Markets & Economy

It may feel like we’ve been picking on retail for the past few years, but it hasn’t been without reason. The consumer retail sector has historically been a hotbed of creative destruction, and this time is no different.

Even in normal times, buyer ‘wants and needs’ are ever changing. Products that were once fashionable quickly become dated and drab. Services that once felt luxurious eventually become table stakes. Consumer desires evolve, and their expectations for a positive experience keep rising.

What constitutes a great experience has also changed. Technological shifts have caused consumers to demand new, better experiences than they had before, and those companies that have been slow to adapt are suffering.

Too Much Retail Space

Most trends in traditional retail could simply be described as problems, and the biggest problem is excess supply. In the United States in particular, there are way too many big box stores selling too few differentiated goods.

For example, the US has far more retail square footage per capita as the next closest country, Canada, and even Canada has far more than the next closest. Compared to its Western competitors, the US is significantly oversupplied with retail real estate, and all this excess space can only work if retailers actually need it.

Enabled by the expansion of the internet, people now can shop online anywhere, anytime, for anything. This includes traditional in-store retailers, but also to niche sellers of unusual or highly differentiated goods. Try as it might, the local mall cannot possibly have the same breadth of selection as the entirety of the internet.

These two forces, excess supply and deteriorating demand, have created a challenging backdrop for many so-called ‘brick and mortar’ traditional retailers. The trend has accelerated over the past several years, and we’ve chronicled these issues in prior articles.

Source: GGP Retail Real Estate (2017).

Trends Accelerated by COVID-19

It almost goes without saying that traditional brick and mortar retail has been hard hit by the pandemic. On top of existing challenges, the losses could be devastating.

This year, retailers JC Penney, Neiman Marcus, and J. Crew filed for bankruptcy protection to continue operations, while Lord & Taylor and Pier 1 Imports filed for bankruptcy to liquidate operations completely. Some stores may survive the bankruptcy process, but a sizeable amount of capacity will be coming out.

Additionally, Macy’s, Dillard’s, and Saks are all facing liquidity constraints that will impact their ability to compete going forward. For example, Macy’s suppliers recently lost insurance, a supplier backstop should Macy’s fail to pay. This will impact Macy’s ability to secure quality inventory going forward.

Many healthier companies are also facing store closures, or even an acceleration of existing store closure plans. These include well known retailers such as Kohl’s and Bed Bath & Beyond. The impact of all these closures will be far reaching, and it is likely to materially threaten malls across the country.

The CEO of PVH Corp—owner of Van Heusen, Tommy Hilfiger, Calvin Klein, and other brands—recently commented that COVID-19 could result in the accelerated closure of 20-25% of the US retail industry stores over the next 2-3 years.

Opportunity Amid Disruption

The clear winners are those best able to capitalize on these accelerated shifts, and we see them as breaking into two buckets.

The first type of winners are those retailers with enough scale to compete on price. These can be digital-first enterprises, but also traditional retailers that are sizeable enough to effectively control costs. In many cases, a competitively priced ‘omnichannel’ offering—the ability to shop online and pickup in-store—can even become a preferred option for many customers.

On the opposite side of the spectrum are highly differentiated, niche retailers. These businesses include very focused traditional retailers, as well as many small and local retailers. Differentiated businesses are able to provide unique goods or services beyond what could be offered in a broad, mass market shopping experience.

Retail is transforming, but just because there is immense change does not mean there are not opportunities. We believe the process of creative destruction is a good thing, and we are actively looking for select areas of opportunity to capitalize on the disruption.

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This material contains the opinions of Manning & Napier Advisors, LLC, which are subject to change based on evolving market and economic conditions. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.