Analyzing Retail Industry Disruption

Part One - Intro/Favorite Retail Industry Chart

While we all discuss the potential of A.I. for consumers, do any of us remember that e-commerce/digital was a major let down vs. original expectations for most (outside of Amazon)?  How does A.I. improve the quintessential Four P’s (Product, Place, Price, Promotion) of the Retail industry? Does that provide a sustainable competitive advantage or is it just another level of “table stakes” for the industry? 

I, like the rest of you, am trying to dig into the potential disruption from A.I. for the Retail industry.  My thought process always starts with history; therefore, I built a case study regarding what people initially thought about the last major disruption to this industry, e-commerce/digital, and how it ultimately progressed.  This will be a multi part series. Starting first with how do we measure this evolution?

Not all Retailers are the same – Introducing favorite chart from my Sell-Side Research days. 

Retail has some of the highest labor content per sales dollar across the economy, so this chart succinctly illustrates various difference in business models across the broader industry.  Corporates are often constrained by limitations of underlying business models; specifically, economics related to those models.  I recently updated this to gain a better sense of what A.I. disruption could mean to the Retail industry by using digital disruption as a case study.  Will get to that in later parts of this series but first wanted to dive more into the chart itself. 

Low touch business models, such as Wal-Mart are much more likely to have lower employee coverage levels than the high touch service business models of Specialty Apparel retailers, such as Victoria’s Secret, Abercrombie & Fitch, and Lululemon.  I always liked to view the range between Dollar General and Wal-Mart as about the best you can ever get in terms of longer-term sustainable retailer efficiency. 

I am sure many people have specific questions towards individual retailer results on this chart, especially the ones that stand out.  As with everything in life, there is always a reason, and I am happy to chat with you about those unique business model characteristics.  I certainly have thought about this subject for almost a decade.

Funny enough, I originally made this chart back in early 2016 and considered everything below Dollar General as the “Retailer Danger Zone”.  Almost half of those names have gone bankrupt since (JC Penney, Bon-Ton, Sears, Stage Stores, and HH Greg).  Lumber Liquidators and The Tile Shop barely avoided that fate.  That’s not to say everyone below this line should be considered in danger – Floor & Décor certainly isn’t as their business model and product category allow for impressive and somewhat unique efficiencies relative to broader Retail peers (unfortunately to those who saved Lumber Liquidators and The Tile Shop). 

But it’s not just about that specific arbitrary line.  There is a ton of information to be gained about the competitiveness of various business models by looking at this data within the underlying sub-sectors of Retail.  I will provide two examples to demonstrate. 

Fashion Retail

It certainly makes a tremendous amount of sense that Ross Stores should have less employee coverage than Lululemon.  But should Nordstrom have less coverage than Ross?  Not to pick on Nordstrom specifically, as it remains 2-3x higher the customer service content of its Department Store peers at Macy’s and Dillards.  Ross likely bought their product on massive discount relative to where Nordstrom buys its product, so can afford to invest a bit more in service (service here is probably more about keeping the shelves stocked and store relatively clean/presentable). 

When you start asking questions like this, you start to get into other inherent business model features of these names, such as the much cheaper rent that Department Stores pay relative to Specialty Apparel (including variable), but also how vertical integration can sometimes provide (with good product) substantially better gross margins for the Specialty names than Department Stores that have to split margin with Wholesale brands.  Department Stores today continue to benefit from an assumed traffic driver advantage that began to dissipate many years ago once the e-commerce shift accelerated.  How long that lasts is certainly up for debate but I suspect recent challenges in the Commercial Real Estate industry could accelerate the answer to this topic. 

Athletic Retail

This one indicates that Academy Sports is punching above its weight relative to the comparable business model in Dicks Sporting Goods.  Yet I suspect that is likely related to the main merchandise difference between the two, which is the relatively high AUR (average unit retail) firearm category (particularly as Academy is a bit more of a discount focused retailer, ergo the lower employee coverage).  Big Five seems to be a real under-performer here.  Hibbett and Foot Locker have a much higher mix of athletic footwear in their merchandise mix than all the others.  That category specifically requires a strong customer service offering for two reasons: 1) product is inherently technical and new, so you often need a knowledgeable employee to assist the evaluation process – see Best Buy in the expanded chart, 2) Nike and other brands typically give better allocations of “hot” product to retailers that present that product in the best possible manner. 

Last Thoughts On My Favorite Chart

With this one chart, we can understand many limitations present to any Retail business model.  Especially just how much any retailer can cut employee expenses without seriously jeopardizing their competitiveness.  We also can gain insight towards the marginal cost of potential growth.  And what exactly management needs to do employee wise to effect change within an organization.  As we track this metric over time, we can certainly gain a better understanding of the trend that any retailer is on. 

Now that we have an actual baseline to measure efficiency success in the broader retail industry, we can move forward to the next part of this series, which is the digital/e-commerce disruption case study.