Thursday, July 13, 2017

Retailers' Woes Have Nothing to Do with Amazon

One more of the most confounding features of modern times is that we have more information than ever before, but less common sense. In short, we have more data, but it doesn't help us because we're unable to commandeer it properly.

Retailing data tells us Amazon.com--which recently had 1 billion USD of sales in 30 hours--is going to destroy traditional "brick and mortar" stores. Others argue 90% of retail sales are still done in-person, so while the internet's share of sales is increasing by 1% a year, traditional retail is not dead.

Everyone misses the point. I visited the local mall today. I live in an affluent area where people have lots of disposable income. Here's what the mall looked like inside: 
Looks dead, right?

The main foot traffic was in the food court, a cafe, Starbucks, Apple, and Hollister (which has somehow solved the puzzle of teenage fashion). With Amazon and other online choices now ubiquitous, we've forgotten the days when internet sales weren't successfully gaining market share and "dot com" was synonymous with "bust."

1. Internet Retailing Was Once Considered a Fad

It wasn't always certain that internet retailers could even survive. Amazon.com was allowed a sales tax exemption for many years because it continually posted losses and claimed poverty. States that tried to tax Amazon soon saw it move completely out of their state to limit the law's ability to tax entities without minimum contacts in a particular jurisdiction.

Recognizing his business's unusual dynamic, Bezos once said, 
"[W]e don't make money when we sell things. We make money when we help customers make purchase decisions." By the year 2000, Amazon had posted a loss of 1.4 billion USD. At one point, Amazon hired Walmart executives to increase profitability, causing a major culture clash with existing employees, who were generally younger and more urban. Most of the managers poached from Walmart eventually left Amazon, but Amazon's poaching left a bitter taste in Walmart's mouth that persists to this day.

Today, Walmart is more profitable than Amazon but has finally realized it needs to catch up in the online space to prevent Amazon from capturing retail market share as Amazon continually improves efficiency and passes cost savings to customers--just like Walmart. Bezos has always been unperturbed about profitability comparisons: 


"[D]on't worry about our competitors because they're never going to send us any money anyway. Let's be worried about our customers..." 

2. It's All about Inventory, Inventory, Inventory

Stores are expensive to maintain. You've got lawsuits resulting from poor customer service or arbitrary hiring decisions. You've got some customers slipping and falling on your floors--sometimes intentionally. You've got theft, which most Americans don't realize costs retailers about 40 billion USD annually--with the plurality of the theft coming from employees, not customers, in the U.S.

The biggest hassle of retailing, however, is inventory management, not HR. Most retailers live or die by major holiday events and new product launches. If a store buys too many products that later become unpopular, they either have to mark it down--which they can't always do because of complicated MAP, or minimum advertised pricing rules--or return them to the supplier for a fraction of the costs already paid. In some cases, with very popular items, a retailer is not allowed to return any portion of the inventory bought and is stuck with it no matter what. Under such a framework, retailers who overestimate or underestimate customer demand--especially during the holidays--tend to see wild swings in revenue while still dealing with relatively fixed overhead.

Amazon bypasses such issues by theoretically having unlimited shelf space and using algorithms to personalize the shopping experience for each customer. While Macy's and Nordstrom must not only figure out which products are "hot" and stylish, but how to allocate enough shelf space for them--potentially losing sales on less popular but profitable items--Amazon can stock everything. While Gap and Target can't really individualize your shopping experience without assigning you a personal shopper as soon as you walk in the door, Amazon is able to collect information every time you log on its website and browse--even if you don't buy anything. With online retailers' greater abilities to reduce human error and gather reliable customer data, how can brick-and-mortar compete?

3.  Actually, I Lied: It's All about Customer Service

If it's all about inventory management, why isn't Starbucks failing? How come Chick-fil-A has lines every time I visit? Well, have you ever seen the outside of a Starbucks look like this? 
In a local mall's parking lot
Oh, you're going to argue I'm only using food retailers as examples? Ok, why are Apple and Nike so popular? Why did Apple open "brick and mortar" stores several years ago? Why is the Apple store always busy while the Microsoft store across from it in my local mall almost always empty, except for kids trying out video games?

It's the customer service--a long lost art. When you go into any Starbucks, you can personalize your drink any way you like. If you still don't like it, you can demand the barista re-make it. When you have a problem with an Apple product, you can bring it into a store and get it looked at by experts. When I question the workers at the Genius Bar, they take such pride in knowing everything about their products, they often get offended or bemused. When I pointed out one of the outlets in the table didn't work, the worker smirked and said he knew--the implication being, "You can't know more than us about Apple, buddy." Another Apple employee once answered numerous questions about DJI and GoPro drones in depth--which aren't even Apple's own products.

Does Starbucks make money on its 100% customer satisfaction policy? In terms of hard numbers, absolutely not. Does Apple maximize profits by paying higher wages to experts who actually care about their products when it can sell its products online or through other retailers? Nope. But both companies have such high margins, they don't mind losing money here and there if it brings back customers. In short, high margins are supported by excellent customer service, and excellent customer service allows higher margins.
From The Everything Store (2013)
Lots of people shop at Ross and Kohl's, but they wouldn't go there unless they could get 75% off original prices. When you have non-existent customer service, you can lose customers easily unless you keep prices so low, they will tolerate ineffective and surly employees--who might be adding to the $40 billion theft problem while you shop. 
Unfortunately, you can't quantify the value of consistently excellent customer service in a spreadsheet, so some managers who take over stores with declining YoY revenues focus on everything but the customer experience, dooming their efforts from day 1 and antagonizing formerly loyal employees. 

4.  Overseas Malls Are Mostly Doing Just Fine

Let's contrast the American shopping experience with other countries. Malls are central meeting points in many non-U.S. countries because they offer air conditioning, excellent WiFi, and wonderful food courts.

Discounters haven't made inroads overseas. (A Filipina friend, a highly educated regional manager of a popular pizza joint, has never heard of Ross or Kohl's.)  American brand names still command high prices because MAP restrictions force retailers to compete based on excellent customer service, not low prices. Dirty, unappealing malls exist, but they only have mom-and-pop stores and small businesses, not brand-name retailers. Every single mall overseas I've seen with brand-name businesses is pristine and staffed with people who work hard.

When customer service fails overseas, it's because good intentions often overwhelm common sense. For example, in Panama, as soon as I walked in a sporting goods store--where I eventually bought an authentic Kobe Bryant jersey for 40 USD--an employee asked if I needed help. When I said I was just looking, she still followed me around. At first, I thought she believed I was a potential shoplifter, but then she started being really helpful, like taking the hangers from the clothing I was looking at and pointing to nearby mirrors. I take a long time before buying anything because I walk around for at least 5 minutes, asking myself, "Do I need this? Do I really need this?"

After 5 minutes of walking around doing my usual retail self-questioning, I decided the cute, petite Panamanian employee following me everywhere was working on commission, and it would be rude not to buy something. When I told her I was going to buy the jersey, her expression didn't change. She walked me to the cash register but didn't ring up the sale herself. That's when I realized--she wasn't working on commission. That's just normal overseas customer service.

It's not just in Panama where I experienced "excessive" customer service. Let's take another "P" country, the Philippines. Every time I walked into a middle class or upscale mall, I saw at least three workers ready to assist me in each section. Like I said earlier, I'm so used to American customer service--or lack thereof--it took me a long time to realize I just had to patiently deal with overly helpful employees when shopping.

5. Retail Used to Be a Viable Career and Still is Overseas

Many SE Asian malls, such as ones operated by Ayala Corporation, prefer to hire college graduates as workers, the idea being that such persons will speak English and are able to identify with affluent shoppers. Yet, even in overseas malls where the staff comes from more humble circumstances, I experienced genuinely helpful, normal, and intelligent people. 


When I bought a soccer jersey in a mall frequented by Panamanian locals where workers make 2.60/hr USD, I still got got excellent customer service. Using Google Translate, I was my usual annoying self and asked a lot of personal questions from the employee, including about her wages.  I tried to tip her after she amiably answered my prying questions, but she looked surprised and called to her supervisor, asking if she could accept the tip. Her supervisor cocked an eyebrow, then nodded and looked away, probably having committed a violation of store policy but at least having the discretion and common sense to know when to override it. 

Retail wages in other countries are generally good. In Panama, the worker making 2.60/hr USD could afford to buy a home, which cost her 59,000 USD. (Yes, I ask a ton of questions--I have no shame when it comes to gathering data.)  She took out a mortgage with an 8% interest rate, which most people would consider quite high, but she owns a home--something almost no retail worker in a developed country can do. Sure, she's far away from the Malecon, where a one bedroom high-rise condo costs 250,000 USD in a beautiful area resembling Venice Beach, but she owns property and isn't at the mercy of a fickle or greedy landlord/slumlord.

In hindsight, Amazon's most valuable competitive advantage didn't come from data, but from the underlying premise of Bezo's business model: if a process works, lower-level workers should talk to each other less, reducing the potential for conflict or mistakes. If a customer has to email someone and ask for help, there's a flaw in Amazon's self-contained eco-system, and because Amazon owns every piece in the system, it can keep perfecting its processes until you can get anything you want, however you want it, without needing to contact an underpaid American customer service worker. Even before robots, AI, and drones, Bezos envisioned and created seamless automation, bypassing the risks of imperfect customer-facing service. Amazon is taking market share from "brick and mortar" not because of lower overhead due to the lack of a physical presence, but because it focused on creating a seamless customer experience. In fact, Amazon will be opening a traditional brick and mortar store right across the street from the mall I visited today. That mall is the most posh outdoor mall in the entire city. When it comes to the customer experience, Amazon doesn't mind paying more. 

In contrast to Bezos, Starbucks CEO Howard Schultz made coffee a premium beverage by encouraging employees to create the perfect in-person customer experience. Before Schultz, no one could charge more than 1.50 USD for a cup of coffee, but after seeing the more fashionable coffee experience in Europe, Schultz returned to America, determined to bring a better coffee culture to the States. 
From Schultz's Onward (2011)

Read my last line above--pay particular attention to the word, "culture"--and the words, "human connection," in Schultz's own book. Schultz didn't bring coffee to America. He brought a specific cultural vision and added excellent customer service.

Two CEOs, two seemingly different visions, but the same focus: a perfect customer experience.

6. Conclusion

I don't have an MBA, and I've never managed a retail store, but I'm not surprised customer-facing American retail is suffering. In the absence of sincere, dedicated leaders, relatively low wages make it hard to convince employees to deliver excellent service or to see themselves as a part of a brand's cultural continuity. 

In addition, lower-level employees, including store managers, often lack discretion to satisfy customers, so higher wages alone may not increase initiative. In fact, Costco pays higher wages, but people go there for competitive prices, not customer service. Unsurprisingly, Costco is struggling to find its niche with a younger generation of shoppers who want better overall experiences, not just lower prices. 

If individual American retailers cannot consistently create excellent experiences, then mall operators themselves should. Ethnic malls have a much more diverse tenant mix, which increases foot traffic at different times of the day, alleviating parking woes. Such malls usually have a grocer as the anchor tenant (H Mart, Mitsuwa, etc.) as well as sleek food courts within the grocer itself or the mall, using delicious food and smells to drive traffic. Upscale malls overseas have numerous events sponsored by major brand names--just think of the fun activities and giveaways inside an American sports arena on gameday, and you'll get a good idea of what a Hong Kong mall looks like on a daily basis. American retail is suffering from an identity crisis and is trying to compensate by increasing ad dollars and focusing on image, not experience. Yet, companies like Abercrombie and Fitch (excluding Hollister) and J. Crew, which arguably care the most about their image, are suffering the most. It's time to get back to basics. 

Disclosure: I own shares of ANF, M, TGT, various REITs, and other companies mentioned herein. My positions may change at any time. You are responsible for your due diligence.


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