Sliding Down the Bleeding Edge
Can malls hang onto online shoppers?
Mark Borsuk*
Managing Director
The Real Estate Transformation Group
ARES 17th Annual Meeting
Corporate Real Estate - Session 29
April 20, 2001 - Coeur D'Alene, ID
Copyright © 2001. All Rights Reserved. Mark Borsuk.
ABSTRACT
The mall developers' ambitious plan to bring shoppers online and offer new economy
services to tenants is stumbling. What are the conflicts, compromises and challenges
facing them? For shoppers, the initial attempt was a bust. Seeking to drive online sales
through mall stores failed to align the shoppers interests with those of the developers.
The current idea favors using the Web as "brochureware deluxe" to spur foot
traffic. The next iteration may be to create captive tenants along the lines of MetaSpacesm.
MetaSpacesm is a blueprint for integrating place with cyberspace. For the
retailers, the developers are better focused on providing them with broadband and software
applications. Unfortunately, the first-mover advantage of providing broadband has a short
shelf life. Furthermore, using landlord-developed retail software applications seems
questionable. Finally, merging place with cyberspace creates greater complexity and risks
for the parties as it introduces intellectual property and telecommunications legal issues
into the lease.
I. Online Shopping and the Mall - Does it work?
In January, thirteen percent of the entire US population, or thirty-eight million people,
bought a product online.1 Last year twenty million households
were buying online and next year their number will double to forty million. See Slide 1.
The phenomenal growth of the Internet population, the popularity of online shopping and
the $29bn 2 of merchandise sold last year makes online buying
as American as apple pie. Mall developers are not ignoring the trend. They are seeking to
capture the allure of cyberspace, counter supposed shopper flight and provide new value
for tenants. 3
A significant portion of the online population matches mall shopper demographics. First,
women represent fifty percent of the online buyers.4 The Real
Estate Transformation Group projects them to reach sixty percent of the online buyers by
2002. Women comprise about two-thirds of the mall shoppers.5
The household income levels of mall shoppers and online households are correlated. The Pew
Internet and American Life Project survey for November-December 2000 found that sixty-four
percent of households earning between thirty and fifty thousand dollars were online.
Seventy-two percent of the households earning between fifty thousand and seventy-five
thousand dollars were online and above seventy-five thousand dollars, eighty-two percent
of households were online.6 According to the ICSC these three
income brackets comprise almost sixty percent of mall shoppers. 7
Race and ethnicity also play a factor but to a lesser extent. The ICSC reports about
twenty-five percent of mall shoppers are African-American, Hispanic and Asian.8
However, this varies by region, with the highest concentration of Black shoppers in the
South and the highest concentration of Hispanic and Asian shoppers in the West. Online,
the situation is different. Forty-three percent of adult African-Americans and forty-seven
percent of Hispanics are online. Traditional mall retailers may find reaching these
potential customers is easier online than through their stores.
Even though the relationship between online household income and mall shopper income is
favorable, the type of merchandise sold online in many instances is dissimilar to what is
offered in the better malls. See Slide 2. The reason for the mismatch is upscale malls
offer a wide variety of experiential goods and services. Shoppers need to touch, feel and
enjoy the experience before purchasing. It is one thing to buy a book or office supplies
online, but quite another to buy fashion items like dresses, shoes and fragrances.
The asymmetry between the online demographic and the merchandise would seem to shelter
many malls from the fear of sales cannibalization. In a sense, the mall owners are like
the Navy Brass during the inter-war years (1919-1940) trying to grapple with the potential
threat of ship-based offensive aircraft. Naval strategy was built on massing firepower in
line-of-sight confrontations. Battleships became the epitome of naval pride. The surprise
attack on Pearl Harbor forced the Navy to shift to a carrier based battle strategy.
The mall developers, like the Navy Brass, recognize a growing threat, but are still in a
defensive posture. They need to protect their legacy assets, the malls. The time has not
arrived for them to make a strategic shift. When it does, the conflicts and compromises
inherent in the present strategy will disappear, just as Pearl Harbor resolved the debate
over the primacy of the aircraft carrier.
However, during the hiatus, many mall retailers have a powerful incentive to serve their
growing customer base online. One important reason is to provide customers with a
ubiquitous presence. This is called omni-channel retailing. 9
A growing number of customers want to query the merchandise online by size, color, pattern
and price, and purchase whenever and wherever it is convenient for them. Another reason
for having the selection online is to reduce in-store inventory and possibly store size.
Finally, a Web site gives merchants greater opportunity to learn about their customers'
preferences, run targeted email promotions and provide ancillary services. Thus, improving
technology and customer interest gives tenants reason to move a portion of the shopping
experience online to the detriment of mall owners.
Recognizing the trend, the mall developers have shifted from trying to force online
transactions through the stores to a strategy of driving foot-traffic by providing
information on mall events and store promotions. "Brochureware deluxe" is an apt
way to describe their fallback position. Using cyberspace this way is not likely to be any
more successful. A recent Simon Property announcement to end MallPerks may explain why.
MallPerks was a frequent shopper gift program that ran from 1997 and had over two million
members.10 One possible explanation for the curtailment could
be that property owner promotions have very little impact on store sales. Furthermore, if
the program was disappointing to motivated terrestrial shoppers, can it be successful in
an online format?
MetaSpacesm provides mall developers with the opportunity to integrate
cyberspace with their properties. Unlike the original effort to drive online sales through
mall stores 11 or the current approach, of dispensing
coupons, developers have the opportunity to align their interests with those of the
shopper and merchant. The essence of MetaSpacesm revolves around the captive
tenant. The merchant is beholden to the developer because the merchant does not have an
independent Web site. The developer provides the hosting, ancillary services and the
physical location to conduct business. See Slide 3. MetaSpacesm tenants do not
threaten big name retailers. Instead, they are locally based, highly focused and single
store merchants. They complement rather than detract and provide the online shopper with
an incentive to purchase online or visit the MetaSpacesm location in the mall,
office building or hotel.
MetaSpacesm is one of several models for integrating physical space with
cyberspace. In Hong Kong, Dickson Poon created a highly sophisticated technology marvel
called Dickson CyberExpress ( www1.dicksoncyber.com ). 12
What sets this development apart is that a luxury goods retailer created it. The 70,000
sq.ft. shopping experience is located on three subterranean levels in a Kowloon railway
station. The integrated online and offline shopping areas are: Entertainment World,
E-World, Sports World, Fashion World, iCosmetic World and Kiddy World. The fact that a
retailer created this center puts the mall developers on notice to broaden their horizons.
Mall developers are groping for the right formula, but the present effort is misguided and
unsustainable. They need to consider a hybrid of MetaSpacesm and CyberExpress
for aligning their interests with those of the customers and merchants.
II. Developer Provided Broadband and Software Applications -
What Value?
Mall developers had little incentive until last year to provide telecommunications and
software applications to merchants. This is different from the office environment, where
tenants demand access to high-speed data networks. The change in retailer needs resulting
from customers buying online motivated the large mall developers to offer broadband and
software applications specialized for retailers. The MerchantWired consortium
(www.merchantwired.com) is led by Simon Property, and General Growth Property offers GGP
Network Services (www.generalgrowth.com) to its tenants. Services include creating and
hosting Web sites, providing faster credit card authorization, reducing telephone charges
by Voice over IP, and application software.
While the need to acquire software and telecommunications competencies for retail
developers was foreseeable 13, the current offerings are
sub-optimal and have a short self life. Two examples illustrate the challenges, conflicts
and compromises ahead for the developers.
A. Broadband Revenue Prospects Dim.
The effort to avoid having their malls consigned to legacy status has focused developer
attention on broadband. They are responding to meet perceived tenant needs and to retain
Wall Street's support. Bandwidth describes the capacity of wiring (or in the case of
wireless via a laser or microwave broadcast) to carry communications and how much
information can travel along a pathway in a given period of time. Services like full
motion video and Voice over IP to use the Internet as a telephone become practical at
higher bandwidth. Broadband refers to high data transmission speeds.
Simon and GGP believe retailers need broadband for internal communications, credit card
processing and customer support. However, the lack of exclusivity, the commodity nature of
broadband and the inherent risks in providing the service make the profit potential
limited and transitory.
The broadband strategy of office building owners is instructive for analyzing how mall
developers will fare. What makes the office example important is that tenants are users
and continually need more bandwidth. In general, the building owners have not provided
exclusive services to tenants, but instead allowed multiple competing carriers to serve
their tenants. Furthermore, the Federal Communications Commission ruled last year that
property owners could not enter into exclusive access agreements with telecommunications
providers. However, landlords can still designate the tenant's broadband service provider
through the lease. Nevertheless, most retail landlords will find it advantageous to follow
the lead of the office building owners. 14 Not only is it
possible that GGP could aggressively market to MerchantWired's customers and vice versa,
but other broadband providers may seek to provide their services to retailers. The advent
of multiple broadband providers will commoditize the service and continue to force down
prices.
Another question concerning the mall owners' broadband effort is, why was it not done in
conjunction with the National Retail Federation or the International Mass Retail
Association? Collaborating with the NRF and IMRA would have smoothed the way for rapid
acceptance by members, making it a win-win situation. Instead, the mall developers must go
it alone to sell the service.
Additional questions remain. How will MerchantWired compete with a retailer's existing
broadband provider? Could the landlord force the tenant to use one broadband provider?
These questions were asked during a presentation at the National Retail Tenants
Association (NRTA) Roundtable on April 11 in Oakland, California. The retailers and their
counsel were clearly chagrined over the prospect of having limited service options.
There is also the question of whether retail developers are taking excessive risks by
investing in a service likely to be commodified. Again the experience of the office
building owners is instructive. In February BOMA (Building Owners and Management
Association) hosted the Broadband Building & Commerce conference. The purpose was to
discuss how building owners could use broadband to attract and retain tenants, and
generate profits from these services. Many of the owners and managers attending expressed
reservations over directly providing broadband and software applications to tenants. The
risk was too high relative to the income potential. See leasing discussion below. Most
thought creating an environment for multiple providers with some modest revenue upside was
the optimal strategy. Despite the protest from one brokerage firm's research director
about how providing broadband would greatly enhance earnings, the audience remained
cautious.
In sum, retailers will need broadband in their stores, but the developers' first-mover
advantage is transitory. Competitors are likely to reduce profit opportunities, with the
developers exiting the business within two years.
B. Will Retailers Use Landlord Developed Inventory Software?
MerchantWired is offering retailers a software application that gives shoppers the ability
to determine whether an individual item is in a particular store, purchase it online and
have it ready for pick-up or shipping. The Web sites for Best Buy and Circuit City also
have a similar capability, although they do not use the same software.
Offering advanced inventory management software for multi-channel retailers is a coup for
MerchantWired. The consortium is an investor in Found.com (www.found.com). However,
landlord-created software for a retailer's internal use raises a number of questions.
First, where is the software's retail genesis? In February, Chain Store Age carried a
supplement entitled The Multichannel Challenge: Merging Clicks With Bricks. The supplement
discussed Found.com's origin and functionality, and showcased a retail user. Most notable
were profiles of the company's key executives: an ex-football legend, a former investment
banker, and a computer developer. The lack of retail experience was painfully evident,
especially in the crucial areas of multi-channel retailing, inventory management and
supply chain logistics.
Second, even assuming the software works as advertised, why was MerchantWired not
partnering with the NRF, a recognized retail consulting firm, or a proven retail software
vendor to market the software? Developing enthusiasm among potential users without the
support of trusted intermediaries seems counter-productive.
Finally, retailer-created solutions from Best Buy and Circuit City could rapidly undercut
Found.com's initial advantage should they choose to offer their inventory management
software to the retailer community. They could do so on their own, in partnership with a
software vendor or through a trade association.
Collectively, the major mall developers have rapidly acculturated themselves to the
mainstays of the New Economy, broadband and software applications, to benefit their
tenants. In the case of broadband, there seems little chance of fending off competition
and preventing an erosion in profit margins. Partnering with an untested start-up to offer
complex inventory and transaction management software seems overreaching.
III. Retail Leasing - New Risks for Tenants.
The developers moving into cyberspace extend the traditional lease beyond the confines of
real property and contract matters into the realm of intellectual property and
telecommunications law. Landlords and tenants face new challenges and conflicts in this
wired world. See Slide 4. The parties are just beginning to recognize the issues.
A. Intellectual Property
Law.
Tenants must be aware of how intellectual property law can impact their relationship with
mall owners. Patent infringement by the developer's Web site is a real concern.
Amazon.com's One Click ordering system is an example of a business process patent.
When Barnes & Noble.com sought to use it, Amazon.com sued. The inadvertent use by a
developer of a business process patent could potentially draw tenants into litigation. How
can the tenant offset the risk? Trademark violations are another potential problem.
Recently, Simon Property sued MySimon.com, the online comparison shopping site, over
trademark infringement. Could a mall owner's Web site design possibly infringe on a third
party trademark? If so, what protections should the tenant seek? Finally, copyright issues
abound. Is the developer's Web site using words, images and sounds of others without their
permission? How does a tenant protect against the risk?
B. Broadband, Web Hosting
and Telecommunications Law.
The advent of high-speed data networks and software applications in the mall raises new
legal questions for retailers.
Retailers need to inquire about the reliability, redundancy and fault tolerance of data
networks, especially if the merchant's point of sale system (cash register) is connected
to the network. See Slide 5. What is the landlord promising in terms of system downtime?
Is it realistic during the heavy demand periods like sales and over the holidays? Should
the tenant demand a higher performance level like five nines (99.999% = 5 minutes and 27
seconds per year) or something stricter? What are the safeguards against viruses coming
from a landlord-supplied service or hacker intrusion through the landlord's system into
the merchant's computers?
Online security is another critical issue. How secure is the broadband connection being
supplied by the developer? Does it fully protect merchant data transfers? What happens
if a hacker breaks into the landlord's Web site and compromises visitor information? Could
the retailer incur liability for a security breach on the landlord's site? Would it be a
violation of federal or state privacy laws?
C. New Real Property
Issues.
Tenants also need to consider the physical aspects of the New Economy. What are the risks
of electrical power interruptions, severed data lines, failure of the air conditioning
system, potential EMF hazards, and the applicability of the ADA to cyberspace.
Retailers need to know how the mall owner defines broadband? Will it be fast enough for
the retailer over time? Uninterrupted power supply is another concern. A poignant example
of how dependent computers and the Internet are on electricity is the California power
crisis. Does the mall have an on-site generator to supply it during brownouts or grid
failure? Redundant communication lines are also necessary. Is there an extra cable to
switch to when a backhoe severs the phone or fiber optic line in the parking lot? A
back-up air condition system may be required. How will the mall's servers be protected
should the cooling system fail? Another concern is EMF emissions. Will electric and
magnetic fields interfere with the tenant's computer equipment as more cables, servers and
switches are stuffed into the property? A related EMF issue is the ongoing debate over
whether the radiation emitted presents a health risk.
In addition to redundancy and safety issues, retailers will need to consider the
applicability of the ADA (Americans with Disabilities Act) to Web sites. What special
measures are necessary, if any, to assist online customers whose hearing or vision is
impaired? Does the retailer have potential liability for the landlord's failure to provide
the proper software protocols? 15
The advent of landlord-sponsored broadband and software applications for merchants place
them in uncharted leasing waters. Most tenants will have little experience with the new
risks. They can be expected to act with skepticism and caution, in contrast to the mall
owners' enthusiasm for cyberspace.
IV. Can Mall Owners Leverage Cyberspace?
It is unlikely mall owners will be successful in boosting sales from online transactions
and making money by providing broadband services and software applications. National
tenants have a strong incentive to migrate some sales online as their customers'
experience with the Internet grows. Providing broadband service to tenants is likely to
become a low profit, commodity business and the upside for software applications like
Found.com seems limited.
What mall developers need to do is what they do best - merchandise their malls with an
ever changing assortment of experiential retailers including MetaSpacesm
tenants. They also need to utilize the Internet and broadband to make the physical
experience as interesting and entertaining as possible. (10-22-01)
*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.
Some have called him a "fringe visionary" for advocating radical change in store
leasing strategy. In his view, high tech is becoming everyday tech for many people.
Everyday tech changes geocentric shopping habits, retailer space needs, rents and property
values. Everyday tech also makes possible MetaSpacesm. MetaSpacesm
is a retail development model that fully integrates place with cyberspace.
Mark writes frequently about the impact of online buying and MetaSpacesm. His
articles appear in California Real Estate Journal, Chain Store Age, Discount Store News,
ICSC Research Quarterly, Pensions & Investments, Real Estate Review, Shopping Center
Business, Shopping Center World, The Industry Standard and Urban Land. Much of his
analysis is on the Internet.
Mark has presented his views to the American Real Estate Society (ARES), the Appraisal
Institute, the International Council of Shopping Centers (ICSC), the International Mass
Retail Association (IMRA), the National Association of Industrial and Office Properties
(NAIOP), the National Association of Real Estate Investment Managers (NAREIM), the
National Retail Federation (NRF), the National Retail Tenants Association (NRTA) the
Stanford Real Estate Round Table, the Urban Land Institute (ULI) and institutional
investors.
Prior to entering real estate, Mark was a foreign exchange trader and currency advisor in
New York and Tokyo. Speaking and reading Japanese, he pioneered in the analysis of the Yen
and the Japanese money markets. His articles appeared in many financial publications
including Euromoney and the Asian Wall Street Journal.
Mark holds an MBA from Sophia University (Tokyo), a Japanese language certificate from
Nichibei Kaiwa Gakuin (Tokyo), and a JD from Loyola University (Los Angeles) where he was
a member of the Law Review.
15 Bob Tedeschi, Advocates
of People With Disabilities Take Online Stores to Task, New York Times,
January 1, 2001. (http://www.nytimes.com/2001/01/01/technology/01ECOM.html?searchpv=tech)
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