Shut up shop

Research findings out today show that 896 stores disappeared from Britain’s town centres in 20161. On average, between 14 and 15 stores were closed every day, while only 12 stores were opened. It also showed that Britain’s town centres are shifting towards ‘leisure and experience’ destinations, like coffee shops and gyms, and away from ‘traditional retailers’, like clothes and general merchandise.

I wasn’t surprised by these research findings, and don’t think many others will be either. Most of us will have seen the changing landscape of our own local town centres, and seen the high profile failure of household names like BHS. In fact, only a couple of weeks ago Jaeger – another well-known retailer, which can trace its roots back to 1884 – entered administration, putting its 46 stores at risk.

In my opinion, the prognosis for many of these ‘traditional retailers’ is bleak, and in some cases terminal. We will continue to see shrinking town centres, and more ‘traditional retailers’ entering administration. The ailment that afflicts them is online shopping and, sadly, there is no cure. Online retailers can provide a superior consumer experience in many respects, and there is little traditional retailers can do about it.

For example, online retailers can not only offer a far greater range of products, but they can also shift them more quickly in order to meet consumer tastes. This is because online retailers operate from large distribution centres, which can hold a huge range of products, and where it is easy to replace one product with another if consumer preferences change.

Online retailers can also offer superior prices. This is partially because their business models are less labour intensive and they don’t have to pay rent on a network of stores. But, it is also because they are willing to invest significantly in prices and generate very low margins, enabling them to grow quickly and gain market share. This is understood and often encouraged by their shareholders who prefer sales growth and market share gains over profits.

More consideration is needed when examining who provides a superior service. With a traditional retailer, going in-store means a consumer can get advice, will receive the good immediately and, if necessary, return the product easily. If the store has an online presence, customers can also use ‘click and collect’ services. However, these are all areas in which online retailers are constantly improving, and any advantages traditional retailers have is being eroded. Many online retailers already allow shoppers to read reviews and get advice, and from a customer service perspective, delivery times and costs are decreasing while free-returns are becoming the norm.

Unfortunately for traditional retailers the online retailers are getting more aggressive. They see themselves in an ‘online arms race’, reinvesting all the benefits from their growth back into the business to provide even more superior products, prices and service to their customers. This then drives further growth, the benefits of which are also reinvested. This is a continuous process which extends the position of online retailers compared to traditional retailers.

Most traditional retailers are acutely aware of the challenges above. However the solutions are hard to find as they reflect a structural difference in business models. They are not to blame for the situation they are in. In many cases they are trying to find solutions, but just like the typewriter vs. the computer, or the horse vs. the automobile, there is little you can do when you are faced with a significantly superior replacement.

The stock market is aware of these trends and as result online retailers trade at a significant valuation premium. As a growth investor I am attracted to the high growth and structural advantages that online retailers offer, but I recognise that expectations are high, and these businesses need to continue to grow strongly to justify the valuation. In contrast a value investor might look at a ‘traditional retailer’ on its low valuation with strong cash flow, and argue that the market is being overly pessimistic on its outlook. Both can be successful investments, but over the long-term it seems clear to me which business model will win2.

Matthew Hall

 

1. Source: Independent newspaper, 12/04/2017
2. This is an opinion. It is no recommendation to buy or sell any particular security. This communication has not been prepared in accordance with legal requirements designed to ensure the impartiality of investment (strategy) recommendations and is not subject to any prohibition on dealing before publication of such recommendations.

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Author - Matthew Hall

Matthew Hall

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