The creative destruction of retail

The great Australian retail adjustment is happening now at a store near you.

  • Myer Managing Director Bernie Brookes recently announced the retailer’s plans for more serious efforts in online retailing, with $9million set aside to improve Myer’s online presence.
  • Target yesterday sent a letter to suppliers explaining why they are going to pay 5% less for all their goods from now on – take it or leave it (ht: Adrian).
  • Mark McInnes, head of Premier Investments, the owner of Dotti, Just Jeans, Portmans and Jay Jays outlets, has closed 19 stores and threatens to close more if he cannot bargain down the rents paid by his remaining stores.
  • Masters, the hardware joint venture between Woolworths and Lowe’s Companies Inc, opened its first stores early this month to compete with Bunnings in the hardware and homewares market.
  • Dick Smith has also had his say about the supermarket discounting wars and executive pay.

Not only are the retailers making some tough decisions, but shopping centre owner Stockland, whose CEO Matthew back in February noted the sunny outlook for their three Rs strategy – residential, retail and retirement – is finally coming to grips with reality and is rushing to offload a selection of retail property holdings.

The new and surviving businesses in the great retail adjustment will be far more innovative, and offer far better consumer value than the current crop.  This process of creative destruction is necessary to cleanse the system of outdated practices which no longer deliver consumer value.  For those who have witnessed the efficiency of retail practices abroad, it is clear that Australia has some catching up to do.

But the adjustment won’t be pretty for some.

One unfortunate part of the great adjustment is the likely fall-out on employment in the sector.  The retail sector employs one in eight people in the labour force, and is heavily dependent on casual employees, making it a likely source of unemployment as economic unease continues.  These shop assistants won’t be immediately snapped up by the mining, gas, and engineering investment boom.  I also expect a significant scale back on the uptake of ‘Christmas casuals’.

There are a few scenarios I think might play out during this retail adjustment.

First, a new click-n-brick department store retailer will enter the Australian market, while some of the incumbents will adopt this model (as Myer seems to be considering).  Like Apples famous stores, the physical shops will serve necessary customer interaction roles – pick up and testing of goods, trying on clothes and shoes, handling refunds and exchanges.  There will be fewer of these stores, they will require much less floor space and they will require just a few expert staff.  Transactions will mostly take place online, with either store pick up or home delivery options.

Second, many large department store and supermarket retailers will find a more efficient use of floor space.  Supermarkets might take a few hints from ALDI, or take the alternative path of a combined warehousing and retailing model, much like Costco or Ikea.

Third, online food and grocery delivery will find a leader.  The home delivered food and grocery market is very fragmented and localised, with fresh produce boxes, and local milk and dairy, businesses demonstrating that demand for this service is strong.  Supermarkets are testing the water with home delivery, but I expect one leader to emerge with model that really masters the home delivery niche.

With a fear of debt continuing to restrain household spending, competitive pressures in retail will continue for some time.  While I have no idea which companies will mostly nimbly negotiate the challenges presented in this period, I am certain that Australian consumers will be better off.  Unfortunately, the cost of this great adjustment will fall on those employed in retail with limited options for employment in other areas.

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  1. Spot on. IMO there are three big drivers of Aussie retail uncompetitiveness – lack of innovation especially online, high wages and high rents. These will all be addressed in order for it to be successful again.

    IMO the AUD could depreciate 30-40% and the trend would remain the same – people will increasingly shop overseas online because its a) at least 50% cheaper in many cases b) easier.

  2. IMO the employment adjustment will come after Christmas 2011 and the ‘sales’. I think most businesses will hold on until then – in hope? – and once Christmas confirms how bad things are, cost cutting in the form of headcount reductions will truly/sadly be on.
    That of course has a massive flow on effect to housing and construction. 2012 is my pick for the hard landing here, confirmed by June 2012.

  3. Nasty impliations for commercial real estate, with so many poor quality buildings outside the big malls that are/will be vacant.

    I have no sympathy for the retailers who revealed their margins and trashed their cred by steep discounting for vol in the GFC. The Myer chart since listing at $4.05 in November last year is a shocker. So is David Jones over the same time. Woolies has gone nowhere for 5 years.

    The current high consumer savings will take a few years to restore balance sheets. We will see a new reail landscape by then. Meanwhile: Avoid.

    • Can’t wait for Abbott and Hockey to win the election early next year. They will prove once and for all their right wing theories are no better than those of the left. Have a guess who gets to pay?

  4. Transition is not that easy.

    Coles and Woolworths current enjoy a duopoly on the Australian retail market. Any new player coming into the market must deal with the huge fixed cost in real estate, and the ability of the duo to cut price and drive you out of business.

    By encouraging the shoppers to move onto the internet, the protection from ‘fixed cost’ will disappear. Online shopper only care about price. Further more, there is nothing that will stop manufacturers from bypassing the duopoly control and sell directly to the public. The legendary profit margin enjoyed by the retailers will be gone.

    This is the dilemma for retail : reject the internet and suffer a slow death, or embrace it for an even quicker death.

    On final bash at Target’s ‘5% discount or we don’t buy from you’. Unhappy suppliers deliver substandard goods, and there is no profit margin if the item cannot sell. Trimming cost should start from inside the company.

  5. Hmm bad news for soon to be graduates. They can rarely find a job in their discipline of study after studying four+ years so they turn to retail for quick money while they suit up every 2nd day for an interview for a mail mans job in a big firm in the hope of climbing the corporate ladder.

    I can see a lot of students moving back in with their parents putting further pressure on the unfortunate boomers who didn’t get rich from sky rocket housing prices or on the ones who have over leveraged.

    Big social changes are to come about, boomers children won’t move out until they marry like it was pre 1970 or until they are in their late 20’s and have a successful job and can afford to live independently with all the perks of living at home.

  6. I know of a very substantial property trust that is already looking at models for converting traditional sites in to newer style retail formats (along the lines you mention plus some even more innovative concepts.). They’re even happy to let tenants out of their leases to ensure they have empty properties to do so (they really don’t care if they move or go broke). It will be very interesting to watch as it unfolds.

    Also, don’t confuse online grocery with fresh fruit and produce – Much of this demand is driven by a desire for quality and freshness – price is not the primary driver. The supermarket’s habit of buying up cheap crap fruit,veg and other perishables has fed this demand. IMO, the emergence of a leader in non-perishable grocery won’t drive the type of consolidation many may think.

  7. Economists (like the ones at the OECD) are finally starting to tumble to the reality pointed out by Don Brash and Owen McShane in NZ as far back as 1996, that “pro cyclical” regulations of housing markets will flow into cyclical volatility in the rest of the economy too, especially retail.
    The “artificial boom” effect of people cashing out equity from inflating house “values” during a housing bubble, can inflate GDP by 2 or 3 percent. Re-look at your GDP figures in this light, and you will see just how FUNDAMENTALLY sound your economy ever was.

  8. Out of interest, why don’t more businesses buy the real estate they operate out of, or for bigger operators like Coles & Woollies to build their own stand-alone stores and avoid having to deal with Westfields etc?

    A cursory look at commercial lease costs seems to suggest that if you have a solid business, this would be the way to go longer term.

    • Both Coles and Woolworths have done this. It goes in cycles. They generally build stand alone supermarkets (with a few specialties – so a neighbourhood centre) in regional or non-core locations that cannot support a bigger centre or where that centre cannot support them. Then they eventually decide they don’t like having all this property on their books and they sell it off with strong covenant and long lease terms. They have done the same thing with their industrial/warehouse/distribution centres over the years.

  9. Not all retailers have done badly – ORL has done extremely well over the past 3 years.

    I wonder how they’ve managed to deal with Dave’s “lack of innovation especially online, high wages and high rents”?

    (This is not a rhetorical question.)

  10. Just repeating what I said elsewhere – equity withdrawal from increasing property values in the last 10 years added roughly 10% extra spending power to homeowners. With that now gone retail needs to shrink by 10%.

    The RBA recently reported that saving and paying down debt now accounts for over 8% of disposable income, so thats nearly another 10% less retail required.

    Add changing spending patterns (online, buying services more than products), and we really only need 60-70% of the retail outlets we currently have.

    We are going to see a lot of empty retail space and with it a steep rise in unemployment – as someone said recently “the girls who work on the perfume counter at Myer aren’t going to be absorbed by the Mining sector”