Controversial

Physical Retail’s 2 Percent Solution

Online competition is hammering brick-and-mortar stores, as in-store sales continue to fall. To protect their market shares, U.S. department stores must generate 2 percent top-line growth, a new Fitch Ratings report suggests. Ironically, mu

The urgency for department stores to react to declining in-store sales caused by online competitors has been widely reported. Now there’s new data that show just how much they need to bolster sales to stay competitive or, even worse, survive.

In a new report, Fitch Ratings suggests U.S. department stores would need to generate top-line growth of 2% or more to protect their market shares as online shopping and other factors threaten their revenues.

Indeed, as department store sales decline, sales of traditional department store merchandise – specifically apparel, accessories and home goods – are still growing at rates in the low-single digits, Fitch notes. Online shopping is becoming an increasing threat for department stores and other brick-and-mortar specialty clothing, accessory and home-furnishing retailers and is accounting for much of the sales growth in those categories.

Moreover, Fitch says, sales productivity within department stores has meaningfully declined, as sales for the top-10 U.S. department stores in
aggregate have remained essentially flat since 2001, despite square-footage growth of approximately 18%. Fitch expects that secular and competitive pressure could lead to more store closings or potential restructurings over the next 24 to 36 months.

Such a decline would have negative implications for retail traffic patterns and competitive dynamics within malls, especially where department stores are anchor tenants, Fitch said.

The decline occurring in shopping-mall sales became widely evident during the recent holiday season. And the trend’s potential sustainability became clear when various big-box retailers, including Target, Walmart and Kohl’s, recently reported drops in first-quarter sales.

To help improve its sales generally, Target is working quickly to drive more newness in its merchandising and presentation, John  Mulligan, Target chief financial officer and interim CEO, said during a recent call with analysts. Digital visits to Target were up more than 20% from a year earlier, and the company is looking to accelerate its digital transformation and become a leading omnichannel retailer, he added.

“To do this, we will move more quickly to become more flexible in how we serve our guests, eliminating barriers that prevent them from shopping with us where and when they want,” he said. The company also is increasing its in-store promotions to help drive traffic.

Department stores are the most pressured category in domestic retail, Monica Aggarwal, Fitch Ratings senior director, said in a statement. “Department stores that actively invest in and manage both physical store space networks and online platforms are strongly positioned to generate incremental sales and gain market share,” she said.

Industry growth of 2 percent could be achieved by relatively flat to modest comps growth at the store level and mid- to high-teens growth from online sales for retailers that now generate 10% of their revenue from online, Fitch estimates. Online growth of 15 percent to 20 percent would translate into a 150 to 200 basis-point contribution to overall comps, it added.

Fitch does not expect promotional activity to abate given the fight for share among the traditional brick-and-mortar retailers and strong growth in online sales. As a result, it believes gross margin for the sector could remain under modest pressure in 2014.

Despite the mounting pressures on in-store sales, some traditionally online-only stores are adding a brick-and-mortar presence. In today’s omnichannel environment, it pays to have a presence in both online and offline environments, while also supporting a mobile online-commerce presence. But the challenge is to make a profit at both ends of the commerce spectrum.

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