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August 31, 2020: IBM breaks down its 2020 US Retail Index findings, Best Buy pushes ahead with its store hub model, Nike to close major wholesale accounts.

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Hosted by Julia Raymond

Written and produced by Gabriella Bock

Edited by Trenton Waller

 

TRANSCRIPTION

Julia Raymond:
Today we’re joined by guests David Hemmat and Karl Haller. David is the chief executive officer of Resolve Digital, a custom software development company specializing in solutions for e-commerce. Karl is a partner, CoC leader and retail industry expert for IBM Global Business Services. Before becoming a partner at IBM, Karl was a retail executive for flagship brands such as Brooks Brothers and The Limited. David and Karl, thank you both for joining The Rundown today.

David Hemmat:
Thank you for having us.

Karl Haller:
Thanks very much, it’s great to be here.

Julia Raymond:
It’s great to have you. We will first talk about a new report released by IBM covering the state of US retail. Their 2020 US retail index found that the COVID-19 pandemic has accelerated retail trends by five years. The study indicates that digital consumer engagement is the new normal, with e-commerce sales accelerating from 13% growth in Q1 to 26% growth in Q2. What’s more, the report revealed that consumers are redefining what is and isn’t an essential good.

Julia Raymond:
The study shows that while clothing sales have declined, categories like groceries, alcohol, and home improvement materials have all seen a major boost. Karl, being a partner at IBM, I wanted to turn this over to you first. You’ve been a retailer in your career, so when you see this data, what speaks to you? What should our retailers who are listening be taking away from this report?

Karl Haller:
Sure, thanks again for having me. I think these findings are quite interesting. This study is one that we put out regularly, we do regular forecasts of the retail economy and what’s happening at specific retail lines of trade. I would say at the macro level, the retail industry has recovered much faster than most people, frankly including me, thought it would. As of July, the non-auto retail and food service portion of the overall retail economy has had two straight months of over 4% gains versus last year, and across what I’ll call the COVID period, the March through July, the business is only down 1.8%.

Karl Haller:
We’re actually almost fully back to normal, taking into account the deep trough that everyone went into back in March and April when all the shutdowns happened. That being said, it’s still a world of haves and have-nots, and I think for the retailers this is where it starts to get really important. There are haves and have-nots right now in both consumers and in retailers. When we look at who has been most affected by the pandemic, it has been the more traditional “blue collar” or “service” workers who have either seen more furloughs or seen more layoffs, while in general more of the “white collar” workers have been able to shift toward work from home, and have largely seen, except for health concerns that the families may have had, have largely seen their own personal family economy do okay.

Karl Haller:
We’re seeing something very similar happening in the retail world. We’re seeing that the retail industry has really bifurcated into essential versus nonessential retailers, and that was really decided initially by the government back in March, when they said, “Okay, drug stores, grocery stores, home improvement centers, ecom, et cetera, you guys can stay open, and everyone else has to shut down.” Since that time, those essential retail businesses have been growing at a mid-double-digit clip, in the mid-teens.

Karl Haller:
Nonessential retailers which are specialty apparel, furniture, department stores and all the bars and restaurants, they’re still down in aggregate 30% over the past five months versus what they were in 2019. As we look forward, we see a lot of the continuation of those trends, and I think we’re going to continue to see, as you mentioned in some of the channels that are successful, non-store is continuing to grow, and in fact the rate of growth is accelerating. We’re continuing to see a lot of strength in grocery, we’re continuing to see strength in the mass and discount segment and the home improvement segment.

Karl Haller:
Conversely, we’re seeing continued challenges on the part of what I’ll call most of the mall retailers and the other nonessential retailers. We also are seeing that the tailwinds that the government has been using to prop up the consumer economy for the past five months are going away. We’ve had roughly $1 trillion pushed into the consumer economy, either the direct $1,200 one-time payments, the additional $600 per week in unemployment insurance, as well as the portion of the PPP funds that flowed through directly or indirectly to employees or into the consumer economy.

Karl Haller:
As of right now, most of that money has gone away, and we do not see a continuation of those tailwinds, and potentially we see some pick up of headwinds around the election that’s coming up, which can sometimes put uncertainty, especially if it’s polarizing and relatively evenly divided. Of course, we also have the pandemic sitting out there, that every time we think we’re getting ourselves back to normal, we start seeing caseloads rise, which again, create uncertainty and fear among consumers, which causes them to depress their spending.

Karl Haller:
We’re a little concerned that right now over the summer could be as good as it gets for the balance of the year, and there are not a ton of tailwinds that can prop up the entire retail economy.

Julia Raymond:
Great points, Karl, and I appreciate the parallels you drew between the consumer sector, the have and the have-nots, and then the retail sector mirroring that same concept, just with essential and nonessential, because there are a lot of nonessential stores, you said in aggregate, they’re still down by 30%, even though we are seeing home improvement and grocery and those type of retailers doing well if not better than previous years. David, what’s your take on some of the findings from the report and the things Karl just mentioned?

David Hemmat:
I was thinking a little bit about what Karl mentioned regarding essential and nonessential businesses, and what I’m seeing is a lot of the market share, a lot of the sales that the nonessential or specialized businesses were doing have shifted to essential retailers that are large enough to offer a wider variety of products. That’s kind of unfortunate for the smaller more specialized retailers. Another thing that we’ve seen is a lot of innovation going on, and I think that the larger retailers were just better prepared, and that includes a lot of the essential retailers.

David Hemmat:
We’re seeing smaller retailers trying to catch up. I have some thoughts that are not necessarily in the report, but a lot of the product categories that were traditionally bought in-store have started to move online. I think groceries is one of the ones that comes to mind, this has been something that has been moving online for years but has probably accelerated significantly in the past few months, and that might not be coming back to stores. There’s a portion of those sales that will stay online.

David Hemmat:
Another thing that we’ve seen is a lot of new online shoppers that maybe weren’t shopping online before and now are, and are now comfortable with the concept, and they might not be going back either.

Karl Haller:
We see those same things among the clients we work with and in the data that we report on and track, all of those same trends are happening. We have a consumer pulse study that we do just about every month, and we’ve found that, this was in April or May, only 65% of US consumers were primarily shopping for groceries by going to the store, buying their groceries and bringing them home. More than a third was shopping in a different way, whether that was shopping online and having it delivered, whether it was shopping online and curbside, or whether it was actually shopping in the store and then having things delivered to home after the fact.

Karl Haller:
I think that speaks a lot to what David was saying about this, one, the innovation and the new ways people can shop, and also this gradual shift toward digital customer engagement which has really accelerated over the past five months.

Julia Raymond:
That’s a great point, because you said, David, some products, not only are people moving their shopping habits more online, but some products that were not traditionally purchased online have now moved online, and that’s outside of grocery. Even with IBM, I was looking at some of the data, and you guys are saying your client, Joanne Fabrics, they saw a huge demand for face masks. It’s a very tactile business they run, and people come in and they touch the fabrics. Now all of a sudden, inventory inquiries rose four times above the last holiday season, that’s huge.

Karl Haller:
Yeah. I was just on with the CIO of a major fashion company this morning, and they are seeing the same things. One of the things that all retailers have had to do, and David, I’m sure you’re experiencing this with your clients as well, is scale up what they’re doing with regard to digital customer engagement. The systems that they’ve had, they’re used to peaking for November/December period, but now they have to peak, and it’s not really a peak, it’s just a surge, now it’s what they might’ve prepared for over a three-day, four-day, five-day period, now is just kind of still the new abnormal, but over time it may become the new normal.

David Hemmat:
I think that’s something that maybe doesn’t affect digital infrastructure so much, because it’s easier to scale, but it especially affects stocks. I think that there have been dramatic increases in certain inventories and decreases in others, causing shortages and so on, and that’s something difficult that a lot of retailers have had to deal with.

Karl Haller:
Yeah, I would agree. Also the overall demand has changed, and also the localized demand has changed. We’re doing a lot of work right now helping clients get beyond what I would call historical and seasonal replenishment patterns and historically-based assortment planning and allocation patterns, because they’re seeing spikes and troughs in demand that could be 10, 20, 30% depending what’s going on in a given market. We think that those demand patterns will continue to be bumpy.

Julia Raymond:
I’ll just jump in here really quickly, Karl, because that’s a huge topic we speak about with our retailer community is the localization of supply chains. I’ll ask you guys one last question then we’ll move to the next topic, but David and Karl, is there anything you would tell retailers should be top of mind as we move into the holiday season?

David Hemmat:
The main thing I can think of is I’m not expecting consumers to rush back to shops, even as things normalize. The way I see it is we had a big increase in out-of-store shopping, and I expect that a small portion of that increase will go back to in-store shopping, but I expect to see continued online demand. In that sense, from my perspective, retailers need to think about how they are going to focus their marketing efforts now that they’re going to have more people shopping online and less people shopping in stores.

Karl Haller:
I would echo that. To me it’s kind of a case of fishing where the fish are, and that’s both from consumers, how you’re going to attract them, how you’re going to engage with them, how you’re going to sell to and serve them, and how you’re going to enable them to receive those goods, and also looking at the product categories. Because there are big shifts in what people are buying, and I think in our own personal purchases in our families, we all see it. We now have had a good five months of data coming out of the Bureau of Economic Analysis in terms of what consumers are spending more on and what they’re spending less on.

Karl Haller:
We are seeing some declines in apparel in general and upticks in what I’ll call big-ticket discretionary purchases, whether that’s things for the home, whether that’s electronics devices, whether that’s items to prepare for work from home or school from home, or frankly, whether it’s what I’ll call big-ticket toys for the affluent, many of whom gave up their vacations and decided to spend that money on something for themselves and their family that they own, rather than paying whatever, four or five figures for a family vacation over the summer.

Julia Raymond:
Absolutely.

David Hemmat:
That’s funny you mention apparel, I can see why people would be shopping less for apparel. I just wanted to add one last thing. I think there’s an opportunity for retailers here. Physical stores are expensive, and as shopping moves online and towards certain categories, there is an opportunity there to decrease the inventories and make store operations more efficient.

Julia Raymond:
Absolutely.

Karl Haller:
We would agree. We’ve been working a lot on how to help retailers bring things like computer vision, automation, robotics, and other really transformative capabilities into their stores so they can reduce the amount of manual task effort that their associates have to do. We’re still bullish on stores overall, but stores have to be reinvented from top to bottom.

Julia Raymond:
Keyword “reinvented”, I think we can all agree on that. Karl, you mentioned electronics, and that was a great segue for our next topic, because like you said, people might be spending some of their discretionary income on big ticket items versus a vacation or a holiday that they may have taken in the past, pre-pandemic.

Julia Raymond:
The next retailer is Best Buy, they’ve seen significant increases in sales during the pandemic, they posted a very strong second quarter earning, with online sales shooting up 242% year over year. To meet the dramatic shift toward online shopping, they will begin piloting a ship-from-store hub model this coming month. They will use 250 of their stores to ship out significantly more online orders than regular locations, and will support same and next day delivery. They’re also continuing to add more third party pickup locations for online orders, with more than 16,000 locations already offering that. David, what do you think of Best Buy’s ship-from-hub model?

David Hemmat:
I love it, just from a supply chain perspective. One of the most well-known problems in supply chains is where do we keep inventory, and how much of it. I think that if you can move sales online, consumers really don’t care where their product is coming from, as long as it arrives quickly. If I buy from Best Buy, I don’t know where they’re shipping it from, and I frankly don’t mind where they ship it from as long as it gets here quickly. That gives Best Buy the opportunity to do a couple things.

David Hemmat:
One is they can centralize their inventory a little bit, which allows them to reduce it significantly. They don’t need to have security stock in every single location. Another element is it allows them to specialize. Supporting online operations is one of many, many things that a Best Buy store does, and if they can have certain locations that are much more efficient at it, then that might help reduce their costs. It will increase the learning speed, they’ll be able to ship things around faster if they need to.

David Hemmat:
I see it as a win for them, and I don’t see any downsides to the consumer, as long as they can keep their delivery times. Additionally, I think there might be some opportunities there to decrease shipping costs, if they’re able to figure out how to make that work for them.

Karl Haller:
I was thinking about it … I’m originally from Columbus, Ohio, which has five Best Buy stores, and if you just think in each of those five stores they had one on the floor and five in the backroom, maybe now they have two in the backroom and they can keep 10 at the delivery depot at whichever of those stores becomes the delivery center for Columbus.

Karl Haller:
They could see a 15 to 20% reduction in inventory, which across Best Buy is huge, and then they lower their costs by concentrating the pick and pack, that phase from a supplies, a materials, and a labor perspective. You’re exactly right, it develops skills within the group in those delivery depot stores, and they’re going to have fewer pickup locations, and they can probably start to bundle more items together, which as you said, will reduce in the shipping costs. I mean, it’s a real win-win, and as long as they’re concentrating around the markets, which I’m sure they are, they’ll take one store in a given multi-store market and turn that into a delivery depot, and that allows them to cover the country just as efficiently as they would’ve been doing so before.

David Hemmat:
I’m sure the folks at Best Buy have investigated and researched this well, much better than we have, and so I’m sure they know what they’re doing. I do see it as a challenging operation. Yes, there are these opportunities to reduce costs, to make things more efficient. One thing we didn’t mention was if you are able to kind of centralize your delivery operations, you don’t need to have every product at every store, you can reduce your inventory significantly that way too. I think it’s going to be challenging. I’m sure Best Buy can pull it off, but it’s not something I would see as an easy solution.

Karl Haller:
Yeah, the execution is always key.

Julia Raymond:
Are you guys surprised though at all that we’re seeing a lot of stores rolling out smaller formats, and the average Best Buy store is still 40,000 square feet?

Karl Haller:
I’m not surprised to see stores rolling out smaller formats. I expect Best Buy also is going to roll out some smaller formats. We’re seeing a ton of experimentation among retailers of all types. Outside of bankruptcy, it’s tough to unwind in a material way a 1,000-store retail portfolio. You’ve got rent deals in place, you’ve got leases, you’ve got build out costs, you’re still paying off the capital costs that have been amortized over a certain lifespan. I think this is a smart, practical move to address a need, save costs, save inventory, and free up cash to start investing in other areas.

David Hemmat:
I think that a few years ago, Best Buy did start the omnichannel model and really, really, really put time and effort into pushing sales outside of their stores or through pickup and so on, but I think that traditionally part of buying at Best Buy has been going to the shop and just looking around. I think that’s something that’s difficult to step away from once you’re already invested in it, and so I think that that’s part of why it’s taken Best Buy so long to do this.

David Hemmat:
Frankly, I would expect the ship from hub model to be pretty much universal, it’s what makes sense from a theoretical perspective, but once you have something up and running and it works, it’s difficult to shift away from that.

Julia Raymond:
Are you saying not only from the business perspective, but also what consumers expect from you?

David Hemmat:
I think what consumers expect from you and from a business perspective. These are changes that take years to implement and a lot of money, and so once you have a model that works, it’s hard to step away from it. I’m thinking of why didn’t Blockbuster move online in time, and it was very difficult for them. They had I don’t remember if it was hundreds or thousands of locations, and a big investment in them, and so it was easier for smaller players to make that move.

Karl Haller:
Yeah, exactly. Frankly, you have senior executives who have spent 20 or 30 years perfecting the skills that got them to that role, who tend to own the budgets and tend to be compensated or bonused based on driving that portion of the business. Sometimes it is, it’s very difficult, I’ve found in my own experiences on the corporate side, it is difficult to innovate through and within an existing business model. That being said, we are seeing a lot of it, we’re seeing it among companies like Best Buy, other big retailers, Wal-Mart, Target, even the department stores, Macy’s and Nordstrom are both doing and trying a lot of very innovative things, and we’re seeing it on the branded side as well.

David Hemmat:
Yeah, I think this is definitely consumer-driven innovation though. It’s clear that consumers are more and more buying outside of stores, and it’s up to the retailers to catch up.

Karl Haller:
Yeah, exactly, and it depends on what numbers you look at, but we still have somewhere around twice as much retail square footage per person in this country than the next-most densely populated country, or densely retail stored country.

Julia Raymond:
Undoubtedly, and that is one of the craziest things about this year and the lack of foot traffic. The next retailer we’re going to discuss is Nike. They’re doubling down on their consumer-direct strategy, and reportedly closing nine of its wholesale accounts with retailers like Belk, Dillard’s and Zappos. A spokesperson for Nike told members of the press the wholesale exit comes as part of their bold vision to create a “marketplace of the future”.

Julia Raymond:
Also included in its strategy, Nike plans to open 200 new small-format stores and work with select strategic partners. Earlier this summer, their CEO John Donahue told analysts that Nike aims to conduct 30% of its own total product sales by 2023. Karl, will reducing the wholesale accounts to focus on direct to consumer change Nike for the better?

Karl Haller:
I think this is another good move, it’s an offensive move, it’s not a defensive move. It’s part of what Nike has been doing over the past, you could say three to five years, but if you go back to when they first opened Nike towns 20-ish years ago, maybe even more, taking control of their own distribution, managing the shopping experience, making the store environment where you buy Nikes brand enhancing. These are plays that Nike has been doing for awhile, and frankly, this move from a brand that was traditionally wholesale distribution into more of a vertical model is something that actually I’m surprised it’s taken Nike this length of time to get there.

Karl Haller:
Because we saw brands like Coach and Ralph Lauren and Burberry, they were all traditional wholesale-based businesses, and I believe each of them now generates the majority of their sales through their own retail stores, or did before a lot of their stores closed, but through their own, I’d say, a controlled retail or a controlled online environment rather than through wholesale. I bet Nike is going to blow away the 30% through its own stores and its own e-com, I would imagine they’re going to get closer to 50 by 2023.

Karl Haller:
I think it’s a strong move, they’re the strongest brand in athletic footwear. It’s like the media business, where content is often king, and Nike has great content which is that great product, and they realize that’s what’s driving the customer to buy. They don’t need to be in every footwear store and every department store and a bunch of independent quasi-discount stores for people to find them, they have plenty of ways to go out and touch customers. Frankly, the fact that they get both the retail and the wholesale margin gives them a good funding source to enable that growth to happen.

David Hemmat:
Mm-hmm (affirmative), and in my mind, it’s an interesting move. First thing is, it seems to be working. I’ve seen sales are up, earnings per share are up, they seem to be rolling out successfully. One key element here is differentiation, so they are pulling out of shops that don’t allow them to differentiate their brand and trying to replace that with sales where they are able to really enhance their brand, the way they communicate with consumers.

David Hemmat:
If I had thought about this before seeing it rolled out and working, I would’ve been concerned about losing, let’s call them non-loyal customers. I’m one of those customers, I have Nike sneakers, I didn’t set out to buy them. I went out to buy sneakers, and I just happened to find some Nike ones that I liked. Moving out of these larger retailers that sell multiple brands, that would be my concern. That’s the consumer they might be missing out to, the consumer that’s not going to walk into a Nike shop. Yeah, I think that’s my take on it.

Julia Raymond:
I was just going to say this speaks to their brand loyalty. They have a lot of consumers who will go directly to Nike who will only buy Nike shoes, but there are a lot of people who pop into a Belk or Dillard’s, or not Zappos since it’s online. Do you think that it will really impact those retailers they had wholesale accounts with?

David Hemmat:
The retailers, for sure.

Karl Haller:
Yeah, I think the impact is much bigger on the retailers that Nike has dropped than it will be on Nike.

David Hemmat:
I agree, I think that a lot of them count on having brands like Nike to bring the consumers into their shops. The impact is probably much worse for the retailers than it is for Nike. Nike will probably quickly recover that, and now they have the extra margin, so that helps too.

Karl Haller:
Yeah, and one other thing, you can bet that now that Nike has shown they will play hardball with a major retail chain, Macy’s, Nordstrom, Foot Locker, the chains that are still important to Nike, when Nike calls and says, “Hey, we want a better in-store shop,” or, “We want a bigger department,” or, “We want more sales associates,” you can bet that those chains are going to listen, because they’ve seen Nike is not afraid to drop someone.

David Hemmat:
One concern I have, I have friends who are runners and they all wear Asics, that’s their brand of choice when buying running shoes. Nike is interesting because it’s not only sportswear but it’s also fashion wear, and in that sense they have a much broader audience. I’m wondering if those consumers that aren’t looking for something very specific will be attracted to the Nike shops.

Karl Haller:
I’d love to hear both of your opinions on this, I thought the fact that Zappos was included was very notable. They didn’t say anything more about it, I’m not sure if this was a shift to consolidate more of digital commerce onto nike.com, although I noticed Nordstrom is still selling plenty of Nikes on nordstrom.com, or if it was the fact that Amazon owns Zappos and Nike had already pulled off of Amazon.

Karl Haller:
I found Zappos carried over 3,500 Nike items across men’s, women’s, and kids, and Nike had its own shop on Zappos. I wonder if there’s something more behind that decision.

Julia Raymond:
That is curious, Karl, because Zappos does well. They are a brand that stands up on issues just like Nike, it seems like they had a great thing going, but maybe it is the Amazon play. What do you think, David?

David Hemmat:
I’m thinking not necessarily about Nike, but of commerce in general. I think that in the past, distribution was a big, big challenge. With things moving more and more towards the online model, a lot of brands that wouldn’t have wanted to take care of distribution and retail selling in the past because it wasn’t their specialty, let’s just put it that way, are suddenly finding that it’s accessible to them. Amazon is interesting because, and I guess Zappos too, what they’ve done is they’ve done a lot of marketing to get people to their shop.

David Hemmat:
That’s something Nike can’t compete with, so maybe there’s just no reason for Nike to sell through those other online retailers. They’re really not providing anything for them, Nike’s got the marketing it needs, they’ve got the brand recognition, and they also have the capability of servicing their own sales and deliveries.

Julia Raymond:
Do you think Nike’s biggest competitors would make a similar move down the road and follow suit, or do they just have so much more competitive advantage that they can’t?

David Hemmat:
That’s a good question, maybe Karl can speak to that.

Karl Haller:
I think it comes down to the power of the brand, really I think. If you think about, and again I’ll draw some parallels, you mentioned, David, Nike is performance but also fashion, if you think about the parallel to the fashion industry, the most powerful brands in fashion are Hermes and Louis Vitton, they both only sell through their own stores. Even when you see a Louis Vitton shop in a department store, that is a concession that is still owned and operated by the brand.

Karl Haller:
I think if a brand is strong enough, then the brand will continue to develop and operate more of its own distribution, both digital and physical.

David Hemmat:
That’s a very interesting thing you brought up. I think with high-end luxury brands, part of the thing is they need to be able to offer a flawless shopping experience because that’s part of buying the brand. I think that’s the direction Nike is pushing here, it’s saying, “Hey, you know what? We don’t want our shoes to just be in a box on a shelf among hundreds of other brands and other boxes. We want our brand to be different, to look different, and to communicate differently.” I’m not sure who Nike’s biggest competitor is, I could say Puma is probably second or third in that segment.

Karl Haller:
Adidas.

David Hemmat:
Adidas, that’s right, Puma is lower. I don’t know if they could pull it off, that’s a good question. I think Nike is in a very special position, they are definitely the most well-known brand in that segment.

Julia Raymond:
Maybe it’s an opportunity there for their competitors to consider following in their footsteps, or maybe take some of their positioning with the wholesale accounts and move their product that way. We’ll see, because nothing is promised with the pandemic at play.

Julia Raymond:
Karl and David, it was great to have you both on the show for the first time, and I hope to have you back.

David Hemmat:
Thank you so much for having us, it’s been fun.

Karl Haller:
Yeah, thanks very much, this has been a great discussion.