Retail Shrinking to Grow

The landscape for retailers is undergoing a generational makeover. It comes not just from shift to online but also potential rewriting of trade policies. But as I wrote back in December, this could be a golden era for retailers who get it right. They just need shed their old way of thinking.

This mainly means viewing their main asset, real estate, in different light. Namely, in the short term it might mean “shrinking to grow” as we’ve heard from everyone from Macy’s (M) to JC Penney (JCP) will be closing stores. But this may not be a bad thing if they can then leverage existing locations distribution centers that support the best performing stores with an eye towards improving overall returns.

A recent article from the Harvard Business Review provides a great deep dive into the challenges and opportunities among retail today. As expected from such a an erudite publication, it’s longer than the usual internet “click bait” article, but well worth the time to read. After all, the U.S. economy is 70% consumer driven, so understanding the trends and which companies are capitalizing them is crucial to all investors.

Companies in all industries eventually see their revenue growth slow. Retailers are no exception. Fickle consumers, intense competition, changing markets, and the rapid encroachment of online retailing all combine to exert pressure on the top line. The retail graveyard is filled with chains such as Circuit City, Austin Reed, Linens ’n Things, Loehmann’s, British Home Stores, RadioShack, and the Sports Authority—that expanded rapidly and then, faced with declining growth, couldn’t find ways to change course.

What should a retailer do when growth slows? Is it doomed, or is there a way to prosper when its business matures? To answer these questions, we examined the financial data of 37 U.S. retailers with recent sales of at least $1 billion whose top-line annual growth rate had slowed to single digits. Some of these retailers had seen their bottom lines fall even faster than their top lines; others had achieved double-digit earnings growth and above-average stock market returns. Our analysis showed that the less successful retailers had continued to chase growth by opening new stores far past the point of diminishing returns. By contrast, the successful retailers had drastically curtailed expansion and instead relied on operational improvements at their existing stores to drive additional sales. This allowed them to increase revenues faster than expenses, which had a powerful positive impact on earnings.

That may seem like a simple strategy, but it’s one that most retailers do not follow, for three reasons. First, Wall Street and the capitalist culture celebrate—and demand—growth. Indeed, slow growth is regarded as something between a disease and a moral failing. When faced with declining growth, companies are urged to go back to the drawing board, rethink the business, and come up with a new strategy to pump up the top line. Second, leaders of many retail chains don’t know when to make the transition. Consequently, they keep expanding until their chains begin to collapse under their own weight. And third, growth companies and mature businesses require very different operating strategies. Many companies that excel at growth lack the capabilities to make the switch.

In this article, we explain when living with slow growth makes sense, providing metrics that can help retailers determine when and how to move from a high-growth to a low-growth strategy. We also offer a framework for creating a low-growth strategy that allows retailers to increase revenues faster than expenses by leveraging their existing resources. If retailers do this, they can stay in the maturity stage of the life cycle for a very long time, forestalling decline. Though our focus here is on the retail industry in the United States, we hope that companies in other industries will take the broad lessons to heart.

Read the entire article at Harvard Business Review

— The Option Specialist

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About the Author: The Option Specialist