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Retail reboot: How e-commerce is forcing an industry transformation

A Wal-Mart Grab and Go centre allows customers to shop online and pick up products at lockers.

KEVIN VAN PAASSEN/The Globe and Mail

At first glance, the newest Future Shop looks much like any other. Flat-screen televisions, tablet computers and other electronics are on display for customers to see and try out.

But at only 8,000 square feet, the store in Cornwall, Ont., set to open next Friday, is tiny – less than a third the size of the chain's typical big-box format. Part of the store is a 4,000-square-foot warehouse stuffed with a much broader array of electronic goods that cater to online shoppers. It's about double the size of the storeroom of a typical Future Shop or its sister chain, Best Buy.

The new-concept Cornwall store marks a strategic shift for Best Buy Canada, which operates the two chains, as the company works to keep pace with the rapidly changing retail industry.

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Best Buy Canada is increasingly counting on its buoyant Internet business and so-called "endless aisle" of items stocked only on its website to help bolster its business, as it continues to invest in smaller stores such as the one in Cornwall.

"That's a very different store," said Thierry Hay-Sabourin, vice-president of e-commerce at Best Buy Canada. "That transformation we're in right now is absolutely critical for our future growth."

The Future Shop store reinvention is part of a wider retail reboot sweeping through the industry as retailers and malls are being forced to adapt amid the relentless surge of e-commerce. Shopper traffic in stores is in decline. At the same time, e-commerce is soaring and has never been more competitive.

Meanwhile, consumers expect more for less, as retailers increasingly lure them with a variety of new ways to shop in person and online, with added bonuses such as free shipping.

It all adds up to intensifying competition ahead for an industry already at war as big new entrants in Canada battle with established players to win over fickle consumers.

"Retailers face a multifold increase in the complexity of their business," said Gerald Storch, chief executive officer of Storch Advisors and former CEO of retailer Toys "R" Us Inc. Retailers will need to invest in a number of digital and physical sales channels to remain competitive, he said. "The alternative is obsolescence, irrelevance, and extinction."

Changing stores

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The trends for shopping in stores versus online are on two decidedly different trajectories. In the first nine months of this year, shopper traffic to stores fell 7 per cent from a year earlier, extending years of declines, according to retail analytics firm HeadCount in Edmonton. (It tracks a sample of a broad base of retailers across Canada.)

So far it hasn't hurt retailers too much because sales have held up – a 4-per-cent gain in the nine-month period – the result of fewer browsers and more shoppers who research online before hitting the store to make targeted purchases. But declining traffic is a troubling sign for retailers. "Less traffic means fewer sales opportunities," said HeadCount founder Mark Ryski.

Online retail sales, meanwhile, are expected to jump to $39.9-billion or 9.5 per cent of total sales by 2019 from $22.3-billion or 6.1 per cent this year, estimates Forrester Research.

Nobody is predicting a collapse of in-store shopping, but signs indicate the high-growth era is over. In the U.S., store count growth has slowed to less than 3 per cent from more than 12 per cent in the past three years among largest retailers, Moody's Investors Service calculated recently. The situation is probably similar in Canada, industry sources said.

With some store networks under pressure, retailers – and property companies – are being forced to find creative ways to keep stores relevant to consumers, and not become dwindling profit centres.

Retailers are increasingly encouraging shoppers to order online and pick up in the store – or, ironically, shop online inside the store. They're setting up e-commerce pickup points in stores and malls as a less costly do-it-yourself delivery option. In this way, they're trying to get customers who fetch their orders into their stores to buy more. Wal-Mart Canada Corp. is testing pickup lockers at some stores, where shoppers can retrieve purchases ordered online and pop in the store for any other items.

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Many of these new shopping methods are experimental, since nobody knows exactly where the balance between stores and e-commerce will settle.

"There are going to be winners and losers and the fallout is not going to be distributed evenly," said Michael Turner, senior vice-president of real estate management at Oxford Properties, one of Canada's major mall landlords whose properties include Yorkdale Shopping Centre and Square One Shopping Centre. "There are more questions than answers."

The Amazon threat

Amazon.com Inc., the 800-pound gorilla of e-tailers, is expanding quickly in Canada. In the past 18 months, Amazon.ca has doubled its offerings to 50 million products, including toys, beauty and health items, said country manager Alexandre Gagnon. And it's not stopping there.

"As a company we think Canada is very important to us," Mr. Gagnon said. "We just saw a need, which is a business opportunity," and "we just keep launching new programs."

Rivals are keeping a close eye on Amazon. "Absolutely they are on our radar screen," Kevin Macnab, president of Toys "R" Us Canada, told a conference recently. "We're doing all that we can do to compete against them."

Steve Matyas, president of Staples Canada, added: "What they've done has made me much more paranoid than I've ever been before." In the pre-digital era, Staples tracked prices once a month at rivals such as Grand & Toy, Wal-Mart and Costco, he said. In contrast, "we watch Amazon multiple times per day."

Amazon is forcing rivals to invest more than they normally would in their e-commerce without enough time to do it in a measured way, said Mitchell Goldhar, owner of mall landlord SmartCentres. But for e-commerce over all, "there's no clear path to profit."

Amazon, for its part, has a deliberate strategy to put up with losses in its quest to snatch business from rivals.

"There is a reason Amazon's profits are so paltry," said Mr. Storch, the former Toys "R" Us Inc. head. "They keep saying they're 'investing' for the future but, in many ways, they are just pouring money into the sinkhole of free shipping, trying to cover the high logistics cost of shipping products to consumers' homes by giving it away."

The strategy has helped Amazon make gains in Canada. It already generates roughly $1-billion to $1.5-billion in sales in Canada, or 5 to 7 per cent of the Canadian retail e-commerce market, estimates retail analyst Peter Sklar at BMO Nesbitt Burns. If it were to achieve the same share of retail sales here as it has in the U.S. and Britain, Amazon's revenues could triple or quadruple over the next few years, he said.

Wal-Mart's challenge

Wal-Mart, for its part, isn't about to let Amazon.ca invade the Canadian marketplace without fighting back. That means investing in both physical and digital stores, even as its same-store traffic is declining while the amount that each customer purchases rises.

The gap between the two e-tailing titans is telling: Amazon's websites here had 15.7 million "unique visits" in September, almost three times more than Walmart.ca, according to comScore.com. While Amazon.ca stocks 50 million items, Walmart.ca carries just 150,000.

Wal-Mart Canada chief operating officer Gino DiGioacchino said he's ready for the challenge.

"Retail will evolve quickly in Canada," Mr. DiGioacchino said. "I'm not going to be obsessed, nor should I be obsessed, with short-term profit against long-term success in serving our customer."

In the fight with Amazon, "our store network becomes a competitive advantage," Mr. DiGioacchino argues, helping provide customers with different "access points" or ways for them to receive their e-commerce orders, whether it be home delivery, store pickup, Canada Post depot or a pickup station in the mall.

Wal-Mart's new "Grab & Go" pickup service, which it started testing in 10 outlets a few months ago, allows customers to buy online and pick up at lockers in a store that are accessible with a code sent to them.

"Everyone always forgets an item on their shopping list," Mr. DiGioacchino said. "What we're seeing with the Grab & Go is that the store itself allows them to add that extra item."

Some customers prefer a store pickup over home delivery, even though Wal-Mart offers free shipping on almost all orders. "Quite frankly, most customers are not at home during the day," he said. "Waiting for a package to arrive at home is actually not convenient."

But the discounter's investments in e-commerce can take a toll. Wal-Mart Canada cut 750 employees this spring, with an expected 200 more reductions coming soon, as the world's largest retailer looks for more efficiencies. The streamlining helped Wal-Mart increase its gross profit in its latest quarter, after it had slipped in three of the previous seven quarters. Its same-store sales, after a string of declines, also picked up 0.6 per cent, even as traffic fell 1.4 per cent, it reported this week.

The last mile

Across the retail industry, companies are working to figure out the right cyber business model for the so-called last mile – getting orders to customers.

The last mile can eat up 75 per cent of a non-food e-tailer's distribution costs. Retailers and malls are searching for ways to get customers to fetch their own orders rather than get caught up in the costly business of free shipping.

Mr. Goldhar of SmartCentres is preparing to launch soon a test of free drive-through pickup depots for e-commerce orders in three Toronto-area malls for its tenants and non-tenants. It's a way to keep consumers coming to his malls and, potentially, buying more when they get there, he said.

In the future, "we know that it can't be all home delivery," he said. "It's just not affordable. We're all just working through it. It's not an apocalypse in retail. It's not like everybody is unhappy with going out shopping."

To put the cost of shipping e-commerce orders to customers in context, it's about three times more expensive than the traditional retail practice of stocking stores and having shoppers purchase products and take them home themselves, Mr. Storch estimates. What's more, merchants' costs can be 66 per cent more to ship online orders to customers than having them pick them up at stores or malls, he calculated.

To underline the complexity, he figures there are more than 80 different ways in the new "omni-channel" universe to meld online and physical store retailing. For instance, a shopper can order an item from home, from a store, from a mobile phone or desktop computer; the order can be fulfilled at a central warehouse, at a store stockroom, at another store, at a supplier; and the retailer can ship the product to the customer's home, office or elsewhere, to a store or to a different location.

It's "a challenge, yes, but I think most see this as an opportunity to be creatively competitive in more ways than in the past," said Eric Ziegele, a retail practice director at Toronto-based T4G, which has helped major retailers such as J. Crew and Macy's with their e-commerce and store merchandising planning. "In many ways the presence of online shopping has been the catalyst to create a new normal for shopping behaviour."

Huw Thomas, CEO of Calloway REIT and a former executive at Canadian Tire, said many retailers in Europe, where e-commerce is more developed, have switched from home delivery to "click and collect" pickups.

"Most retailers are trying to figure out the e-commerce model," he said. "There are very few significant-size retailers that have profitable e-commerce businesses. ... The delivery component of the e-commerce equation is a very, very expensive piece of the puzzle because, in essence, you're matching the prices that you have in a physical store, but you're delivering for free sometimes very substantially-sized product to a consumer."

Smaller stores

Big-box chains such as Staples and Best Buy have started to shrink their stores as more business flows online, and each of them closed 15 stores, the former this fall and Best Buy last year. Staples expects to scale back its space by 20 per cent over all, Mr. Matyas said. At the same time, the chains are opening smaller stores.

Toys "R" Us Canada is shrinking the retail space in some of its stores and expanding the storage rooms for e-commerce pickups as it starts to ship online orders directly from its outlets.

Fashion chain Groupe Dynamite recently started to test reducing inventory by up to 10 per cent in five of its stores, providing salespeople with tablets to fulfill e-commerce orders for customers who want merchandise that isn't stocked in the stores. It invested this year in a new e-commerce platform which cost the equivalent of five new bricks-and-mortar outlets, said president Anna Martini.

But even as sales shift to the Internet, retailers still need to invest strategically in their physical stores as well to showcase their brands, which can lead to duplicate costs in the short term. Canadian Tire's Sport Chek, for example, is building flagship stores that are much larger than its standard outlets with digital screens and other tech gadgets to keep its younger customers longer, and buying more.

A growing array of online-only retailers, such as ClearlyContacts.ca, are beginning to recognize the value of running bricks-and-mortar stores by launching them. Even Amazon plans to launch its first store this holiday season in New York, according to a media report.

"We're not seeing customers say the physical store is dead," said Clint Mahlman, chief operating officer of London Drugs, which is beginning to plan for stores that are about a third the size of their current mega-outlets. "What they are saying is that what they expect from a physical store is very different."

Mall overhaul

As the retail industry transforms, so do the commercial real estate companies that own the store properties.

Major mall landlords are moving upscale, focusing on the savviest retailers and dropping laggards. RioCan Real Estate Investment Trust, one of the largest shopping centre owners, has been selling off weaker malls and shifting to more urban and non-retail uses of its space.

As a result, medical clinics, spas, fitness centres, restaurants, libraries and community centres are popping up in RioCan and other malls more frequently. In the U.S., data centres even rent space in former department stores.

Malls and retailers are investing in more technology: Oxford teamed recently with Cineplex to install new interactive digital services and screens. Cadillac Fairview named Jason Anderson, a former Microsoft Canada executive, as its new senior vice-president of marketing.

The rapid retail changes reduce the need for big-box stores as well as more power centres, which are the open-air suburban malls with big parking lots, and superstores such as Wal-Mart, Staples and Best Buy. RioCan, known for its power centres, is building two in Calgary and "they'll be among the last of their kind," said RioCan CEO Edward Sonshine.

"Even the existing power centres will have to be re-imagined a little bit," he said. "You have to look at different types of uses." Some retail categories, such as books and music, have been "devastated" by the digital rush, he notes.

Still, some retailers say landlords have to move faster to respond to consumers' digital needs and attract shoppers.

Marie-Andrée Boutin, vice-president of real estate at shoe chain Aldo Group, said malls need to offer more dining, entertainment and other events and services that consumers can't get on the Internet. They need to borrow from the playbook of some U.S. malls that are adding e-commerce order pickup stations, reserved parking for those pickup customers and same-day delivery service, she said.

She said lower-ranked enclosed malls will feel the squeeze rather than top so-called "A" malls such as most of those owned by Oxford, Cadillac and Ivanhoé Cambridge.

But if sales among mall tenants decline as e-commerce picks up, the owners will no longer be able to command as high rents because they are often based on sales-per-square-foot performance in the centres, she said.

Already, Aldo is securing lower rents at some weaker malls because the sales-per-square-foot performance in the centres is falling as more business is going online, Ms. Boutin said.

"E-commerce will affect the whole bricks-and-mortar Canadian portfolio," she said.

Added London Drugs' Mr. Mahlman: "With the rapid change in e-commerce, a lot of the rule books are having to be renegotiated and rewritten." Malls "seem quite slow to react to things – to how fast customer needs are changing."

Malls may also have to accommodate more trucks coming for e-commerce merchandise deliveries, Joe Megibow, chief digital officer at fashion chain American Eagle Outfitters, told a recent conference. He also pointed to tech snags. A promotion the chain ran in the fall "was kind of a mess" because it required customers to download a new version of the retailer's app and there often wasn't a WiFi connection in the mall stores.

Such stumbles are inevitable as retailers and property owners experiment while e-commerce forces change across the industry.

"The consumer is shopping both online as well as bricks and mortar and I think that line is getting very blurred," said Ron Wratschko, executive vice-president of operations at Cadillac Fairview.

It is doubling its marketing spending next year while bringing new restaurants and other entertainment to its malls.

Said RioCan's Mr. Sonshine: "Everybody is re-imagining their business."

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About the Author
Retailing Reporter

Marina Strauss covers retailing for The Globe and Mail's Report on Business. She follows a wide range of topics in the sector, from the fallout of foreign retailers invading Canada to how a merchant such as the Swedish Ikea gets its mojo. She has probed the rise and fall (and revival efforts) of Loblaw Cos., Hudson's Bay and others. More

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