesses, of course, is being able to spend enough on website design and back-end fulfillment to be able to compete with the big competitors such as Amazon and WalMart. Having an online presence won’t be sufficient if the interface is confusing, the check-out process is time consuming, or the delivery options are expensive. You can bet that the large online retailers are spending millions of dollars and mining every byte of data about their customers to make the process as intuitive and simple as possible.
Kohl’s has taken the unusual step of reaching an agreement with Amazon to accept their returns. If you purchased an item directly from Amazon, you will generally have the option to return it to your local Kohl’s store rather than packing it up and shipping it back. Kohl’s will not only process your refund, they often give you a discount code for a purchase in their store. Early data suggests that Kohl’s stores are seeing an increase in foot traffic of as much as 25 percent. It will be interesting to see if this “make a deal with the devil” strategy works over the long run for a retailer that has been struggling as of late. Amazon, on the other hand, is able to address a major complaint of online shoppers -- returning merchandise is a hassle that limits how much some people are willing to buy online. This agreement is their way of adding “bricks” to their business model.
I need help. The second type of transaction is one in which you know generally what you want but you would like some assistance in making the final decision. Perhaps you want to compare several competing options, or maybe you have questions about the product’s performance or construction, or you might simply want an expert’s opinion before you make the purchase. Stores that focus on this type of shopper are certainly not immune to being disrupted by online shopping sites, but they have at least some advantages. Most of us have learned the value of a really good salesperson -- someone who listens to what we want and then can cut through the clutter of competing products to show us the best options and provide meaningful insights into what meets our needs. While online platforms have made great strides in offering “expert” advice to try to replicate a knowledgeable salesperson, they still have a ways to go.
Take running shoes as an example. When I search for “men’s running shoes” on Amazon, I get literally hundreds of possible products for me to evaluate. And yes, there are ways for me to filter the results to a more manageable number. But what I really want is a knowledgeable person who can evaluate my needs, my body type and running style, and then match me with two or three options that are both high in quality and appropriate for me. Plus, in-person shopping gives me the ability to try them on to make sure that they feel good on my feet. I’m willing to pay extra for a knowledgeable expert to “curate” the enormous world of running shoes to just a few quality brands and then to use their expertise to help me find the best option. However, if I am happy with my purchase, I will probably order my second pair online to save a little time and money!
Thus, a brick-and-mortar store has an advantage if they can leverage their knowledge to provide excellent customer service. Unfortunately, many retailers have squandered that advantage by replacing knowledgeable employees with people that are willing to work for minimal wages. This undoubtedly improves profitability in the short run, but staffing a store with uninspired employees plays into the hands of online retailers in the long run. You can bet that artificial intelligence experts are working on finding ways to make our interaction with a computer at least as natural and helpful as the average sales clerk. It may be that the best approach for small retailers will be to increase the wages for their staff in order to attract and retain people who really excel at customer service and are passionate about their products.
This is also a generational issue. Older shoppers are more likely to prefer personal service while younger generations are more comfortable with online reviews and rating systems. Systems based on artificial intelligence are already supplementing the online shopping experience, and brick-and-mortar stores are experimenting with that technology as well, but again the younger generations are likely to be more open to having an automated robot helping them pick out their next pair of shoes.
I’m making an impulse purchase. Humans are social and emotional animals, and that leads us to make shopping choices that have little to do with need. Shopping can often be a social outing (or so I’ve been told) where the real objective is to have fun with friends and the functional value of the item purchased is secondary. Or perhaps I’ve had a hard day and I need a little “retail therapy” to lift my spirits. Whatever the reason, some purchases are more about the experience we are having as we shop and less about the actual thing that we buy. This type of transaction is most immune to being disrupted by online shopping sites, but there may not be very many stores that can survive primarily on impulse buys. Still, many brick-and-mortar stores would benefit from improving the experience of shopping to make it more fun and more social.
In recent years, the rising popularity of walkable, mixed use districts that include locally-owned retail shops with drinking and dining options is a testament to the power of “experiential” retailing. In fact, the decline of retail spending at enclosed malls has coincided with the growth of retail spending in more urban locations that better fit the preferences of younger generations. And yes, these areas have been hard hit during the pandemic because they encourage the public mingling that is scary for those concerned about viral spread, but I am confident they will bounce back fairly quickly after the pandemic has passed. There is a pent-up demand to socialize with friends that I think will explode once people feel safe being out in public. The restaurants, bars and boutique shops that are able to survive may well see record sales as people rush to partake of the outings they have avoided for so long.
In the longer term, retail businesses that offer creative and authentic goods and services have a chance to build a profitable niche that online retailers will have difficulty replicating. Shops that specialize in expertly curated merchandise, hand-made or artisanal products, or goods with an artistic flair are likely to prosper provided they emphasize the experience of shopping over efficiency and volume.
The Special Case of Restaurants
According to a September press release by the National Restaurant Association, nearly 100,000 restaurants have closed either permanently or long-term since the beginning of the pandemic. Nearly 3 million employees are still out of work and the industry is on track to lose $240 billion in sales by the end of the year. (6) And those restaurants that remain open are typically surviving on revenue that is 30 to 40 percent lower than the previous year.
Pre-COVID, the restaurant industry had been a bright spot for shopping center owners, with new openings often compensating for the closures of retailers focused on traditional goods and services. The pandemic brought that trend to a quick end and it remains to be seen how quickly customers will return to eating out once virus concerns start to wane. Without strong restaurants, many shopping centers and shopping districts would lose a great deal of their vitality and customer traffic, putting landlords in an even more precarious position than they were when they were only dealing with concerns about online retailing.
So what will next year bring? Even assuming that vaccines move forward relatively quickly, it will still be months before social distancing and capacity limits are eased to any significant degree. Many stores and restaurants are hanging on by a thread hoping that strong holiday sales and a rapid distribution of vaccines will keep them in business. Unfortunately, I believe holiday shopping is likely to decline compared with 2019 and likely to take a turn toward value and practicality rather than luxury and pleasure.
Consequently, I think the pace of store closures will continue at a high level for much of 2021 which means that both commercial property owners and cities will suffer. Look for Part 2 of this series to address who is likely to suffer the most and what can be done to recover as our society moves forward.
Thoughts? As always, share your thoughts and ideas by leaving a comment below or sending me an email at firstname.lastname@example.org. Want to be notified whenever I add a new posting? Send me an email with your name and email address.
“US Ecommerce Growth Jumps to More than 30 Percent”; eMarketer; October 2020; https://www.emarketer.com/content/us-ecommerce-growth-jumps-more-than-30-accelerating-online-shopping-shift-by-nearly-2-years
“The Unmalling of America”; Gregory Scruggs; Lincoln Institute of Land Policy; December 2019; https://www.lincolninst.edu/publications/articles/2019-12-unmalling-america-municipalities-navigating-changing-retail-landscape
“More than 14,500 Stores are Closing in 2020 So Far - A Number that Will Surely Rise”; Walter Loeb; Forbes; July 2020; https://www.forbes.com/sites/walterloeb/2020/07/06/9274-stores-are-closing-in-2020--its-the-pandemic-and-high-debt--more-will-close/?sh=3d3a86ca729f
“As Covid-19 Shuts Malls and Hotels,Their Owners Fall Behind on Loans, Setting the Stage for a Changed Landscape”; Michael Braga; USAToday; November 2020; https://www.usatoday.com/story/money/2020/11/13/closed-stores-hotels-retail-loan-defaults/6219469002/
“Virus will alter Malls and Offices”; Telis Demos; Wall Street Journal, November 27, 2020.
“100,000 Restaurants Closed Six Months into Pandemic”; National Restaurant Association; September 2020; https://restaurant.org/news/pressroom/press-releases/100000-restaurants-closed-six-months-into-pandemic