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News Releases - October 29, 2000

Borsuk’s article compares the developer’s location centric model linking a web site to a mall and the customer centric model, MetaSpace(sm).  The study analyzes the models from a unity of interests standpoint.  Borsuk believes developers can profit in cyberspace only by aligning their interests with those of the shoppers and retailers.  In his view, the developer’s model is fundamentally flawed by not aligning interests.  This will lead to investor disappointment.  What adds value for shoppers and merchants is MetaSpace(sm), although it does not fully resolve the developer’s dilemma.

 *Shopping Center Business, October 2000, pp. 120 – 127.

 TOPICS

 *From Theory to Praxis - Borsuk to speak to NRTA in Orlando.

 *Online Merchandise Buying Forecast - $32bn in 2000.

 *Surge in Online Buying HHs - Moving from early to late majority buyers.

 *Retailers’ Free Internet Service - This is a big deal!

 *Multi-Channel Customers Buy More - Critical questions.

 *Does Lightning Strike Twice? - Are retail REITs technology plays?

 *ICSC Law Conference 2000 – E-commerce leasing issues debated.

 *Borsuk To Address NRF Conference in New York on Strategic Leasing Issues.

 *PARIS Flat - Available from May 2001.

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 *From Theory to Praxis: Borsuk to speak to NRTA in Orlando.

 On Dec 13 Borsuk will address the National Retail Tenants Association (NRTA) on leasing strategy for a wired world.

 The goal of NRTA is to provide mass merchandisers with leasing expertise (www.retailtenants.org).  NRTA members handle everything from lease negotiation to CAM audits.  Formed in 1996, NRTA addresses concerns not generally covered by the ICSC and NRF.  Members include Wal-Mart, Office Depot, Toys-R-Us, Radio Shack, Rite Aid, Best Buy, Circuit City, Borders, Barnes and Noble, CVS, and the GAP.

 The presentation, “Don’t Be A Cyberputz: Store leasing strategy for the omni-channel retailer,” will explore how online buying is a disruptive technology, the reasons for rapid household diffusion, the impact on store economics and the need to change store location analysis.  Borsuk will next outline the strategic implications and tactical considerations for store leasing embodied by the WiredLease(sm).  He will also discuss new leasing issues raised by the location and customer centric online models.  Borsuk will conclude his remarks by highlighting the growing importance of the real estate team in an omni-channel world.

 Borsuk expects a lively debate to ensue with practitioners on such topics as in-store sales cannibalization, whether sales per customer are expanding for multi-channel retailers and whether members are considering sales channel reformation.

 *Online Merchandise Buying Forecast - $32bn in 2000.

 More households online are spurring increased buying.  General merchandise, apparel and furniture (GAF) sales during the holidays (Nov-Dec) should exceed $10bn or about five percent ($10bn /$195bn) of store purchases.  For 2000 total online merchandise sales could reach four percent ($32bn / $820bn) of GAF sales.  See table below.   This assumes GAF sales reported by the NRF grow by five percent over 1999.  Even more important, when online sales are compared to catalog purchases, online buying is equal to fifty percent of projected 2000 consumer catalog purchases ($60bn). 

 What is driving online sales is a combination of the early and late majority starting to purchase (see analysis below), national retailers offering free Internet connections and a wider array of merchandise.  Estimates for year-end online buyers bears this out.  eMarketer (www.emarketer.com) predicts 45 million buyers during the holidays.  This represents a one-third increase over last year.  Jupiter estimates a fifty percent increase to 48 million from 32 million last year. 

 In addition, a Roper Starch survey found among home Internet users fifty-six percent currently shop online, up from thirty-one percent in 1998.  During the holiday period twenty-eight percent are expected to purchase online, up from fourteen percent in 1998.  Also, AOL recently reported seventy percent of members had purchased online within the last six months.  AOL has twenty-five million members.

            NRF/Forrester Online Data & RETG Estimates.

                        Merchandise only             Total

Jan’00               $2.0Bn                          $2.8Bn

Feb                   $1.6                              $2.4

March               $1.7                              $3.0

April                 $1.8                              $3.3

May                  $1.8                              $3.4

June                  $2.3                              $4.0

July                  $2.3                              $4.0

Aug                   $2.3                              $4.2

Sept                  $2.3                              $4.2

Oct                   $3.5                              $6.0

Nov                  $6.0                              $7.5

Dec                   $4.0                              $5.5

Total                 $31.6Bn                       $50.3Bn

 Note:  NRF/Forrester monthly online purchasing survey for January to September.   Estimated October - December sales developed by The Real Estate Transformation Group.  The merchandise only calculation excludes food and beverages, all travel related services and the “other” category. 

 *Surge in Online Buying HHs - Moving from early to late majority buyers.

 By year-end 2000, fifty million households will be online according to Forrester Research.  Separately, Nielsen/NetRatings found there was online home penetration of fifty percent or more in 19 of the 35 major markets surveyed in September.  Almost two-thirds of homes in the San Francisco market are wired.  

The rapid increase indicates the “early majority” phase of the Internet diffusion is occurring and poised to enter the “late majority” phase over the next two years.  Dr. Everett Rogers pioneered the study of technology diffusion in the 1960s.  He found users comprised five distinct groups when adopting innovation.  There were the innovators, early adopters, early majority, late majority and laggards.  Their adoption pattern resembled a bell shaped curve with the early (34%) and the late (34%) majority falling on either side of the mean.  The percentages for the other segments were innovators (2.5%), early adopters (13.5%) and laggards (16%).

The “S” curve phenomenon describes the accelerating rate of online household growth.  It is slow in the beginning as innovators and early adopters start to use the technology; it rapidly accelerates through the early majority and into the late majority before decelerating with the laggards.  When adoption over time and adopters per period are plotted, the diagram resembles an “S.”   Online household adoption hit rapid growth, the inflection point, during 1998 with about twenty million households online.  The slowdown, the deflection point, in online household growth will occur around 2002 as the late majority join in increasing numbers.  At that time there will be sixty-five million households online. 

More importantly, buying households will explode from twenty million this year, representing about forty percent of total online households, to roughly forty million by year-end 2002.  This would equal about sixty percent of total online households.  Borsuk’s Power Point illustration of the “S” curve for online buying households is available by email.

A new book “The Soul of the New Consumer” by Laurie Windham and Ken Orton of Cognitiative, Inc. (www.cognitiative.com) discusses the significance of online buying households.  The classic Rogers analysis, shamelessly expropriated by Geoffrey Moore in “Crossing the Chasm,” is used to described how shoppers and buyers arrive online.  

Their analysis takes the Rogers classifications and overlays them with purchasing proclivities.  Based on three years of qualitative and directional research using focus groups and surveys, Windham breaks down potential online buyers into six categories: convenience, price-sensitive, comparison, brand loyal, focused and storefront-adverse.  Depending on the item or service sought, a customer’s purchasing decision may reflect a number of these motivations.  For example, a customer can be brand loyal but be price-sensitive by waiting for a sale.  

Interestingly, Goldman Sachs’ Anthony Noto used a diffusion analysis last month to forecast online buying accelerating during the holidays.  In a research note entitled “Crossing the chasm into holiday 2000 and cash update,” he argued while household Internet use had achieved mass market status with more than forty percent online, online buying households were just entering the period of rapid growth.  He described a market confusion over the lag in households buying online versus getting online.   They are not synonymous.  This perceived lack of growth misled the marketing into thinking online buying was not taking-off.  Rather, he thought the “sweet spot” for online buying would become evident by year-end.

Another way to view Rogers’ innovation adoption segmentation model is to look at Gateway’s continuing rollout of showrooms and the store-within-a-store concept at OfficeMax.  The strategy could be the most efficient way to reach the early and late majority for two reasons.  First, these people are unlikely to purchase their computer from a catalog or online.  Second, Gateway is seeking to exit the commodity end of the business, selling boxes, and move to offering solutions like Internet hosting and software training. 

Online buyer price sensitivity fits with Windham’s motivation analysis for the early and late majority.  This issue should concern mass merchandisers. 

Shopbots designed to facilitate comparison shopping are growing in popularity.   According to the WSJ article in the E-Commerce section of the October 23 issue, the two most popular, DealTime (www.dealtime.com) and MySimon (www.mysimon.com), registered a combined total of almost six million unique visitors in August.   This was up from three and a half million last December.  See “No Comparison: Shopping ‘bots’ were supposed to unleash brutal price wars.  Why haven’t they?”, p. 18.

Last month’s NRF.COM conference had a presentation devoted to shopbots.  MIT Professor Erik Brynjolfsson discussed his study “The Great Equalizer? Consumer Choice Behavior at Internet Shopbots.”*  He found that while shopbots are primarily used for finding the lowest price, other factors allowed some retailers to maintain higher prices due to reputation and service.  The study focused on books and clearly demonstrated Amazon could charge a premium.  (“The Internet and the Future of Your Business”, Tape GS06, Innovative Resources 1-888-447-6872). 

*(http://ecommerce.mit.edu/erik/index.html)

Professor Brynjolfsson made a number of interesting observations about search and switching costs.  Search costs have become very inexpensive due to the Internet and more particularly shopbots.  This means there is now what Borsuk calls an “everyday lowest national price” for much branded merchandise.  The thought of customers demanding price matching from competitors thousands of miles away is a nightmare for retailers. 

Switching costs are another important issue.  According to Brynjolfsson there remains significant value in being an online first mover within a merchandise category.  The Professor noted once a customer becomes familiar with the online merchant, there is less incentive to switch.  This dovetails with the price premium noted by his shopbot study.  However, looking ahead, will the early and late majority accept persistent premiums for branded goods?

The value of shopbots for book buying seems to have been lost on the NYT’s reporter David D. Kirkpatrick.  On October 9, in an article entitled “Quietly, Booksellers Are Putting an End to the Discount Era,” he wrote “The price increases at the online stores are particularly significant, however, because of their implications about the future of Internet bookselling.”  (www.nytimes.com/2000/10/09/business/09BOOK.html)

Much of the article’s online analysis considered Amazon’s pricing.  As previously noted, Amazon’s reputation for service and on time delivery allows it to charge higher prices.  Had he used a shopbot like Dealtime, his negative conclusion about saving money online could have easily gone the other way.  In addition, the story contained a subtle bias about the value of a customer’s time.  While in Manhattan walking to a bookstore may represent a pleasant diversion during the day, loading up the kids to drive to a suburban superstore takes considerably more time and effort.  The issue of convenience continues to be a factor for a substantial segment of online buyers.

*Retailers’ Free Internet Service - This is a big deal!

Mass merchandisers are hoping to reinforce their brand name with existing and potential customers by giving them free Internet access.  This will impact mall developers hoping to exploit cyberspace.  Kmart (www.bluelight.com), Ace Hardware (www.ourhouse.com) and Barnes and Noble (www.bn.com) are offering free Internet connections to anyone.  Costco requires membership.   Kmart is experiencing strong demand; there are four and one-half million registered online users and six million are projected by year-end. 

Rogers’ innovation diffusion analysis suggests that the mass merchandisers are on the right track.  They sense online buying is going from elitist to plebeian.  This intuition is supported by a Yankee Group survey released on October 16.  The survey found one-third of online households were new users, defined as being online for less than a year, and forty-seven percent of them had free Internet service accounts.  Put another way, the growing demand for free online connections signals the arrival of mainstream America. 

What will mall developers do when J.C. Penney, Target, Wal-Mart and Sears start offering free connectivity?  The retail REITs hoping to monetize the click stream may find their plans in shambles.   Not only will it dilute interest in using the developer’s home page to start surfing but also in branding malls in cyberspace.  

*Multi-Channel Customers Buy More - Critical questions.

Is the online channel spurring in-store sales?  Microsoft and the NRF sponsored a study to determine shopping and buying channel preferences.  The study “Channel Surfing: Measuring Multi-Channel Shopping”* (http://nrf.com/hot/press/sept2500.htm) surveyed seventeen retailers offering merchandise online, by catalog and in the store, although not all offered through the three channels.   The retailers sampled reflected an overwhelming soft goods orientation with six department stores and five apparel retailers participating.

*(“Multi-Channel Shopping – The Customer Perspective”, Tape 0026-24, Innovative Resources 1-888-447-6872)

The study discovered two important interrelationships.  First, multi-channel customers spent about thirty-three percent more in the store after visiting a web site while catalog shoppers spent twenty percent more after going to the web site.  Second, twenty-three percent of store shoppers who visited the retailer’s web site made a purchase online.  In other words, approximately six percent of all store shoppers bought online. 

The NRF study confirms multi-channel buyers are the retailer’s best customers. For example, J.C. Penney reports customers who use all three channels spend four times more than single channel customers. Staples notes customers who shop two of its three channels buy more than single channel customers and those who buy across all three channels spend the most.

The promised follow-up study should ask whether multi-channel buyers will shift transaction channels over time?  Could it be that as more of the early and late majority buy online, they will do so less in the store?

The change in multi-channel shopping behavior may already be occurring.   The second quarter survey by HarrisInteractive* found the number of online browsers actually declined from Q3’99 (48M) to Q2’00 (45M) while the number of buyers increased by about fifty percent (19M to 30M).  

*(www.harrisinteractive.com/news/index.asp?NewsID=162&HI_election=All)

*Does Lightning Strike Twice? - Are retail REITs technology plays?

A September report by Deutsche Banc Alex. Brown presented an intriguing idea for valuing retail REITs.  It argued revenues derived from information technology should receive a higher stock valuation than the traditional multiple applied to rent.   While the logic of a “wired” premium is defensible, it does not follow the premium is significant or sustainable.  The WSJ has already raised a red flag about the risks of wiring malls.  See Ray A. Smith’s REIT INTEREST column on August 23. 

The new valuation methodology was applied to the Simon Property Group (SPG).   The research team’s precise analysis yielded a twenty-three percent premium for the B2B and B2C initiatives over a presumed net asset value of $34.  In early September shares were trading around $23.  A significant portion of the analysis derived from information given by Simon at the September conference in Atlanta.  The Simon power point presentation is available on CD.  Contact them at http://about.simon.com/contact_spg/.  See also Connie Bobbins Gentry, “Tenants Benefit From Technology Alliances,” Chain Store Age, July 2000, pp. 143-145.

Despite Wall Street’s generally optimistic view of SPG’s B2B and B2C efforts, it could end up being more like a money pit than a cash machine. 

The B2B effort called Merchant Wired is an ambitious undertaking.  It is a consortium of big mall developers with the exception of General Growth Properties (GGP).  Merchant Wired will hardwire the malls, install the necessary plumbing, provide merchant hosting services and offer retail software applications.

While the consortium’s partners are impressive, IBM, Cisco, AT&T, Wall Street does not seem to be asking the obvious questions. 

First, how can non-technology and non-retail players, the property owners, hope to provide retailers with cost effective solutions?  What do mall developers know about retailer supply chain problems and needs?  Why would retailers provide proprietary information to Merchant Wired?

Second, the natural partners for Merchant Wired are the NRF and IMRA.  Having their imprimatur would certainly help to legitimize the effort and gain converts.  What happens to Merchant Wired if the retail trade organizations seek to offer their own broadband and software solutions? 

Third, Merchant Wired is pushing into tough businesses, i.e., deploying a telecommunications infrastructure and Web hosting.  Did the mall owners ever consider acting as a facilitator for their tenants to partner with the pros rather than trying to build a network from scratch?  Furthermore, Merchant Wired envisions becoming a retailer applications software provider.  This is a high concept in search of a need.  Does anyone really believe mall owners could ever develop better retailer specific software applications than retailers and their phalanx of consultants? 

An early warning sign of this strategic error is the effort by Merchant Wired and Mallibu.com to offer online shoppers the ability to locate and purchase from a store’s inventory.  See “Shop Online—Pick Up at the Store.”*  Assuming retailers embraced the counter-intuitive idea, does the landlord-provided software solution (www.found.com) enjoy support among merchants?  Again, why would a retailer rely on a non-retailer for a complex systems integration application instead of using a trusted provider or developing it in-house?  Some cynics might say that the developers were getting loco weed mixed in with their arugula.

*(www.businessweek.com/reprints/00-24/b3685268.htm)

Fourth, what have office building owners, the people who actually have broadband intensive tenants, been doing to meet their needs?  Have they been installing propriety networks with custom built software applications?   In the case of EquityOffice (EOP), the largest public owner, just the opposite is occurring.  At least three providers per building offer tenants voice, data, high-speed Internet and e-commerce services.

Equity Office is not the exception.  The Building Owners and Managers Association (BOMA) urges its members not to enter into exclusive contracts with telco providers.  See “Critical Connections: Partnering in the Information Age” (www.boma.org).

Furthermore, the FCC requires multiple telco provider access to commercial properties.  An order issued on October 12 forbids telecommunications carriers in commercial settings from entering into exclusive contracts with building owners.* 

*(http://www.fcc.gov/Bureaus/Wireless/News_Releases/2000/nrwl0038.html)

What happens to Merchant Wired when other providers of retailer broadband services start using their newly installed telecommunications infrastructure?  Even more galling would be competition from another mall developer to provide services.

The B2C effort is even more problematic.  The two initiatives, shopsimon.com and clixnmortar.com, are fundamentally flawed from an alignment of interests standpoint.  Again, the contradictions inherent in the concept have blinded many analysts who are still awed by the technology.

Mandating online order fulfillment from in-store inventory does little to benefit retailers.  See “Who’s the Fairest Of the Malls? Can shopping centers convince national retailers to go local?”*  In addition, the rapid growth in free Internet connections will hobble the developers’ effort to attract a critical mass of shoppers who would use their sites. 

*(http://www.thestandard.com/article/display/0,1151,16795,00.html)

In summary, retail REITs, like office properties, are not technology plays but real estate investments that seek to maintain their competitive edge by investing in information technologies to serve tenants.   In the case of retail, getting too far ahead of tenants is a risky business.  In addition, the shopper technology being offered does not align itself with either the customers or the merchants’ interests.

*ICSC Law Conference 2000 – E-commerce leasing issues debated.

Over 1,400 lawyers attended the ICSC Law Conference held October 18-21 in Orlando.  It was the largest gathering ever for shopping center attorneys.  The ramifications of the Internet on malls was a major theme.  In addition to Borsuk’s breakfast roundtable on the PresenceAgreement(sm), there were seven others discussing the Internet and retail lease issues.  Two panels provided attendees with an opportunity to hear landlord and tenant lawyers express their clients’ concerns.

Peter Linneman, Wharton School of Business Professor and Director of the Zell-Lurie Real Estate Center, was the kick-off speaker.  In an entertaining and partisan talk Dr. Peter told the lawyers not to worry about online buying, that it was snake oil and Amazon’s business model was fundamentally flawed.  Those not listening carefully may have missed his qualifying comments.  First, low margin retailers would suffer from online competition along with Power Centers.  Second, leases were likely to get shorter along with retailers taking less space due to better inventory management.  Third, mall branding might work but he was uncertain about its success.

The presentation suffered from one glaring omission.  It ignored traditional retailers going online and the potential impact on space demand.  He also did not comment on how project financing would change with shorter leases. 

A tidbit gleaned from the “E-Commerce and the Retail Lease-Gross Sales, Use Clauses, Percentage Rent” panel was about WebVan’s Atlanta success.  One panelist thought it was having an impact on community centers.  This raised a concern.  While it was true home delivery would not eliminate all trips to the market, it would reduce sales volume, thereby decreasing percentage rent, and also lower foot traffic.  The latter point is significant since there is a rent premium attached to community centers generating high foot traffic.

The most discussed “E-topic” was percentage rent.  One vexing issue for landlords is online ordering with in-store pick-up.  Despite all the talk about migrating sales and tracking them for percentage rent purposes, Craig Schmidt, a retail REIT analyst with Merrill Lynch, calculates regional malls derive less than four percent of their total rental income from overage.  Thus, while percentage rent does contribute to overall performance, the debate was more emotional than rational.

Problems associated with co-tenancy, radius and exclusives in a wired world were also debated.  However, the sub-text of the discussion was even more interesting.  It was the sea change in attitude among the lawyers, probably two-thirds of them male, about the benefits of online buying.  No longer was there a need to ask the audience about how many purchased online.  Rather, there was overwhelming acceptance of online buying with participants offering many positive comments and personal anecdotes. 

Borsuk began his roundtable with a brief overview of the location and customer centric models.  One of the lawyers representing a retailer was surprised to learn that the developer’s model required the online purchases to be filled from in-store inventory.  In addition, there was little enthusiasm for landlords offering retail software applications.

Borsuk raised several issues for discussion.  First, the necessity of integrating and interrelating intellectual property and telecommunications law into a document that he calls the PresenceAgreement(sm).  Second, drafting the prototype agreement requires an interdisciplinary approach.  The team needs to consist of real property, IP and telecommunications lawyers supplemented by allied specialists.  Third, the increase in potential liability from system crashes, service disruptions, regulatory oversight, copyright violations, and trademark and business-methods patent infringements was cited as a great concern.  The increased liability results from landlords providing broadband and tenant web site development and hosting services. 

The concept of a PresenceAgreement(sm) was controversial.  There was a strong difference of opinion at the “E-Commerce” panel over whether the new provisions should go into a separate lease attachment.   The main objection seemed to be it would make the lease too long for clients and lawyers.  However, this is more form over substance since the “E-rider” would grow quickly as real property lawyers focused on the interrelationships.

The landlord’s potential liability for providing wired services was also challenged at the roundtable.  Several attorneys thought that the indemnity, hold harmless and insurance provisions could offset the new risks.  Borsuk argued the landlord’s exposure was greater than the protection afforded by the traditional risk shifting mechanisms. 

The recent judgment against MySimon in a trademark dispute with the Simon Property Group is a harbinger for landlords and tenants in their relationship and with third parties online.

A roundtable hosted by Gene Sykes (gene.sykes@azbar.org) presented an innovative “omnibus e-commerce” clause that tied important provisions and concepts back into the traditional lease.  After a perfunctory skirmish over including online sales in percentage rent and audit rights, the discussion moved to charging tenants for maintaining the property’s web site, reciprocal use of tenant and landlord web sites, new assignment and sublease considerations and tenant signage in cyberspace,

A strange affinity also exhibited itself at Gene’s roundtable.  Each of the lawyers, who did not know one another, independently sat next to other lawyers who reflected their client’s orientation.  Thus, all the landlord lawyers sat together and all the tenant lawyers sat next to each other.  Participants speculated about whether unique pheromones for landlords and tenants created the affinity.

In sum, shopping center lawyers are taking cyberspace seriously.  Over the next several years, leases will reflect these new concerns and bargaining positions.

*Borsuk To Address NRF Conference in New York on Strategic Leasing Issues.

On January 14, 2001, Borsuk will speak at the NRF Annual Convention in New York.  The talk, called “Avoid Catastrophic Failure: Strategic store leasing issues for the omni-channel retailer,” will review online holiday shopping and the NRF’s multi-channel study in the context of non-geocentric shopping habits.  Borsuk will describe how non-geocentric buying impacts store site selection and leasing strategy.  He will outline “hot button” leasing issues with special attention to the developer’s location centric model.  Borsuk spoke to the NRF in 1997, 1998 and 1999 on changes in leasing strategy for retailers.

*PARIS Flat - Available May 2001.

The Paris flat is available from mid-May 2001.  The sunny condo on the fourth floor (walk-up) of a landmark building was completely renovated in 1999.  The full floor unit has three bedrooms and two full baths and is located in the 9th arrondissement.  The property is two blocks south from the Moulin Rouge (Montmartre) and convenient to all public transportation.  To see the apartment go to www.parisflat4u.com.   Contact Liliane Travert-Borsuk (markborsuk@aol.com) for additional information.

Contact Information

Mark Borsuk (mark@borsuk.com) is Managing Director of The Real Estate Transformation Group, a firm analyzing information technology’s impact on space demand and providing strategies for property owners, developers, retailers and lenders.  In addition to consulting, Mark is a retail leasing broker and real property attorney practicing in San Francisco.  For further information contact Mark Borsuk at (415) 922-4740.

Continuing thanks to The Space Place (www.thesapcepalce.net) for hosting RETG articles.

Copyright 2000.  All Rights Reserved.  Mark Borsuk.

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