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The end of the department store

A number of high-street department stores are in trouble. Is the model broken?
March 20, 2018

Two pieces of data have prompted doubt over the viability of the department store as a successful retail business model in the 21st century. First, our recent analysis of property leases found that department chain Debenhams (DEB) was the most highly leveraged business among its peers, with a significant proportion of those leases extending beyond 20 years. Second, recent data from the US showed that retail sales contracted for a third consecutive month – the first time that has happened since 2012. Breaking that data down further, most of the contraction was limited to three specific sub-sectors: auto dealers, gas stations and traditional department stores. Department stores saw sales slump by 0.9 per cent, while internet retailers managed to grow sales by 1 per cent – admittedly not a huge improvement as consumers tighten their belts across the board.

This data could have been augmented by particular first-quarter retail trends. For example, some analysts believe delayed refunds from the festive period could be weighing on spending. After all, wage growth in the US has been better than expected, while the household savings rate is said to be “picking up”. This should be giving shoppers more loose change to play with. So, if spending gathers pace ahead of the summer, the big question is whether internet sellers will continue taking market share from traditional stores.

 

A digital Christmas

The news that internet retailers are growing faster than traditional bricks and mortar isn't new. What's more, plenty of department stores – both in the UK and the US – now operate extensive online operations. But while this might be a growing division (online sales at Debenhams rose 10 per cent over Christmas and by 22 per cent over the past two years) it hasn’t been enough to offset the declines seen on the high street.

This was made evident by Debenhams’ Christmas trading update released at the start of the year. Although digital sales grew strongly, it didn’t prevent the group from issuing a 35 per cent profit downgrade. The weeks either side of Christmas proved to be particularly painful, with Boxing Day sales performing below expectations. But this wasn’t the case for all retailers – even those with physical stores. Market newcomer Joules (JOUL) reported sales up by a fifth over the festive period, while long-time IC favourite Ted Baker (TED) reported a 9 per cent improvement. Of course, neither of these groups are department stores, which prompts us to ask: is there something fundamentally broken with the department store model?

 

A failing model

Something clearly isn’t working. John Lewis Partnership (JLP) was forced to cut its famous annual staff bonus to its lowest level in 64 years after profits took a 77 per cent plunge for the year ended January 2018. Sir Charlie Mayfield, the chairman of JLP, called it a “challenging year”, marked by subdued consumer demand and a number of operational changes across the company that resulted in redundancy charges and restructuring costs. But even excluding these one-off expenses, profits still fell by more than a fifth. Mr Mayfield said the only way John Lewis will regain its footing is to step up investment in innovation, with potential strategies ranging from staff promoting the store via their own social media platforms and expanding own-brand ranges.

House of Fraser is another department store that could be teetering on the edge. The group also reported disappointing Christmas sales and admitted it was in negotiations with landlords to curb climbing rents and rates. This was followed by news that the group’s controlling Chinese shareholder is selling off its stake in the business less than four years after it bought it. The 51 per cent holding is reportedly being taken on by tourism group Chinese Wuji Wenhua. It seems the existing shareholder failed to translate the brand abroad and delayed several necessary investments across the UK stores.

 

The great, big internet

It can’t be denied that the evolution of the internet has rendered the premise of the traditional department store almost completely obsolete. Once upon a time, department stores were a true innovation in the retail sector, acting as a gateway to mass-produced goods – sometimes from international markets – to local high streets. First formed in the 19th century, prices were set, which marked a significant shift away from the haggling of market stalls. As some historians point out, their retail dominance was based on urban environments built around new public transport systems. It’s therefore not too great a leap to suggest that, as social history changes and evolves – not just in human behaviour terms, but also urban geography and demographics – the department stores stand to lose even more ground.

The internet makes everything more difficult. Mass availability of product is now taken for granted, while the web allows shoppers to seek out the best price at the touch of a button. The importance of customer service becomes less and less important, especially if it’s compensated for with convenient delivery and refund options.

 

Survival strategies

In short, if department store companies are going to survive, their formats must change. This year, investors can expect to see further store closures and a serious rationalisation of square footage. For a company such as Debenhams, this might prove to be an expensive course of action if it tries to exit lengthy lease arrangements. For those stores remaining, digital innovation has to be top of the agenda.

This doesn’t just mean operating a slick online business. Clothing chain Zara – which is owned by Spanish group Inditex (BME: ITX) – announced last week that it plans to introduce augmented reality (AR) displays into 120 stores beginning in April. It's rumoured the AR displays will allow customers to hold a smartphone up to a sensor in the store or store window, and see outfits displayed on a model. The customer can then click through to purchase the clothes via a mobile shopping site. Newswire Reuters said it was “the latest effort for a brick and mortar retailer to use technology to win millennial shoppers and compete with online behemoths such as Amazon (US:AMZ)”.

Inditex has proved itself a high-street winner for many years, but it’s interesting to see the group blurring the lines between retail store and retail website. A ‘pop-up’ store trial in London’s Westfield shopping centre in Stratford has been designed purely to function as a space for customers to place and collect online orders. Customers can receive their orders the same day if placed before 2pm or the next day if placed in the afternoon. According to fashion business publication Drapers, the shop also has a product recommendation system based on information screens embedded into mirrors. When customers scan an item using radio frequency identification (RFID) technology, the system can bring up multiple co-ordinating items.