Amazon Isn't Killing Physical Retail

By Daniel B. Kline and Sarah Priestley Markets Fool.com

With all-too-frequent news of store closings and bankruptcies for physical retail chains like Wet Seal and Sports Authority, it can be easy to buy into the myth that e-commerce is replacing physical retail -- but that's far from the whole story.

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On this Consumer Goods episode of Industry Focus, analyst Sarah Priestley and contributor Daniel Kline explain how the physical retail industry is still very much alive and kicking, and what investors need to know about the space. Find out why some retail stores are failing while others are growing, which retailers to watch, what investors should look for to see how well they're handling the transition into the post-Amazon(NASDAQ: AMZN) retail world, and more.

A full transcript follows the video.

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This video was recorded on April 25, 2017.

Sarah Priestley: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It'sTuesday, April 25, andwe're talking consumer goodsand exploring the supposed death of the retail industry. For today only,I'm your host, SarahPriestley, andjoining me in the studio all the way from sunny Florida is ourMotley Fool contributor Dan Kline.

Daniel Kline:
Hey,Sarah! We've been talking about doing this for over a year.

Priestley:
We finally made it, but you have the B-list presenter today. I'm really sorry about that, but Vince is on vacation.

Kline:
It's funny. For ouraudience, I should probably point out thatpresenter means host.[laughs]

Priestley:
Host, sorry.

Kline:
NormallyVince is the host, andSarah is sitting as the host today.

Priestley: Fantastic,thank you for the clarification that we are not on a chat show. I'll divestraight into what are topic for today is: thesupposed death of the retail industry. Retail spending as a whole,according to the Census Bureau, is up5% year over year, and up 17% in the last five years. But the conventional wisdomas you described it in one of your recent articles,is that the retail industry is kind of dead, it's dying. Andthere's a lot of enthusiasm for that, and I'll play devil'sadvocate here for just a minute and go into that. On the surface, there's a lot of evidence that backs up that point. In the past year or two, we've hadbankruptcies fromPayless, The Limited,Wet Seal,Gander Mountain,Sports Authority, andrecently we're seeing a lot of news about store closures.Macy's(NYSE: M)is closing 100 stores, J. C. Penney(NYSE: JCP) over 100,Sears(NASDAQ: SHLD)-- 78 Kmarts, 26 Sears locations, and they've even admittedsubstantial doubt in their ability to keep the doors open.

Kline:
It'sone of those things where what you seeisn't what's actually happening. Youwalk around the mall --we were talking about this upstairs -- the mall near me, the lower-grade mall, about a third of it has become thefake edificeswhere they put a vending machine and a "Coming Soon" sign, and there's nothing there,because a lot of stores have gone out. RadioShack is one you didn't mention, they've closed 1,000 or 1,100 on their way tocomplete oblivion, their second bankruptcy. You look and go, "Oh my god, mall retailers are closing." My Macy's closed,the Macy's I could walk to from my houseliterally closed. And it would seem like that makes sense. The narrative is,the internet is killing physical retailers.

Priestley:
Yeah. TheAmazoneffect, as people call it.

Kline:
AndI believed it as well. And thenI went to the Shoptalk conference. I mention this because this research came from a gentleman namedKasey Lobaugh fromDeloitte. What he pointed out, and he only showed one quarter's worth of data, and the people who track retail data,National Retail Federation and others, they don't break outinternet versus physical retailer sales. So,this is a bit elusive. But, what he said is, during the fourth quarter, the holiday season, the overall dollar growth ofphysical and online was about the same, it was $12 billion each. In terms ofphysical retail, which is much bigger, that turned a 2%-3% gain. On the online side, it was 13%-15% gain. But,the reality is, what we're seeing is,failing stores are closing, andthere are plenty of chains that aretaking their places. If you look in the discount space,Dollar Generalis opening 1,000 stores this year, and they opened 1,000 last year. Even chains that have a perception of struggling, likeTarget(NYSE: TGT), are opening and adding. Target is going into markets thatWal-Mart(NYSE: WMT) had decided to not go after, which is cities, and they're putting in 20,000-30,000-square-foot stores, about 20% the size of their regular stores. You're seeingfragmentation and a shift in retail. Today,there was a story thatWarby Parker, theyeyeglasses people who both of us would probably do well to visit, is opening more retail stores. So,you're absolutely seeing the Amazon effect killing certain retailers, but it'salso creating opportunity for other retailers.

Priestley:
Absolutely. I think theretailers that are being rewarded are the onesthat are actually listening to their customer andunderstanding what their customers want. As you quite rightly pointed out, retail as a whole is growing. E-commerce isgrowing at a faster rate, but e-commerce as a wholeis growing. I thinkMoody'sestimatesthe discount environment to grow 7% this year. Obviously,people are still going to the stores. It'snot like we're going to be telling our grandchildren what a shop was like and staying inside all the time. So,why do you really think that some of these stores have it right,and what do you think investorsshould be listening out for?

Kline:
If you'reDollar General, you're competing on price, you'rebasically going in and saying, "Amazon might be as cheap or even cheaper, but I have it now." They have hitthe sweet spot when it comes to pricing. But a lot of the chains that are working areones that offer an experience.Best Buyhas turned the corner, and part ofthe reason Best Buy succeeds when we just losthhgregg is, when you walked into hhgregg, it was very 1980s retail experience. There wererefrigerators over there, there were stereos over here, there were computers. There was nothing joyous or interactive about the store. When youwalk into a Best Buy now,you can go play with aNintendoSwitch,you can go sit in a chair and try out different audio systems. There's stores within a store, which is a conceptJ.C. Penney is using, too. We've talked, I have a background in retail, I ran a giant toy store for two years. If yougive people a reason to come in,it could be as simple asthere's a coffee shop in my book store andpeople want coffee,if they have to walk by all your merchandiseon the way to the coffee oron the way to play the Nintendo Switch oron the way to get a haircut at JCPenney ortake their picture at Sears or wherever it happens to be,that's a chance to capture them as a customer. So,retailers have to think smarter.I think that's something that Macy's missed out on, and Searsreally missed out on. Yougo to Sears now and they're struggling, andit's still hard to find the merchandise you want. They have not made them. AndI buy clothes at Sears sometimes, they have notmade the shopping experience easy. Thealternative is, I can go to Amazon and say, "I want pants, I want this size and color," and in two days they show up,and if they don't fit, I'm supposed to return them but I don't, soAmazon just gets another pair of pants sales from me.

Priestley:
Absolutely. I was listening to a webinar that wasdone by the same guy from Deloitte, andone of the things he was mentioning was, thedepartment store constructactually doesn't work well for aholistic, natural kind of shopping experience. The example that he gave, which I'mgoing to paraphrase, is thatwhen you go to the luggage section, you may want to buyluggage for your vacation, andwhat would be great to have with this iswomen's summer dresses and bikinis and flip flops andall those kinds of things. But because they'reterritorial about the space allocation, they'reincapable of being flexible toprovide customers want.

Kline:
Butyou are seeing more of that. We talked about Target before. The new Target setup that they'restarting to roll out, I think it's about a third of their stores this year, isgoing to have one entrance for Grab & Go. So, you walk in, you want a snack, you want a drink, maybe they've found thattoilet paper is something that people just want to buy and leave, they need toilet paper --that's a terrible example. The second entrance isgoing to be clothing and seasonal items and things people take more time to buy. So, as a retailer,you have to align your store to your market. It'svery simple. If I walk into a liquor store, they'vefigured out a long time ago toput the gin next to the tonic, and that the olives shouldprobably be somewhere close by. But when you walk into a Macy's, shoes and socks arenot necessarily in the same place, or pants and belts, or totake it, as you did, to another level, where you go to these more esoteric connections. Youneed to see more dynamically changing stores, where they'reseasonally really making movesto captivate customers. Andyou have to just make shopping fun.

Priestley: Yeah,absolutely. I think another thing is, a lot of these retailers sell things that areso easilycommoditized online. Andlike you said, if they don't have that experience element to the shopping experience, they'regoing to lose out. If you takeHome Depot, for example, their stock is up 10%this year, which is completely different from the restof the retail environment. They offer something that you really can't replicateonline. They have expertswho are going to give DIY-ers advice. Youcan't really sell lumber or deliver lumberand paving slabs that easily. AndI admit that that's verydifficult to transfer to clothes and things like that,but it's a similar principle. You're getting a lot moreof a value proposition.

Kline:
There'salso an immediacy. Obviously,if you're going to buydrywall at Home Depot, you're either going to pay them afortune to deliver it. It doesn't really matterif you come into the storehow you get it. But if your sink is broken and you need aplumbing piece, you don't want to wait for two days. AndAmazon has some methods of dealing with that. They have apatent application on a truck that drives around that can 3D print parts like that. Butuntil things like that exist, a lot of the demand at a store like Home Depot is, "It'sSaturday and I'm free and I'm going to build a fire pit outside." Or, "Oh my God,my toilet doesn't flush anymore,I have to get the pieces to do that." Butother retailers have to figure outhow to make that happen. Do you buy clothes online?

Priestley: No, I don't.I don't buy clothes online becauseI would like to try clothes onand feel them and everything else before. Andwhat my husband believes isgoing to happen is that you almost have a showroom where you go andtry the clothes on and then order them and they are delivered at home. I don't know if I buy into that,because I very much like to feel the weight of what I've bought when I've bought it. But,that's another possibility.

Kline:
I do a mix. I will go to aKohl'sor Macy's andI'll buy a shirt. Andif I like the shirt, I will then by 10 more of the shirtonline. I agree, especially with women's sizing, a small doesn't mean things the way, men's sizes are moreexact in terms of inches and length. So,it can be a challenge. But I thinkthe tools are eventually going to make it soyou can virtually try things on.

Priestley:
That's true. I wonder how much they'regoing to catch on. I know there's a lot of tech disruptionpeople are talking about. [Virtual reality],you can look at a screen and it will try on the clothes for youwithout you having to actually go into a changing room. I don't know how much they're going to catch on, andif that's really where the tech disruption is happening. I think the tech disruption is happening much more in terms of the granularity of information that you have over your consumers'social media campaigns, all those things that probably weren't available when these big stores were established. But,I really think, as you said, they could take lessons from these nimble start-up companies that have entered the market with zero barriers and are really cashing in on where the retailers are failing.

Kline: AndI think one of the things you're seeing with Wal-Mart,which is another retailer that's had its strugglesbut is quietly growing and adding stores, is the trueintegration of "buy online, return in store." I buy from Amazon almost every day. And I joked earlier, butif I buy a shirt and it doesn't fit, the odds ofme going through the trouble of returning it are very, very low. Ifall I had to do was walk to the mall anddrop it off at the Amazon kiosk,that would be a lot easier. For now,Target, Wal-Mart, evenCostco isplaying with this a little bit, have that advantage thatyou can buy something digitally, and when it doesn't work out,it's a lot easier to return it thanhaving to figure out how to getUPSto pick up at your house.

Priestley:
Andthat's really a small example of a bigger problem with this. Omnichannel, for a lot ofthe traditional retailerCEOs, really means you haveyour store and you have your onlinepresence, whereas those things,those two things are basically integrated, they'reessentially the same thing. We are online all the time,I can be in a Target store andchecking on Amazon to do a price comparison. It's those kinds of things thatI think they need to stop looking at it like, "5% of revenueis from mobile and 95% is from in store, soall my focus needs to go on the in store," andactually focus on the two thingsas an integrated experience.

Kline:
Marc Lore from Wal-Mart, whoruns their digital operation, talked about this. I think more chains needto bring in digital-first people and empower then.

Priestley: Absolutely,he came from Jet.comthrough the acquisition.

Kline: Andhe created Quidsi, which is Diapers.com. He's been a serial success-failure. He's hadcompanies that weren't making any money that scared Amazon. First Amazon brought Quidsi, and then Walmart bought Jet, which was a company losing money on $1 billion in sales. He's a reallyinteresting case. When you inject himinto this old line way of thinking at Walmart, he goes, "Wait a minute,we are not going to compete with Amazon by selling a Prime knockoff. It isn't going to work. Solet's just give it away." Youhave to be willing -- this is a very tough thing for a retail CEO to deal with -- to have some bad quarters,because you're going to cut into your margins, you'regoing to do a lot of negatives. But if you can capture acustomer and have a good experience, Ibought some things online at Kohl's, and theyshower you with discounts andall sorts of other ways to get you back,it was a pleasant experience andI would absolutely buy from them again. And I think that's what more of your Macy's and your other chains --it might be too late for Sears, I'm not sure Shop Your Way, which they talk about being the future of the company, has any customers. Butyou really need to break everything and figure out, "I have this asset, these physical stores, how do I keep my customers a customer whether they're coming into that store or not?"

Priestley:
And on that point about the physical stores and the size, I'm interested to get your opinion on whether all of this space is still going to be saved, because I have aninteresting statistic. The U.S. has six times moresquare feet per capita retail space than the U.K. Andobviously, so that is the availability of space. But,that's a huge amount of retail space. Can all of this be used?

Kline:
No. It's too much. We talked a lot about this --there's jokes on The Simpsons about the sad mall, butmost communities have the sad mall, whichmaybe has the C-levelMacy's or JCPenney's as the anchor, and it's the only mall that has some local stores, andmaybe one of those places that sells $49 suits. I think you're going to start to see -- and,actually, we talked about this a little bit upstairs -- the new mall is going to push out the old mall. You'regoing to see closures. There's a demand for housing,so you're going to see a lot of conversions. We havetoo much retail space. There were a lot of articles this weekabout how difficult it's going to be to fill the 300-something hhgregg stores. There'sonly so many trampoline places that can go into a town, or movie theaters. And yeah,some malls can be anchored by grocery stores. But, no, we have too much space, and there's going to be an absolute pullback in that area.

Priestley:
Theconcluding thoughts on that basis, then, is that some are going to lose, but generally, if you can target your customer, if you can meet your customer where they're at,you can still make the most of the space that you have.

Kline:
Yeah.I think you have to do what JCPenney is doing andlook at your stores, andmaybe get rid of some of them. Or, change locations.Applenear where my mom lives, inSalem, Massachusetts, was in the mall. They'verecently moved to an outdoor plaza, because they found thatif you're going to get your iMac repaired, it's a giant pain to walk a 27 inch computer through the mall, drop it off, then come back andpick it up, whereas if they could locate in this lifestyle plaza, you can parkright in front of the store,you can walk in, and it's a much easier shopping experience. So, I think stores and retailers need to examine on a store-by-store, location-by-location basis, does this location make sense? CanI make better use of the space? Can I bring in vendors or partners? Are there services? IfI'm a JCPenney,should I double down on salons,should I put in a massage studio, should there beyoga atBarnes & Noble(NYSE: BKS)? Who knows what else. I've joked for years that Barnes &Noble should put in music lessons becauseit would be a very logical tie-in to what they do,and they already sell all the books. You should belooking at diversification and capturing people and going beyond shopping. There's very little that you need that it isn't easier to get from Amazon. So,if the experience isn't enjoyable,and there isn't a nice cup of coffee or a frozen yogurt or something that's part of the experience, thenyou aren't going to leave your house.

Priestley:
You said double down,that was the phrase you usedon the concept, andI think that's exactly right. Theproblem with department stores now isthey're trying to be everything to everybody,and have not really been successful anywhere. I think thesecompanies need to know who their audience is, who their consumer is, and reallyfacilitate what they want. Barnes & Noble yoga classes sounds ridiculous, but ifBarnes & Noble's cafehas a lot of stay-at-home mothers and young students thatmight be interested in doing things like that, then it's a great idea.

Kline:
Ifyou're Barnes & Noble, you're locked into leases, very long-term leases, in a lot of cases. And you used to stock music, DVDs.

Priestley:
Those things used to exist.[laughs]

Kline:
Youdon't need those anymore. And while they've brought in games andsome other sort of incidental retail, mostBarnes & Nobles locations have big, empty spaces. So,what do you do with the space? You couldmake it a day care, you could make it a yoga studio, you could make it music -- you know, privacyplaces, whatever it is, figure out how to monetize that. Retailers use a formula where they look at,how many dollars is this square foot producing? If it's justpicnic tables where people canread your magazines for free, it's not producing any dollars. There's a lot of low-impact ways -- bring in an outside vendor. What'scompatible to book sales? Maybe women's shoes are up. Super logical. You find there's acorrelation, maybe it's pet supplies.I don't know what the answer is. But, do those studies, and go to those vendors. If you go to Wal-Mart incertain markets, there's eyeglass places that are not Wal-Mart, there's Music and Arts,which is a chain of music retailers thatspecializes is mostly in elementary school kids and lessons. Find the things your customers want and bring them in. Even if it's just a breakeven, they're going to shop at you more.Costco worries about frequency of visits. The reason theyessentially give away gas is because you'regoing to come to Costco more often, you'regoing to be more tied to them, you're going to renew your membership, maybe you'll buy more stuff. Every store needs to think that way.

Priestley:
So, final thought, if I'm a Macy's or a Sears investor, what would youadvise me to listen out to,and in the earnings call, what would you want to see from management?

Kline:If you're a Sears investor, don't believe anything they're saying. It's a bit of a shell game. Vince and I have talked about this at least four or five times. If you have $2 billion in assets and $8 billion in debt, you might be able to use your assets for a certain amount of time to forestall your debt. But if you haven't fundamentally changed your business, which they have not, then you're in real trouble. Macy's is a different story.Macy's is a profitable companythat's not as profitable, that'sstruggling. I would look at,are there really new ideas? Are theydoing things differently? Are theymaking bold changes?I would like to see Macy's testing 10 concepts that seven of them sound crazy to see what they are. Maybe they'rerenting out birthday party clowns in one store, andthey are putting an upscale cafes, whichI think some Macy's actually have. But,find different things, try different things. Also realize that if you'reMacy's, the negativity ispartially because you are a publicly traded company, which isexpected to grow, grow, grow. As a private company, whichcould happen, there has been some interest in buying them, they're astable business that just needs to pivot. They'renot a failing business the way Sears is.

Priestley: OK. Well,that's great, thank you very much. Dan,do you have any more final thoughts?

Kline:
I'm just happy to have done this. And you got through it! Sarah was verynervous as we headed into this.

Priestley:
Well,I have big shoes to fill with Vinceusually hosting this.

Kline:
Lots ofjokes I could make about Vince's shoes there. Butwe look forward to having him back.

Priestley:
Listeners, that does it for this episode of Industry Focus. Ifyou have any questions or you just want to reach out and say, "Hello," shoot us an email at industryfocus@fool.com, or tweet us @MFIndustryFocus. If you'relooking for more of our content,subscribe on iTunes or check out the Fool's family of shows at fool.com/podcasts. As always, people on the program may own companies discussed on the show, and The Motley Foolmay have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. For Dan Kline, I'm Sarah Priestley, thanks for listening and Fool on!

Sarah Priestley has no position in any stocks mentioned. Daniel Kline owns shares of Apple. The Motley Fool owns shares of and recommends Amazon, Apple, Costco Wholesale, and Moody's. The Motley Fool recommends Home Depot. The Motley Fool has a disclosure policy.