Brick-and-Mortar Renaissance?

Paraphrasing Mark Twain, “Τhe reports of the brick-and-mortar stores’ death are grossly exaggerated.” And last week, several announcements reflected this. 

First, Amazon’s CEO announced that while being somewhat unsuccessful, they are not giving up on physical stores: 

“Jassy told the Financial Times that the ecommerce giant was ready to ‘go big’ on bricks-and-mortar stores, blaming a lack of ‘normalcy’ during the pandemic for a series of stumbles. Five years since acquiring Whole Foods for $13.7bn, Amazon’s largest ever acquisition, the company has yet to disrupt a grocery sector worth $1.6tn in the US in the way competitors had initially feared.”

At the same time, we also read about Barnes & Noble opening 30 new stores and talking about their turnaround, with the current CEO doing a victory lap:

“Today, B&N is profitable, Daunt says. With about 600 locations, it plans to open 30 net new stores in its new fiscal year, marking the first time in recent memory that the company has gotten bigger, not smaller.”

The fact that both announcements come at the same time is interesting since, for me, Barnes & Noble has always symbolized the lack of innovation and ingenuity that brick-and-mortar stores showed when “fighting” the emerging e-commerce trends (mostly symbolized by Amazon). While B&N didn’t go bankrupt, like Borders and others did, it hasn’t done well throughout the years, and ultimately went private at $6.50 per share purchase (well below its peak of above $30).

But this notion of brick-and-mortar resurgence is not new.

About a year ago, the New York Times wrote: 

“Fresh data from the U.S. government shows something that surprised me: Physical stores beat online shopping in 2021. No joke. Americans spent 18 percent more on food, cars, furniture, electronics and other retail products last year compared with 2020, the Commerce Department disclosed on Friday. Online retail sales increased by 14 percent. In other words, e-commerce lost ground last year to brick-and-mortar stores.”

The year 2020 was the year of Covid, and 2021 was the year post-Covid (in terms of lockdown and working from home), so I checked 2022, and things seem to continue at levels similar to those of 2021, rather than the trend we observed from 2013 - 2019: 

But the signals are mixed. Amazon announced the closure of “eight Go convenience stores in a cost-cutting move”:

“‘Like any physical retailer, we periodically assess our portfolio of stores and make optimization decisions along the way,’ Amazon spokesperson Jessica Martin said in a statement. ‘In this case, we’ve decided to close a small number of Amazon Go stores in Seattle, New York City, and San Francisco.’”

As usual, there are many questions that need to be addressed, but the main one is whether this is the new equilibrium. 

Early E-Commerce Days

To put B&N’s rebound into perspective, we have to go back to the early days of e-commerce and understand the operational innovation it brought. 

When e-commerce first appeared, one of its main advantages was the notion of the “Long Tail” — a strategy that allows firms to make significant profits by offering niche products with limited demand. 

The main disadvantage of brick-and-mortar stores, has always been the limited number of products they can place on their shelves, thus limiting the assortment they offer. In fact, most brick-and-mortar stores didn’t even realize the demand for these “long tail” products because they never carried them. 

To understand the main difference between an e-commerce retailer and a brick-and-mortar chain, let’s imagine a product that sells 25 units per year. Let’s say the brick-and-mortar store has 500 locations but decides to carry the product only in half of the stores. So it carries 250 units across 250 locations for a product that only sells 25 times a year. 

On the other hand, the online retailer can carry 5 units in their warehouse, at any point in time, and replenish them whenever there’s demand. If we do the math, the online retailer turns inventory of this product 5 times per year, while it will take 10 years to turn this inventory around for the brick-and-mortar chain. That’s insane! How can we even predict demand 10 years from now?

If we assume that inventory costs around 20% of the product’s cost (a mix of physical cost and financial opportunity cost), the result is that while the online retailer has to add around 4% (20% / 5 turns a year) to any unit sold for the cost of carrying this inventory, the brick-and-mortar store must add 200% (20%/ 0.1 turns a year). 

In addition, every single product you sell must carry the cost of two additional products just to break even. 

So, as a brick-and-mortar chain, thinking about offering anything in the long tail (in combination with any semblance of a service level), only makes sense for products that garner a high enough margin. 

In other words, as a brick-and-mortar store, the options are either offering products with high margins or focusing on fast-moving items. The main implication, of course, is that most of the brick-and-mortar chains can’t really compete with the price or variety offered by online retailers. 

What Could Brick-and-Mortar Chains Do? 

Given the superior performance of online retailers regarding price and variety (and in many cases even time-saving in shopping), brick-and-mortar stores had to offer something else: better quality of service and experience, or better knowledge of their products. 

REI is a good example of this. A few years ago, when embarking as a family on the Tour Du Mont Blanc, a multi-day hike, we were looking for good hiking equipment, but while browsing through Amazon, it was clear that the online recommendations were not good enough. It’s hard to discern a reviewer’s level of knowledge and activity beyond self-attestation. Walking into a REI store allowed us to speak to store associates, most of whom had done multi-day hikes themselves, it allowed us to measure shoes and backpacks, and fit each of us with the right equipment (trading off comfort and fashion, of course.)

I’ve already described how I was looking for a book lengthy enough for the 8-day hike, but light enough to carry around (filters that Amazon doesn’t offer). But stepping into the local Barnes & Noble, I quickly realized that help was not on the way, and the store associates didn’t view their role as helping beyond identifying the section in which I could find books. This is the only book I’ve bought at a physical store over the last 20 years, and the process demonstrated, yet again, where Barnes & Noble and almost all brick-and-mortar chains went astray. 

So what did B&N do? They added a Starbucks in many of their stores. The idea seemed great, and indeed one of my favorite bookstores of my late teens was Bookworm, a bookstore inside a cafe in Tel Aviv: 

At the time, it was quite small (it has changed locations since), with a curated selection and good coffee, two things you cannot say about the marriage between B&N and Starbucks. The idea was good, but the execution showed a lack of true understanding of what people are looking for in a physical retail experience.

So What Changed? 

Multiple things changed over the last few years which has enabled the resurgence of the brick-and-mortar store. 

When online retail commerce started and stores started cutting costs by reducing wages, thus attracting less informed store associates, customers responded with what some people refer to as “showrooming”: customers checked the product in person (e.g., a TV at Best Buy) and would then buy it online on Amazon, at a cheaper price, and shipped directly to their home. 

Over time, Amazon realized that shipping such products is not economical —shipping and handling is expensive, they’re fragile, and are more likely to be returned since they may actually not fit or perform as expected. 

So even Amazon started offering the option of Amazon picking TVs at your local Best Buy: 

“Two-day Prime shipping not fast enough to get a new TV in time for the big game? Amazon has once again teamed up with Best Buy to let you order a TV from the e-commerce giant and pick it up the same day at your local Best Buy. The option, which first started in a "soft launch" late last year and now has expanded throughout the US, is currently limited to just a small handful of Insignia and Toshiba Fire TV televisions ranging from 24 to 50 inches.”

This is, of course, part of a broader strategy of Buy Online and Pick up at the Store (BOPS), a strategy studied by my colleague Santiago Gallino. There are many benefits as it reduces shipping costs for retailers and allows them to drive more foot traffic to the stores because customers can now verify what the store truly carries before going in. 

Similarly, many online retailers realize the benefits of physical stores as a way of driving demand through additional foot traffic and reducing returns. Warby Parker which started as a direct-to-consumer online glass retailer now has 200 locations. There are certain products we really want to try before we buy. We want advice either from the staff or the people that come with us. 

So is e-commerce in decline? Absolutely not. The most popular apps these days (beyond TikTok) are Shein and Temu, both e-commerce variety players. One for fashion and the other for God knows what type of rubbish this is. But in-person is not dead either. 

The ultimate retail experience might be a mix of online and brick-and-mortar, but the issue is that any mix between the two requires developing a strategy that is much harder to execute. It’s much easier to be one or the other. We have discussed the difficulty that Amazon has faced with their brick-and-mortar stores. 

What can we Learn from Barnes & Noble?

So what is Barnes & Noble doing right this time?

“‘It’s ironic for somebody who runs chains, but I don’t think chain bookselling works,’ Daunt says. “All I’ve done is bring the principles of independent bookselling to a chain and exploded the very notion of what a chain retailer really is. The company took steps before and during the pandemic to remake its business:

• It empowered leaders in local stores to make more decisions, including the books they carry and the way their stores are laid out.

• It stopped accepting payments from publishers in exchange for displaying and promoting certain books — a major driver of returned unsold books.’”

The conclusion is interesting: If you want to compete with online retailers, you must go local. Some of this localization can be done with data and algorithms. But for situations where demand is driven by people (in this case, the store associates making the recommendations), you need to localize by aligning incentives and allowing those at the local level to drive decisions while being held accountable. We have discussed the debate on the central vs. local question through the lens of Catholicism vs. Buddhism. For physical retail to be successful, it seems that the pendulum is leaning toward localizing power. 

And if we’re lucky, this won’t be limited to the selection of books, but also their selection of coffee… Just a thought.