Retail is Currently Broken

By Portfolio Manager, Randall Coleman, CFA

Disturbing headlines like these are  practically a daily occurrence. It seems as though retail is under siege and the response from government is sorely lacking. As lawless behavior and disregard for civility creates an ever-increasing feedback loop, stores have taken the path of least resistance: shutting down. You can’t steal from an empty store.

Is this where all retail is headed? Boarded up storefronts? Are we going to be forced into online ordering for everything we need? Especially in urban environments where the crime surge appears most prominent, what is the future for retail? To make any sort of educated guess, it would help to take a look at the history of retail and apply some technological advancements achieved over the last twenty years or so.

Retail as it exists today is a relatively new phenomenon. Prior to 1916, customers walked into a store and clerks would gather and package whatever goods the purchaser desired: half-a-pound of butter, two pounds of beans, five pounds of flour, whatever. Piggly Wiggly upended that model and revolutionized retail in Memphis, Tennessee that same year, introducing Self-Service retail. Self-Service shifted the retail experience to the consumer, allowing the shopper to select pre-packaged items from shelves without the need of a clerk. Efficiency and reduced labor costs are the most obvious benefits. While other innovations, including fixed prices, cash-and-carry (no running a tab at the General Store any more), introduction of private-label brands and standardized store layout, for our purposes of looking to the future, the self-service aspect is the most important.

Another wildly successful retail strategy has been the “members-only” approach. While Costco didn’t invent this model, it is the standout leader in its adoption. To quote from their most recent annual financial filing (10-K), “by strictly controlling the entrances and exits and using a membership format, we believe our inventory losses (shrinkage) are well below those of typical retail operations.”

Costco members require presentation of their photo-bearing membership card to enter the store. Facial recognition technology has replaced the need for cards. The US Government relies on facial recognition technology to admit returning travelers under the Global Entry program. Whenever my colleague David Ruff and I return from overseas research trips, a simple stop in front of the Global Entry kiosk is all we need to gain entrance to the US, one of the most exclusive clubs on the planet. No card required.

Automated warehouses have existed for years, with the underlying technology getting better, faster, and more sophisticated every year. Self-driving forklifts, automatic bin picking, sorting, 6-axis robotic arms, visual inspection, the list goes on and on.

Marrying the various technologies or selecting the right combination makes absolute sense for the future of retail. Access control? Don’t let the bad guys in. Sorry, members only. Fully automated approach? Walk around the store with a virtual basket and as you fill it, your “real” basket is filled in the fully-automated back room. Swap your virtual basket for your real basket at the checkout counter, pay and leave. Makes sense to me. Some combination or some new idea or technology will fill the retail void being created. In fact, Amazon Fresh is already using the access control and members-only approach, and they’ve done away with cashiers. Perhaps other stores will copy their model.

However, there’s an inherent danger in foretelling the future. Prognosticators frequently miss the Big Thing That Changes Everything. Harry Dent is a well-known prognosticator and author. I found a copy of his book, The Roaring 2000s on my bookshelf recently and flipped through it to see how well he saw the future back in 1998. Arguably the most profound change in the last 20 years has been the rise of social media. Smartphones fueled the wildfire of social media. Harry Dent completely missed the importance of smartphones, making a single passing reference to “portable smart phones.” There is no mention of social media. Market prognosticators are great at selling books and collecting speaker fees. They’re not so great at predicting, as Yogi Berra famously opined.

Keep failed experiments and technology cycles in mind. WebVan was a failed early experiment in highly automated grocery delivery. BlackBerry reigned supreme in mobile communications for ten years, before smartphones starved it to death. Commerce experiments until it gets it right. Model “X” works for some period of time, then something bad happens and it breaks. Then something new comes along and Model “Y” takes over. That’s how it works. We’re in the “broken” phase of retail now. It will get fixed.

The critical lesson for investing for the long-term is to own organic companies that evolve, adapt and change.

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