Two recent developments demonstrate that the retail sector remains extremely competitive and participants need to have realistic business models.
The first is the purchase of US bookstore group Barnes & Noble by hedge fund Elliott Advisors for US$638 million ($972.7m) and the other is Costco's plan to open a $90m, 14,000 square-metre store in West Auckland.
These developments reconfirm that retailing is splitting into two major business models, namely specialised stores with an emphasis on customer service and the big store model with a low-price focus.
Barnes & Noble, which can be traced back to Illinois in 1873, listed on the New York Stock Exchange in 1993 after issuing shares to the public at US$20 each.
In this pre-internet period the company was planning to open 100 superstores every year, in addition to the more than 700 smaller shopping mall stores it operated at the time. Each new superstore would offer up to 150,000 titles and would become an effective library for its local community.
The bookstore operator performed reasonably well in its early listing days and its share price hit an adjusted all-time high of US$31.56 in March 2006. But it has been all downhill since then as online seller Amazon has decimated the traditional book selling market.
Barnes & Noble's share price has plunged from its 2006 high to last week's successful takeover price of US$6.50 a share while Amazon's share price has surged from US$36 to US$1870 over the same period.
At least Barnes & Noble survived whereas Borders Group, the second largest US bricks-and-mortar bookstore chain after Barnes & Noble, collapsed in 2011. Barnes & Noble acquired the failed company's trademarks and customer list.
Barnes & Noble's net profit peaked at US$152m in 2003 and its total revenue at US$7129m in 2012. The company has closed more than 150 stores in recent years, leaving it with 627 retail outlets. However, its bottom line has continued to deteriorate, and the company reported a loss of US$125m for the 2018 year (see accompanying table).
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Long-standing chairman and major shareholder Leonard Riggio wrote in the latest annual report; "Fiscal 2018 was a challenging but important year for the company. While we made great progress in many areas of the business, we also laid the groundwork for what will be a multi-year strategic plan. The plan will centre on how to better serve our customers, re-imagine our bookstores in the form of a smaller footprint and a return to our bookselling roots, with a greater emphasis on books".
This is the second bookstore chain acquired by Elliott Advisers, which purchased Britain's largest book retailer Waterstones last year. Waterstones has had an impressive turnaround under chief executive James Daunt who will move to New York to oversee the transformation of Barnes & Noble.
Daunt's strategy is to empower each store to meet the needs of its local community. He has been quoted as saying; "the main thing is that there isn't a template, there's not some magic ingredient. The Birmingham, Alabama bookshop I imagine will be very different from the one in downtown Boston. They don't need to be told how to sell the exact same thing in the exact same way".
Daunt empowers store managers, making them responsible for deciding the books to stock and the ones to discount. He is quoted as saying "you want to enjoy yourself, to bring your kids and have fun buying a book. Get that right and customers will come and spend".
The CEO emphasises the personal touch with a big banner on the walls of its Charing Cross Rd, London bookstore with the statement; "Welcome book lovers you are among friends".
Amazon couldn't use these words.
Unity Books, which has stores in Auckland and Wellington, is an example of the successful business model that Barnes & Noble is trying to emulate.
Unity's stores are quite different with the Auckland store having a larger business and sports selection while the Wellington store has a greater focus on politics and New Zealand history.
By contrast Whitcoulls, which was once listed on the NZX but is now owned by Anne and David Norman, doesn't seem to have a clear strategy. Its stores are cluttered and have a mix of everything without clearly identifying its priority offerings.
Unity Books shows there are opportunities for well-run, customer-focused operations with a clear offering, while Whitcoulls staff seem to spend a great deal of time telling potential customers that they don't have this or that book or they no longer carry a requested product range.
Daunt will be trying to emulate the Unity Books business model across Barnes & Noble's 600-plus stores.
Costco is a completely different type of company as demonstrated by the sales and net profit figures in the accompanying table.
Its business model is to generate high sales volumes and rapid inventory turnover by offering members low prices on a limited range of products across a wide range of merchandise. Costco's stores, which it calls warehouses, carry about 4000 different products compared to around 30,000 products found in most large US supermarkets.
Its business model is built on customer membership – usually $60 - which is required to be renewed annually.
Costco's strategy is built on the principle of low prices and a treasure-hunt environment. Treasure-hunt merchandising consists of a constantly changing and unpredictable range of luxury items that entice shoppers to spend more than they might otherwise by offering irresistible deals.
The company opened its first warehouse in a converted airplane hangar in San Diego in 1976 under the Price Club name. It changed its name to PriceCostco in 1993 and to Costco Wholesale Corporation four years later.
Costco listed on the Nasdaq in March 1982 after an IPO offering at US$10 a share. Its current share price is US$260 giving it a market value of US$113 billion. But after adjusting for three share splits since 1982 shareholders have six shares for every share acquired through the IPO. Thus, one US$10 IPO share is now worth US$1560, excluding dividends.
The proposed Costco superstore in West Auckland will create increased competition for domestic retailers, particularly The Warehouse chain. The NZ company sells similar products as Costco, including electronics, jewellery, furniture, household goods, home & garden, clothing, sporting goods, pet products and books.
Costco has a wide range of additional offerings, including petrol, deli products and wine and beer, although it is not clear what the new West Auckland store will offer.
There was no indication that The Warehouse would face major offshore competition when Stephen Tindall established the discount retailer in late 1982. The New Zealand company tried unsuccessfully to expand into Australia, and it is now facing increased global competition on its home patch.
The problem is that Costco has momentum whereas The Warehouse has stalled.
Costco reported sales revenue of US$138.4b for its 2018 year while the New Zealand company had revenue of only $3.0b. In addition, Costco generated membership fees of US$3.1b.
Costco's net profit has increased from US$2059m to US$3134m since 2014 while The Warehouse's net profit has contracted from $78m to $23m over the same period.
It is a similar story regarding share prices, with the Costco's adjusted share price appreciating 142 per cent since the end of June 2014 while The Warehouse share price has fallen 34 per cent over the same period.
There is no certainty that Costco will get off the ground in West Auckland and its product range is also uncertain. Nevertheless, it will be fascinating to see how domestic retailers, particularly The Warehouse, respond to this potential competitor.
Will domestic retailers try to compete on price or will they adjust their business model to offer more personal service and a range of products more suited to local communities?
- Disclosure of interest; Brian Gaynor is a director of Milford Asset Management.