We’ve just seen the future of retail. Many aren’t ready

There was lots of coverage about the liquidation of Barbecues Galore in the media last week (I should know, I was asked about it, a lot!).

Without being on the inside, it feels like a pretty run-of-the-mill business failure – a single category retailer which, facing increased competition, higher costs and reduced discretionary spending, can’t keep the lights on.

I don’t mean that flippantly, or without care, of course. But it’s not unusual.

Far, far bigger, in my view, is this week’s decision by Lincraft.

The homewares and fabric retailer isn’t going broke. But it is shutting down every single physical store.

And becoming a pure-play online retailer.

That is… huge.

It is the first mainstream example in Australia of a retailer whose centre of gravity has tipped so considerably towards ecommerce, that it’s not just closing a few stores, but doing away with physical retail altogether.

Yes, that’s partly because physical retail has got tougher with rising costs and less discretionary spending.

But it’s partly because Australians are voting with our wallets: sure, we’re not making our own homewares and clothing as much, but that’s only a small contributor. The big one? We’re increasingly shopping online, and that’s shaking up traditional retailing.

As I wrote recently:

“Real estate? I wouldn’t want to invest in mid-tier retail real estate for quids. The big ‘destination’ centres will probably be okay. The local shopping centres will be fine for now, but bear watching if/when some individual stores become unprofitable as more shopping goes online. But the mid-tier stuff, that is neither a destination, nor local? That feels really risky to me.”

Essentially, while many customers will still want to walk into a physical store to look at, touch and try before they buy, that number is steadily decreasing.

But what’s not decreasing is the fixed costs of running a retail store; things like rent, electricity, a basic level of staffing, inventory, fittings and more.

Here’s where it hits, hard. And why the change will come sooner than many think.

When your revenues fall below a certain level – and that decline will be less than 10% for many individual stores – you can’t cover those fixed costs any more.

And so, even while your sales remain decently high, you go from making a reasonable profit to losing money.

If that’s temporary, you can probably carry some losses for a while.

But if it’s a permanent structural shift?

I don’t want to speak for (or potentially misrepresent) the good people at Lincraft, but I suspect that’s what they’re facing, at least in part.

And what other retailers will increasingly face.

In the article I wrote, featuring the quote above, I mentioned that at David Jones, “sales fell 8%, [but] the company’s online sales were up 10%.“

How long do you reckon DJs can absorb those store level declines before the stores themselves are loss-making?

Indeed, I have no inside information, but I’d bet a small amount of money that there are some medium and large retail chains nursing store-level losses at a decent minority of their stores already.

They should close those stores, but a combination of long-term rental agreements, and the need to look like they’re growing, probably means they’re happy to paper over the cracks.

And here’s the thing: even if that assumption is wrong, it’s the direction many, many retailers are heading, whether they admit it or not.

For how much longer will we need more than 1,100 Woolworths Group Ltd (ASX: WOW) supermarkets? Around 200 Harvey Norman Holdings Ltd (ASX: HVN) stores, and the same number of JB Hi-Fi Ltd (ASX: JBH) outlets? Will we need 300 K-Marts around the country?

David Jones and Myer Holdings Ltd (ASX: MYR) surely can’t sustain even the 100-odd stores they have between them for more than another few years. (My bet? We’ll have fewer than 30 by the time they’re finished closing stores. Maybe half of that number.)

And if/when those groups are forced to close loss-making stores? They’ll be hoping their brands and online offerings are strong enough to convince current customers to shop online, instead.

Some of them will be right. But all of them?

Lincraft has had the foresight and courage to do the right thing, however much they’d prefer to have done otherwise. Other retailers closed down, altogether, because their online sales weren’t high enough to justify such a move.

Those are the two paths for other retailers to choose to walk… or the market will decide for them. Or, if they take too long, the administrators or liquidators.

If I was on the board of a retail company, I’d want to know what plans management had to turbo-charge online sales growth, and to minimise the length of retail tenancy agreements, to give the company maximum flexibility as consumer shopping habits continue to change.

Yes, some physical retailers will survive, or even thrive, if they can offer something truly unique that sufficient numbers of people want, and are prepared to pay for.

But remember those store economics: even if 75% or 80% of their customers want to shop in-store, that’s nowhere near enough to support the current cost base of many retailers. Perhaps 90% in most cases.

Which means the tipping point is much closer than many expect. And could well be exacerbated (and accelerated) if discretionary retail sales remain subdued.

Okay, that all sounds pretty pessimistic. And it is, if you’re a retailer with little online presence and momentum.

But it also presents opportunities, both for retailers and their shareholders.

When buggies were challenged by cars, the best buggy-makers added engines (no, not literally, but Studebaker was once the world’s largest maker of horse-drawn carriages).

Canadian ice hockey great Wayne Gretzky famously said “I skate to where the puck is going to be, not where it has been.”

The impulse to circle the wagons is understandable, and actually makes sense when it comes to temporary or passing threats.

But when faced with a structural change, swimming with the tide beats swimming against it.

The company that isn’t actively embracing online retail, and prepared to jettison unprofitable store locations, is, to change metaphors, sailing into a very stiff headwind.

The one that reads the permanent change in conditions and sets the spinnaker, instead, will win the race.

That goes for investors, too.

Fool on!

The post We’ve just seen the future of retail. Many aren’t ready appeared first on The Motley Fool Australia.

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Motley Fool contributor Scott Phillips has positions in Harvey Norman. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has positions in and has recommended Harvey Norman. The Motley Fool Australia has recommended Myer. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.