The Decline of Brick and Mortar Retailing

As I’ve discussed earlier, I’m seeing mounting evidence that eventually machines will replace all economically significant human labor. But while I suspect this will happen relatively quickly (at least from a historical perspective), it won’t happen overnight or all at once.

It also won’t happen evenly. Some fields and industries will eliminate large numbers of workers relatively soon while others will hang on and even expand their numbers for many years to come.

One of the ways I look at this is by imagining the production path, from raw materials to finished product, of an item that I might want to buy.  All along that path humans are involved to one degree or another. But gradually, at each step along the way, human labor is slowly being squeezed out of the process as machines replace our effort.

Eventually what we will create, for all intents and purposes, is the equivalent of Star Trek’s replicator. To obtain a product we will punch a few buttons on our phone and, without any human involvement, it will appear at our door.  This could be a wonderful development.  But this will only be the case if everyone has access to those buttons.  Unfortunately I have real concerns that we may be building a world where only a few will be able to use them.

This process of replacing human labor has been slowly happening for decades in many different ways.  But things have begun to change rapidly and it has become impossible for one person to track all the different developments.

While I try to watch events in many different fields along multiple different supply chains, I find myself currently focusing on three in particular. These three – the introduction of self driving vehicles, the replacement of fossil fuels by solar energy and the rise of online shopping – are what I view as the coalmine canaries in the process of automating our economy.  I’ll address the first two in other articles, but in this one I’d like to focus on the decline of brick and mortar retailing and its replacement by online shopping.

Whenever a given industry is first disrupted, people often find it difficult to believe that it could be entirely replaced.  You will often see statements, typically made by those working in the declining industry, like the following:

There will always be a need for X.   It will never completely go away.

Needless to say brick and mortar retailing is no different.  People often fail to recognize that the winds have suddenly changed direction before it is too late.

What has changed and is driving the push toward online shopping is the same force that drives most other economic changes: cost.  Because of automation, online retailers have simply developed systems that can get products to consumers cheaper and more efficiently than brick and mortar retailers.

In addition it isn’t just the final price of a given item that makes online shopping cheaper for consumers (although that is a big part of it).  It’s the entire shopping experience that has become faster and more efficient.

For example most shopping endeavors begin with researching what to buy.  In the past, depending on the product, this could be a lengthy process.  It often involved talking to friends and relatives, reading books and magazines and ultimately traveling to multiple stores to find exactly what you need at the lowest possible price.  It was an extremely inefficient process.  Most people simply didn’t have the time or resources to examine all possible alternatives and often settled on a less than ideal product at a greater than necessary price.

Online shopping is changing this process.  It is rapidly condensing the research process from  hours or even days to in some cases minutes.  It has become increasingly easy to find the ideal product at an optimal price.

And those prices are typically significantly less than what people often pay in a brick and mortar store.  While online retailers have to pay shipping costs, they don’t need to maintain multiple distribution points (stores) or pay clerks and salespeople to help customers.  This means online merchants have a significantly lower cost of doing business and they can afford to pass those savings to customers in the form of substantially lower prices.

The result has been a rapid shift of sales moving from brick and mortar stores to online merchants.  According to the most recent US Government tally, online shopping now accounts for about 8.4% of total retail sales (about $100 billion in the 3rd quarter of 2016). Since the end of the 2008-2009 recession online sales revenue has been growing at a fairly consistent pace of 15% per year (pdf).  (It should be noted that this number includes both online only merchants like Amazon along with the portion of goods that traditional brick and mortar merchants have started selling online.)

But looking at total retail sales is a bit deceptive since this number includes things like automobiles, restaurant meals and building supplies that either can’t, or are not yet, sold online in any significant quantity. A more accurate view would be to exclude those items and look mainly at items typically found in the average mall or shopping center.

In the Government’s monthly retail report this information is mostly captured by two main categories.   The first is a category called “GAFO” (General Merchandise, Apparel and Accessories, Furniture and Other Sales). This includes items sold both online and offline by traditional brick and mortar merchants.  It is identified as government categories 442, 443, 448, 451, 452, and 4532. The second category is what is called “Non-Store Retailers”. This category includes mostly GAFO type merchandise sold by pure online sellers like Amazon and is identified as government category 454.   The total of these categories was about $450 billion in the 3rd quarter of 2016.  This means about 22% of all “GAFO” type items are currently sold online (100/450=0.22).

With online sales increasing at a rate of about 15% per year, this could mean that in about 11 years all GAFO type merchandise will be sold online.  Although even this is probably optimistic for brick and mortar retailers.  Profit margins for a typical retail business are rarely more than 5% (e.g. Walmart averages about 3%).  Because retail store have fairly significant fixed costs, even a relatively small decline in total revenue is enough to make them unprofitable.

Therefore I expect brick and mortar merchants to begin closing stores at a fairly rapid clip. This of course would force even more consumers to begin shopping online whether they want to or not and actually accelerate the growth rate of online shopping. As a result huge numbers of traditional brick and mortar stores could disappear from our cities in as few as 5-6 years.

Why do I think this might be the case?  Lets take a look at a fairly typical shopping mall near where I live.  If we examine their directory (click “Map View” for a clearer look – pdf) we can see that this mall has four major anchor tenants (Macy’s, Sears, JC Penney and Herberger’s) and about 65 smaller locations including a fairly large Barnes and Noble.

Unfortunately for this mall, Macy’s just announced that it is closing their store. Surprisingly they beat Sears to the punch although probably not by much.  It is reasonable to expect Sears will also also close within a year.  Herberger’s, a part of the Bon-Ton chain, has also been struggling for the the last several years.  Finally there are rumors the JC Penney chain may close almost a third of its stores over then next 2 years.

To be fair both JC Penney and Herberger’s could see a fairly significant bump in their business after Macy’s and Sears close.  This means they could remain fairly profitable for at least a few more years.

Although this probably won’t help most of the smaller stores in this mall most of whom likely rely on the customer traffic generated by the anchor stores to survive (in this case at least 10 locations already appear to be vacant).  The survival of Barnes and Noble is particularly questionable.  It is doubtful most of the rest could survive the closing of 2 or 3 anchor stores.

So how long before this mall is almost entirely vacant?  Based on what I’m seeing this could happen in less than 3 years.  If this is the case, I have a hard time seeing most similar malls surviving more than 5-6 years.

Their are a couple of factors that could slow the transition to online shopping.  One thing that I have noticed is that the retailers most impacted by online sellers are those brick and mortar merchants that have traditionally sold their goods at relatively high markups.  Most mall based retailers fall squarely in this category.

On the other hand discount retailers like the dollar stores, TJX and the fast fashion stores like H&M appear to be holding their own.  At least for now, online retailers haven’t yet been able to sufficiently undercut these types of stores enough to make a significant impact.

The problem is the operational model of online retailers is still a moving target (this is particularly true of Amazon). So there is no reason to believe that online retailers won’t continue to expand and move downmarket. But there is the possibility of some type of floor – either in terms of price or service – below which online sellers will never be able to compete.

Although my own guess is that this level, if it exists at all, is probably quite low. Personally the only type of brick and mortar store that I think might have a fighting chance are convenience stores.  But even here I have my doubts.

So how many job will be lost because of this shift?  At this point I have a hard time coming up with an exact number.  But I think we can get some sense of the possible scale by looking at the revenue per employee numbers for different types of retailers.

Currently online behemoth Amazon generates about $550,000 of revenue per employee.  Although admittedly Amazon is more than just a retailer and does business in other areas.  As a result the ratio between Amazon’s retail sales revenue and its retail employees could be significantly lower.  We don’t know because, as far as I know, Amazon doesn’t release this type of information.  Although personally I suspect the actual number is reasonably close and is probably even increasing.

Compare this to current brick and mortar retail giant Walmart.  Walmart currently generates more revenue than the entire online retail sector.  However Walmart gets only about $210,000 of revenue out of each of its 2.3 million employees.  Assuming Amazon’s revenue per employee numbers are roughly accurate, this means Walmart would have to figure out how to either eliminate nearly 1 million employees or double its revenue in order to remain cost competitive with Amazon.

Companies like Macy’s and TJX are even worse.  Each of them is only able to generate about $165,000 and $150,000 of revenue per employee respectively. The only major retailer that appears competitive with Amazon is Costco.  Costco is currently able to match Amazon at about $550,000 of revenue per employee.

As I mentioned, these numbers are just a rough proxy for what is really happening and should be viewed with caution.   But until I can find a study that directly compares the efficiency of online and offline retailers, it is the best I can do.  But if this analysis is even roughly accurate, I don’t think it is difficult to see how several million retail jobs could be lost over the course of the next several years. Online merchants simply don’t need that many workers.

Will our economy grow fast enough to replace those who currently work for brick and mortar retailers?  Based on past history, this is possible at least over the short term. But people working these jobs will likely need to find their new jobs in some other industry (healthcare?).  Unless the total GAFO retail industry more than doubles in size in real terms over then next several years (which would require an unlikely CAGR of 7%-10% or more), there is simply no way the world of online retailing could possibly absorb them.

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