Retailers want to stop growing so fast
After years of build, build, build, America's biggest stores are deciding that it makes sense to slow growth in a slow economy.
NEW YORK (Fortune) -- For years, the big American retailers have tended to open new stores the way Paris Hilton goes through boyfriends: rapidly, and with little thought to the consequences.
Now, pressed by a slowing economy, retailers are starting to scale back expansion plans, in an attempt to curtail expenses and boost profits at existing locations. Wal-Mart said earlier this year that it will slow square footage growth to 5 percent to 6 percent, down from a historical pace of 9 percent, a move that is expected to improve earnings by lowering projected costs. McDonald's, too, has drastically reduced store openings in recent years to better focus on improving operations at existing restaurants, a decision that has helped to fatten earnings and boost the company's share price.
Other retailers are starting to put the brakes on store expansion. Walgreen Chief Executive Jeffrey Rein said recently that a slowdown in store openings was under consideration, signaling an important change in strategy for the drug store chain, which has grown rapidly in recent years through new outposts. Starbucks, Chico's and Wet Seal also have said they would slow the pace of new stores, in a bid to improve profits and sales at existing locations.
"If Plan A was to expand at all costs, many of these companies are now considering Plan B, which is to take a more cautious approach to capital expenditures," said Daniel Scalzi of Matrix Investment Research. Market share gains have been the retail version of the Holy Grail.
It is not uncommon for chains to open stores that cannibalize existing locations. The strategy is not as crazy as it sounds. Retail is a zero-sum game: if you don't cannibalize your own customers, someone else will. Overall sales growth has averaged 5 percent per year for the past decade, according to the National Retail Federation; company seeking to grow revenue faster than the overall market will need to do it at the expense of competitors.
The result has been a glut of stores. Tim Finley, managing director with Alvarez & Marsal, a consulting firm that works with distressed retailers and apparel makers, estimates that the number of stores in this country outweighs the number of shoppers by a ratio of 4-to-1.
One sign that retailers may look to slow expansion is a recent dive in returns on invested capital (ROIC), an important metric tracked by Wall Street. Richard Hastings of research firm Bernard Sands said ROIC dipped sharply for many retailers in the third quarter, as sales came in below plan. Target (Charts, Fortune 500) saw a 15 percent drop. At Kohl's (Charts, Fortune 500), ROIC plunged 30 percent in the period. Wal-Mart (Charts, Fortune 500) experienced a similar drop in ROIC for several quarters before it decided to slow expansion.
Capital spending is usually planned months if not years in advance, so there is typically a lag between a slowdown in sales and a slowdown in spending. "Wal-Mart set the pace and now other retailers are looking at how they can get a better bang for their buck," Hastings said.
Of course, store openings are only part of the equation. Each year, retailers review their real estate portfolios and close dozens of under-performing locations. Although the net effect has been an increase in overall square footage, the number of store closures has climbed in recent months -- suggesting a more cautious attitude on the part of retailers.
Store closures soared 12 percent in the first six months of 2007, compared with the same period the prior year, according to the International Council of Shopping Centers. More telling: only 10 percent of the closures were the result of bankruptcy filings; the remainder was part of balance sheet-related restructurings, the ICSC concluded.
Not all retailers are heading for slower expansion. J.C. Penney has said it is committed to opening 50 stores next year, and Lowe's (Charts, Fortune 500) continues to grow square footage by 11 percent, more than double the rate of the overall home improvement industry. Even with 1,380 stores, Lowe's is only two-thirds the size of Home Depot, the industry leader.
But for other chains, fewer store openings may be the best way to boost profits in a tough economic environment. Walgreen (Charts, Fortune 500) would need to hire 875 new managers to meet the staffing requirements of the 550 stores it is expected to open by August 2008, Reins the CEO, told a gathering earlier this month at the Morgan Stanley Consumer & Retail Conference. "If we were to cut back, we would definitely help earnings," he said.