Patterns of Disruption in Retailing HDCS 4393/4394 Internship Dr. Shirley Ezell

What Can We Learn? Some would describe retailing as an industry filled with uncertainty. Electronic commerce and the role of Internet retailing is part of the near future discussed by all kinds of retail organizations. Electronic commerce is likely to change the basis of competitive advantage.

Mission of Retailing Meets Disruptive Technologies Getting the right product at the right price at the right time has been the basic mission of retailing. The way retailers fulfill this mission has changed as a result of disruptive technologies. A disruptive technology enables innovative companies to create new business models that alter the economies of their industry.

History of Disruptive Technologies in Retail The 4 major disruptions were: 1. Department Stores 2. Mail-order Catalogs 3. Discount Department Stores 4. Internet Retailing. Check out the diverse internet retailers (from Amazon to Chemdex, from eBay to travelocity) and think about how these internet retailers have changed way things are purchased and sold in the marketplace. While disruptions change the economics of an industry, they don’t necessarily change the companies’ profitability.

What Have You Learned About Profitability? Retailing profitability is largely determined by the margins stores can earn and the frequency with which they can turn their inventory over. The average successful department store earned gross margins of approximately 40% and turned its inventory over about 3 times per year. This translates into: the store made 40% 3 times, for a 120% annual return on the capital invested in inventory.

Comparing Profitability with Discount Department Stores and Internet Retailers The average successful discount department store earns 23% gross margins and turned its inventory over five time annually. It received a similar return on inventory investment by changing the balance between margins and turnover rates. If Internet retailers continue like Amazon.com to turn inventory at 2000 rates, they could achieve traditional returns with margins of 5%.

1.Department Stores as Disruptive Innovators The original dominant local retailer gave customers value with large inventories, extending credit, personalized advice. This retailers produce a high-inventory, service- oriented business with slow turnover, struggling to turn their inventories over twice a year. These retailers were forced to charge high prices to earn the margin to stay in business. With the launch of department stores in the late 19 th and 20 th centuries, business men like Marshall Field and R.H. Macy outperformed the existing retailers in customer service, created a disruption, and did a superior job of getting the right products into the right places.

What did Department Stores do? Massed enormous numbers of different products in one location which was very attractive for shoppers. Department stores began to outperform local stores in pricing, and, by accelerating inventory turnover rates, they earned the same returns on much lower gross margins. To compete in the service area they focused their merchandise mix on simple familiar products to compete with the local store, that knows about individual customer needs and preferences.

What Helped these Success Stories & Other Disruptions? Railroads provided access to the goods and transported customers from their homes to stores. Site location became a competitive advantage with scientific counting of customer traffic. Catalog retailing targeting rural customers was helped by free mail delivery. Sears and the money-back guarantees followed by expansion of Sears into chains of outlets.

What Helped these Success Stories & Other Disruptions? (Cont.) The automobile brings in the next changes. Shopping Malls did not alter the business model. They attracted enough customers to sustain a collection of focused retailers such as The Gap, Williams-Sonoma. These malls had similar margins and inventory turnovers as department stores but they also had a deeper product lines within each category. Department stores continue to anchor while many strips/outlets are combinations of category-focused retailers.

2. Mail-order Catalogs Catalog retailing expanded when specialty catalogs followed the trends of the malls changing the generalist catalogs and closing Wards and Sears catalogs.

3. Discount Department Stores Discount Department Stores expanded in the 60’s locating in less expensive real estate at the edge of towns and were disruptive. Their business model changed with low-cost, high-turnover, with success stories of 5 inventory turns per year and gross margins of 20 to 25%. Discounters concentrated on simple products that could sell themselves to compete with limited services and used branded hard goods (hardware, kitchen utensils) and products communicated by pictures to the consumers.

3. Discount Department Stores (Cont.) Department stores reacted by going up market with soft goods requiring more service and product knowledge in selling. Discounters were successful by pricing their goods 20% below the prices of retail department stores. But as department stores left this market, discounters began to compete with only low-cost discounters.

3. Discount Department Stores This left room for another force. Highly focused retailers attack the discounters (specialty discounters such as Circuit City, Home Depot, Barnes & Noble) and became category killers with a sustaining innovation rather than a disruptive force. They offered broader, deeper selections of products keeping the 23% and 5 inventory turns. Most of the discounters, not counting Wal-Mart, left the hard-goods market and it is not usual to see merchandise mixes like Target with 60% to 80% of space with soft goods. Competing against full-price department stores is easier than competing against the category specialists.

4. Internet Retailing The 4 th retailing disruption: The Internet can deliver on 3 of the original retail missions. The Internet can offer a wide range of products. It can earn 125% return on inventory investments and it can turn its inventory 25 times each year needing only 5% gross margins.

4. Internet Retailing (Cont.) Currently, the web seems to be repeating both patterns. However, the Internet department stores will not yield market share to specialized retailers. As the volume of purchases in individual categories grow, search engines and bandwidth may make it easier for consumers to find specialized e-tailors.

Conclusion In analyzing the retailing disruptions, the generalist stores and catalogs dominated at the beginning of the disruptions but were dominated by specialized retailers. The specialists emerged when the market for the new form of retailing was large enough to support sales for narrower but deeper product mix. The disruptive retailers used simple branded product mix comprehended visually and numerically and shifted their mix toward higher-margin products to compete with the discounters.

One question: How fast will the disruptors move up market into more complex products and value-added services? One of the disadvantages electronic sales will need to overcome is delivering products at the right time.

That historically experts have underestimated the ultimate reach of disruptive technologies. Organizations and managers need to recognize the impact of technologies, and move into the mainstream, compete, and change the environment. And What can we Learn?