Brick & Mortar vs. Internet: Bricks Fight Back

Shopping around no longer requires going from store to store searching for the lowest price. If you have a smart phone equipped with a web browser and a robust Internet connection, you can find what you like in one store and then comparison shop, and even make a purchase, on the web.
All of this is great for customers but horrible for retail stores. The stores object to serving as showrooms for customers who make their purchases from other sources. In classic but much maligned capitalist fashion, they are responding by offering ingenious incentives for customers to purchase from them.

One of these strategies is to use the web itself to provide incentives. A free cell phone application called Foursquare allows users to report their location. Retailers can use this information to offer discount coupons to price-sensitive users. Consumers, however, are not yet in the habit looking for coupons on Foursquare, and the strategy has captured only a small portion of smart phone shoppers.

Other strategies require modifications to the stores themselves. The big box strategy of retailing grew out of the need to offer large volumes of a wide variety of goods at low prices. The costs of delivering full truckloads of a product to a store are far lower per unit than less-than-truckload (LTL) deliveries. Customers wanted a wide variety of goods to choose from. The industry responded with large, open stores with lower cost interior furnishings. Inventory levels had to be high so that just about everyone could leave the store with whatever items they had purchased.

Now, however, many customers are willing to wait a day for delivery if they can get a discounted price. Customers still want to see, hold, and maybe try the items before buying them but they are much more likely to make the final purchase online. There is still a demand for variety in the store but the inventory requirements for each item are less. Consequently, many big box spaces are now empty.

Retail real estate owners have responded by subdividing some of the larger stores into several smaller stores. A small store can still display a wide variety of merchandise without the costs of stocking large quantities of each item. Items can be delivered to customers the next day from a nearby warehouse. The advantage of this strategy for shopping center landlords is that smaller stores usually command higher rents than larger stores.

Another strategy is explained in today’s Wall Street Journal. Macy’s, Nordstrom and Toys R Us are now repurposing the warehouse space behind the sales floor in their existing stores to double as distribution space for local deliveries of goods purchased online. Nordstrom now fills online orders from all 117 of its full-line stores, vastly increasing the availability of local warehouse space. This is part of what Macy’s refers to as their omni-channel strategy, where they are seeking to mange demand from various sources (online, mobile and stores) and available inventory in a coordinated manner.
There are several difficulties involved in implementing this strategy. The Journal article cites the difficulties of converting a retail inventory software system into one that can also handle inventory delivered outside the store, but this is the simplest problem to solve. Warehouse and retail inventory systems are both available, so the biggest difficulty would be transferring data between the two systems. If the retail inventory system data is coded in XML, this doesn’t represent much of a problem at all.

A far more difficult problem involves adapting existing retail store warehouse space to handle local deliveries. Online retailers have local warehouses with high ceilings and shipping docks designed to accommodate vans and panel trucks. Retail stores have been designed only to receive goods, not to ship them. The inventory was supposed to only go out through the front doors. The back of the store was designed to prevent the outflow of anything, as such outflow usually involved employee theft. The receiving docks were busy in the morning, before the store opened, so there was no need to provide separate access points from adjacent roads for the truck traffic.

Consequently, these store warehouses will have to endure much inefficiency until and unless they can be modified to accommodate deliveries.
The Macy’s receiving area in the King of Prussia shopping center, for example, only has four dock-height doors. The doors are shielded from an adjacent entrance to the store by a concrete block wall. If they want to make deliveries from this store, they’ll have to install a concrete ramp on one of the doors. This will leave them with fewer receiving doors. Furthermore, the delivery trucks will have to compete with store traffic for the use of a single common access point to this area. The installation of additional truck docks would require major modifications to this entire section of the building.

Accountants and most economists are blind to this entire process. Online shopping has not directly changed the line items for real estate rent on the income statement or real estate owned on the balance sheet. The only way that we can even know that such changes have taken place is through the realization that capital is not heterogeneous. By focusing on the structure of capital, the importance of these developments becomes obvious.
Oddly enough, several supermarkets that were designed between 1998 and 2010 included spaces dedicated to delivery of items that would be ordered online. The supermarket designers were confident that people would want to order their groceries online and have them delivered. This hasn’t been the case, at least so far, but these spaces might be just right for retailers of more durable goods who are looking to expand their ability to accommodate online orders.

So we never know who’s going to win. As the cliché goes, that’s why we play the game.

Doug McKnight has been a commercial real estate appraiser for 23 years. He previously served as a director for the national appraisal firm Marshall & Stevens. He is currently the managing director of CapStruc Advisors and is working on a book on the value of assets.