By Antony Karabus and Greg Apter
The state of traditional retail is in flux all over the world, but Canada faces some unique challenges that are becoming increasingly more significant. Target Canada, Zellers, Jacob, Mexx, Bikini Village and more recently, Smart Set, are some of the headline-making casualties, but all of them share a set of common challenges that have resulted in their departure from the Canadian retail scene.
These challenges include:
- The size of the Canadian pie is only so big. As of July 2014 the Canadian population had increased only 1.1 percent over 2013 (and 1.2 percent the prior year). With most consumers located in only six cities — Toronto, Montreal, Vancouver, Calgary, Edmonton and Winnipeg. Retailers who have failed to reinvent or adjust to shifting market conditions have fallen hard or disappeared altogether.
- The recent sharp decline in the Canadian Dollar from close to parity with the US currency to fewer than US$0.80 is having a significant negative impact on Canadian retailers who are direct importers. As a result, cross border shopping has dropped 14 percent in the past year. It gets even worse if the retailers are borrowers from U.S. lenders in U.S.-denominated loans, as within the past 12 months their loans have become 25 percent-plus more expensive to service and repay.
- The unprecedented increase in retail competition in the Canadian market has significantly “raised the bar” for incumbent retailers. Global leading retail brands such as Nordstrom, Top Shop, J.Crew, Ann Taylor, Brooks Brothers, Tiffany, H&M, Zara, Forever 21, TJ Maxx and numerous others have taken significant market share. This is in addition to an ongoing stream of standalone luxury brand arrivals in Canada.
- Canada is now experiencing a delayed e-commerce/omni-channel growth spurt, much as the US did two or three years ago. This has resulted in massive capital and operating expense spending by Canadian retailers as they seek to catch up with consumers who have already made the channel shift. (For example: it has been estimated that Canadians buy one-third of their consumer electronics online: see the recent Best Buy announcement below.)
A potential silver lining could be the increased market size in Canada due to the potential re-patriation of some of the reported $8 billion in annual cross-border shopping by Canadians. For many years these shoppers have crossed the border into U.S. cities such as Buffalo, Detroit, Seattle and others along or near to the Canada-U.S. border — as often as weekly — to buy everything from cheaper groceries to household consumables, and even gas to fill their cars. Cross-border trips over the past year have dropped 14 percent due to the sharp decline in the value of the Canadian dollar and increased presence in Canada of many U.S. and international retailers. The real question is, will the decline in cross-border shopping continue, or is it just a short term gain?
Adjusting The Real Estate Portfolio
How do Canadian retailers address their real estate portfolio to adapt to the changing retail environment?
A retailer’s real estate strategy is becoming ever more critical to its overall financial performance and profitability. Store cost infrastructure continues to inflate, despite declining rates of growth in comparable physical store sales productivity in all but the high-performing Class A centers. Concurrently, rental rates are also on the rise in these premium centers throughout Canada as the owners (increasingly pension funds) have sharply raised gross rent costs to as much as $250 per square foot, making it harder for mid-tier retailers to operate successfully.
Historic mall-based store occupancy benchmarks of 12 percent to 15 percent of store sales have spiked to as much as 25 percent to 35 percent or more in many premium malls, such as Toronto Eaton Centre, Yorkdale or Vancouver’s Pacific Centre. Separately, we have heard from a number of landlords of Canadian premium malls that sales productivity of $1,000 per foot is now becoming the de facto standard in order for these landlords to renew space with retailers in those premium malls. Certain retailers who have been in these malls for 20 to 30 years have not had their leases renewed by their landlords and have been replaced by U.S., international or the higher sales-per-square-foot Canadian retailers. Similar challenges exist for many retailers in off-mall locations, like power centers, premium street retail or freestanding locations. For example, Aritzia’s new store on St Catherine’s Street in Montreal replaced a weak Mexx store that simply couldn’t compete in the new, high-rent retail environment, while a newly opened DSW replaced a weaker local chain in a Heartland, Ontario, power center.
There are additional counter-forces taking place which should be recognized. Similar to what has been occurring in the U.S., retailers are on a quest for quality real estate, whether inside or outside the mall. For the most expensive, premium locations, traffic and sales are often sufficient to support successful operations, although as detailed above, there is a smaller universe of retailers who can operate successfully in that environment. Concurrently, there are more locations that fall beneath the B-plus level, which is causing an increase in vacancies in the mid-level to sub-par real estate marketplace.
So What’s A Retailer To Do?
Retailers facing these pressures need to address a combination of significant factors, starting with:
1. Re-evaluating their real estate portfolios against their current and anticipated customer profile. Some may have to downsize their premium location store sizes to make the economics more manageable, while others who operate primarily in malls may need to shift a meaningful portion of their portfolio to street locations or B/C malls that are expected to remain relevant (i.e. generate adequate traffic), where they can be economically viable and where their consumers may be migrating.
2. The closure of certain stores and reduction of the attendant infrastructure costs to focus their limited resources on their best stores and e-commerce channel. An excellent example of this was the recent Best Buy Canada announcement that it is closing the Future Shop banner and consolidating the remaining Future Shop stores into the Best Buy banner to create focus on the best stores and remove significant duplicative cost infrastructure that was required to support the dual-banner strategy. We believe this recent decision was the right move for Best Buy, despite the natural hardship it causes employees and suppliers who lose their jobs and some business.
3. Evaluation of their business model and strategy to find the most relevant position and/or “white space” for their retail chain to most effectively serve customer expectations. Re-invention of the concept may be needed for some chains whose sales productivity has continued to decline for some years and who don’t have robust e-commerce businesses.
Hope On The Horizon
The news isn’t all bad. There are many winners and world-class retailers in Canada, all of which share attributes that have allowed them to survive and continue to thrive. They have been able to differentiate, successfully anticipate and meet or exceed customer needs and expectations, hold their own against the new competitors, continue to increase market share, push to invest in new strategies to profitably grow their businesses, and strengthen their balance sheets. These businesses/brands not only rise above the tide in Canada but are global examples of success.
Part and parcel to this success, most of these world-class retailers have a strong negotiating position regarding their real estate needs and are seen as desirable tenants for Canadian landlords.
Lululemon, MEC and Aritzia created significant, clear differentiation and separated proposition from price, which has afforded them the ability to pay the sharply increased premium mall rents. Canadian Tire, an iconic Canadian retailer, has strong store locations near the bulk of most Canadians, and smartly acquired Sport Chek, which has fuelled strong growth by this Canadian sporting goods leader into many excellent locations.
Indigo Books is in the middle of a transformational change from a bookstore chain in a challenged sector to a highly successful self-described “first cultural department store,” and is seeing impressive interim results including a significant improvement in real estate productivity.
Hudson’s Bay Company is probably the most impressive real estate case study. Real estate magnet and owner Richard Baker has created miracles with his retail and real estate portfolios. He purchased the entire Saks chain for $2.9 billion in 2013. In 2014, the Fifth Avenue store alone was appraised at $3.8 billion. The math on that is astounding. That location, which is the most profitable retail location in the world, is now worth $800 million more than he paid for the entire chain just a year prior. And his accolades go on. Baker just announced two real estate joint ventures with two leading global REITs. The recent deals with RioCan in Canada and Simon in the U.S. are designed to further strengthen their real estate holdings and provide investors an easier way to evaluate the company.
Advice To Heed
As retail business challenges continue to arise, real estate and other cost infrastructure strategies, coupled with a sharpening of the customer value proposition, must be a priority. Assuming that this advice is taken, here are the cornerstones to materially enhance success in the Canadian retail market:
- Invest judiciously in omni-channel infrastructure.
- Aggressively assess and execute upon cost infrastructure reductions.
- Invest in analytics for customer insights to inform decision-making.
- Differentiate and localize assortments and product offering.
While outside forces will continue to impact retailers across the globe, those who clearly establish their value proposition (i.e., brand) from price, and proactively realign their priorities, will succeed. This begins with, and ultimately, creates success, when their customer value proposition is more clearly understood and alignment between those customer needs/wants and the retail real estate portfolio exists. This could involve inventive growth strategies, more engaging environments and product offerings, or in some cases, strategic contractions. The Canadian dollar won’t help matters in the near future, but smart retailers will find ways to make it up elsewhere and/or take advantage of the challenging real estate marketplace and right size of their real estate portfolios. Those who don’t take action will wake up to a future where they are no longer relevant.
— Antony Karabus is CEO of HRC Advisory and can be reached via email at akarabus@hilcoglobal.com. Gregory Apter is president of Hilco Real Estate. He can be reached via email at gapter@hilcoglobal.com.