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November 99

Death at the Margin
by Mark Borsuk

The growth of online shopping spells trouble for retail real estate.

In the prewired days, retailers had to open new stores to increase profits. But the growth of the online sales channel fundamentally changes this model: Sales can grow without new stores or with limited store expansion.

For some, the rise of e-commerce has had unpleasant side effects.The online sales channel cannibalizes in-store sales. Even a small shift in sales can be devastating for store profitability. An analysis by PricewaterhouseCoopers found that a 5 percent decline in sales can lower store profits by 20 percent. A sales shift of 10 percent can cause profits to plunge by 40 percent.

But make no mistake: Online retailing will slowly but steadily eat into offline sales. Last Christmas, online buying became mainstream, changing shopping habits and creating a new lifestyle. Unlike the early days of the Net, moreover, women are now at gender parity with men online. They still trail as buyers, but should reach parity in that by next year. By 2002, women will represent 60 percent of e-commerce customers, more in line with the offline norm. The reason is simple: Retailers now understand women are attracted to the right mix of community, usefulness and selection, as well as better pricing. Old-fashioned merchandising savvy is what makes an online site great, not the latest technological bells and whistles. Unfortunately, the retail real estate community still believes women will remain mostly offline shoppers.

Both on the Web and off, customer profitability plays a critical role in store economics. Applying Pareto's Principle to retailing holds that 20 percent of the customers generate 80 percent of the profits. However, if the most profitable customers are more likely to buy online, then the retailer faces the unhappy prospect of maintaining high-cost stores to serve the 80 percent of customers who generate minimal profits. If so, retailers have little incentive to keep as many stores open.

Already, the stock market is signaling merchants selling commodity goods and services to accept the new retailing reality or see their stock prices plunge. The eToys vs. Toys "R" Us (TOY) story is instructive: The market rewards eToys for having no stores and punishes Toys "R" Us for having almost 1,500 locations.

The market's growing preference for the Web is forcing retailers to reform the sales-channel matrix, and the first casualty is the brick-and-mortar store. The anticipated emergence of Wal-Mart – the king of brick-and-mortar retailing – as the Tyrannosaurus Rex of online selling could cause some traditional retailers to rethink their location-based strategies.

In this hypercompetitive environment, landlords should be preparing for preemptive bankruptcy filings, as tenants seek to terminate their store leases. Unlike Egghead's exit from store-based retailing, in which property owners did not suffer seriously, the new strategy will leave landlords and lenders reeling.

Wall Street is worried. Earlier this year, Merrill Lynch (MER) put the word out that some retail real-estate investment trusts (pools of capital invested in property) would suffer from the growth of online buying. Likewise, Moody's has warned that cyberspace sales could impair retail property debt. Today, a significant portion of retail property is beholden to Wall Street, due to the real-estate securitization trend of the 1990s. However, the owners who profited by going public may come to realize that they made a pact with the devil when Wall Street analysts begin referring to stores, and by implication their properties, as "stranded assets."

One opportunity for investing in retail property is adapting poorly performing properties to new uses. Another option is creating what I call "metaspace" by integrating cyberspace into retail space. Proficiency in software engineering, Web site creation and broadband installation is a necessary skill set for real estate developers. Perhaps partnering with a VC can speed the transition for them. In any case, the rise of online retailing will force a reshaping of offline retail real estate.

Mark Borsuk ( is managing director of the Real Estate Transformation Group, a San Francisco firm that analyzes technology's impact on space demand and provides strategies for property developers, owners, retailers and lenders.

This article first appeared in The Industry Standard Magazine on October 4, 1999. For more news and analysis of the Internet, visit


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