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Why retailers need to revisit their real estate strategies

Author: Jon Graub / Peter Lynch 

Source: Retail Dive 

The longstanding formula for ramping up real estate — running a competitor analysis once a year, shuttering the worst of your stores and trying to win some concessions from landlords — needs an update.

No, Amazon is not destroying all of brick-and-mortar retail in one fell swoop. The truth is that stores that fail to resonate with today's customers are the likeliest to run into trouble. Nevertheless, the market is changing in ways that call for new approaches to retail portfolios — especially among chains that expanded aggressively during the go-go years. Below are four steps toward ramping up real estate productivity.

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Stop delaying tough decisions

The practice of delaying tough real estate decisions is common to publicly traded giants, regional retailers and mom-and-pop operators alike. The reason is simple enough: Maximizing real estate always comes with upfront costs, whether the task is shrinking footprints, getting out of bad leases, moving to new locations or revamping top stores. Naturally, cost-conscious retailers can be reluctant to set aside funds for these types of moves. Among the larger operators, shuttering stores can also trigger alarm bells on Wall Street — never a pleasing prospect for decision-makers at these companies. Our firm recently worked with a struggling chain that waited far too long to close 300 underperforming stores. The delayed decision caused this operator to hemorrhage money on low-volume locations that should have been axed years ago. To stay competitive, retailers of all types and sizes need to be proactive and do what is best for the long-term health of the business.

Make portfolio reviews a top priority

Not so long ago, chains could make do with annual portfolio reviews focused on the performance metrics of individual stores and the latest site-selection decisions of their direct competitors. Blockbuster Video, in other words, would take a market-by-market look at real estate decisions by Hollywood Video. Today, the rapid pace of change means that portfolio reviews should be conducted at least twice a year. Are you paying above-market rents at properties with declining prospects due to anchor vacancies caused by recent bankruptcy filings? How fast are the demos changing in the different markets and submarkets in which you operate? Portfolio reviews have a long-term dimension (the multiyear histories and performance of individual locations) but they increasingly have a more urgent imperative as well — the need to grapple with change as it occurs. So far this year, the likes of Payless ShoeSource, Charlotte Russe, Shopko and Gymboree, to name a few, have filed for bankruptcy. What names will be added to this list six months hence? In a marketplace that tends to brutally punish those that wait too long to respond to change, portfolio reviews can help retail chains stay nimble.

Targeting the bottom 10% of underperforming stores continues to be a sound strategy. Let's say a 1,000-store chain should eliminate about 50 lackluster stores per year. If it fails to act, within just three years 15% of its portfolio qualifies as dead weight. Still, there are some caveats. In today's marketplace, metrics like sales per square foot and comp-store sales no longer tell the entire story. These days, the ZIP codes of your online customers are a critical consideration. A moderately performing store might double as a fulfillment center for online orders, playing an important role in your e-commerce strategy. Another store might support your online strategy by giving nearby customers an easy way to make in-person returns. Performance-based categories — "top," "middle" and "poor" —need to be considered in full context, including the ways in which those locations interact with your loyalty program.

The growth of Starbucks' loyalty program is off the charts, for example, not only because the chain's app is so easy to use, but also because the proximity of Starbucks' stores makes using that app fast, too. What would happen if, due to multiple store closures in a marketplace, Starbucks were to add minutes to the average drive times of its best customers? If store closures mean your online orders in a high-volume e-commerce ZIP code will now take three days to arrive instead of one, this is no small consideration.

Revisit your leases

In negotiating with landlords, today's expanding, in-demand retailers — names like Ross Dress for Less, Five Below, T.J. Maxx and Ulta Beauty — drive a hard bargain. However, older retail chains that expanded aggressively in earlier eras continue to pay above-market rents in some locations. Many also signed long-term leases of 10 or 15 years. Now the trend is to renegotiate kick-out clauses and term length with a view toward maximum flexibility. Having more options, after all, enables you to execute on relocation strategies designed to bolster productivity. One retailer CEO, for example, is doing nothing but one-year deals right now, reasoning that an economic downturn and lower rents are right around the corner. In general, we agree with the conventional wisdom here. However, retailers with great and favorable lease terms should consider locking in those situations by signing longer leases of three years or more. Hedging too much can be a mistake. What if those terms are not available the next time the two parties sit down at the negotiating table?

Yes, rapid change is creating challenges in retail, but new opportunities are arising as well. Older ways of thinking about real estate may not take into account new factors, such as the benefits of proximity to non-retail tenants like co-working franchises or medical office buildings, or landlords' increasing willingness to partner with retailers in constructive ways. The latter shift is an important one: When owners and retailers collaborate rather than lock horns, they stand a better chance of finding mutually beneficial solutions.

Nor is following the conventional wisdom in real estate always the best way to go: Shrinking store footprints could be the best response to present-day dynamics, but more creative options might work, too. RH (formerly Restoration Hardware) has scored a big hit, counterintuitive as it might sound, by  "going big" with its 40,000-square-foot gallery store inside a former natural history museum in Boston. Today's customers are responding to novel and rewarding environments. Creative use of real estate can be the key to giving your customers the in-store experiences they crave.


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