On this episode of Industry Focus: Consumer Goods, Vincent Shen enlists the help of Fool.com contributor Dan Kline to ring in the new year with three major trends that will drive retail in 2018.
From the new face of omnichannel strategies to store showcases, companies across the board are embracing experimentation, and consumers are benefiting in the process.
A full transcript follows the video.
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This video was recorded on Jan. 2, 2018.
Vincent Shen: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. We're pre-recording this episode for Tuesday, Jan. 2. Happy new year, Fools! I hope you had some time to relax and are starting strong with your New Year's resolutions. This is your host, Vincent Shen, and I'm joined by Fool.com contributor, Daniel Kline, who's connecting to the Fool HQ studio here via Skype. Hey, Dan! Great to have you with us!
Dan Kline: Hey, Vince! How are you?
Shen: Good. Fools, Dan and I had a tougher time than usual nailing down topics for this show, given that it's the first show of the year. We had the year in review not long ago, and we wanted to kick off 2018 on a similar note, which means going high level and talking about the biggest trends investors can expect to see in the consumer and retail sector this year. Before we dive into that, I'm setting aside a few minutes here for you, Dan, especially, because you're our resident cable and entertainment specialist.
Kline: Oh, and this is a big one.
Shen: Right? I know you wanted to share your thoughts on the Walt Disney (NYSE: DIS) and 21st Century Fox (NASDAQ: FOXA) (NASDAQ: FOX) deal that was announced a couple of weeks ago. I've worked my way through a lot of the breakdowns, the predictions for how Disney will leverage its purchases from Fox, especially the TV and film properties. We're talking about Avatar, X-Men, classics like Home Alone. If the deal goes through, we should start seeing Disney flex its new muscle by the end of 2018. What's your take?
Kline: It's a huge intellectual property deal. You mentioned some of those. There's hundreds of other properties. Die Hard, so many things that could be done, The Simpsons, Family Guy. Fox produces This Is Us for NBC; there's just so many different shows. And when you look at the ability to exploit intellectual property, Disney is the king of this. They already have an Avatar Land, so that brings their theme park and the movie business more aligned, which is good. Their ability to do spin offs for their streaming services, to create everything from video games to bed sheets to theme parks, Disney should be able to shore up its movie division, meaning that right now they can put out eight or nine movies a year between Pixar, Star Wars, Marvel, Disney animation, that are almost guaranteed hits. You mentioned to me personally Pete's Dragon. There are things that fail. But in general, they're going to be able to line up even more hits. This brings the X-Men home, so they will be able to integrate the X-Men into the greater Marvel Universe but also probably put out one or two, maybe a group movie or an individual movie every year. So the box office potential for Disney is huge, but so is their ability to create television shows for ABC, or spin off things with their streaming network. That's the crux of this deal.
There are some other things. The regional sports networks will bolster ESPN, because what they'll be able to do is take the live studio shows that they do in those markets, cut back some of the cost of those by using national ESPN programming, but also have the local feel with reporters in those markets. They should be able to get more bang for the buck out of each of those networks than Fox was able to with the, let's call it little watched FS1, which is not part of the deal. Disney won't be taking that. So this will become a whole synergy for Disney built around all this great IP with a nice little added benefit from the sports networks.
Shen: Yeah. You mentioned the IP angle. I think, on my end, it really amazes me that, at the beginning of last year, 2017, Disney had no streaming services to compete with Netflix besides its minority stake in Hulu. But in the next year-and-a-half, give or take, Disney will have majority control of not only Hulu but two other offerings -- the sports-focused ESPN Plus is expected in early 2018, and then they have that Disney-branded option that's still in the works.
I also have a break down here of domestic box office receipts from the past three years. If you add up the ticket sales for both Disney and Fox, the combined entity would have had an average 35% market share from 2015 to 2017. So again, that gives you a sense of the scale and how much strength they have in the industry.
Kline: And there are going to be some regulatory issues here. It wouldn't shock me if they had to either sell off a stake in Hulu or have an agreement where they share control, because Hulu and the Disney potential streaming service do have some conflict. Now, you could absolutely pivot Hulu to be more of the livestreaming channel service, which is something Hulu is going to offer, but there's a lot of conflict. On the movie side, the numbers are a little bit deceptive, because Disney is probably not going to put out as many movies as Fox did. So, you're they're going to see some movie production move elsewhere. Disney is going to cherry-pick. That division is going to get smaller. It's absolutely going to put out the movies that can make $500 million at the box office. It's not going to put out the bottom 30 movies that Fox put out that, on an aggregate basis, combined, did a lot at the box office, but don't make a lot of profit and don't lead to theme park rides. Because if you look at everything Disney has been doing in its theme parks -- and I live in Florida, I'm a Disney passholder, I spend a lot of time at the theme parks, basically everything is being rethemed to a Disney character. So Epcot got rid of the Land of Energy, they're putting in a Guardians of the Galaxy ride. There was a bird exhibit at Animal Kingdom that's becoming an Up exhibit. Everything in Disney's world is moving toward this synergistic intellectual property model.
Shen: Yeah. And whether that's the theme parks or consumer products or things for television shows and elsewhere. I'm cutting us at about five minutes for that.
Now, I want to move on to our main topics, which are those trends I mentioned for 2018. In the past month, I've seen write-ups from Shopify, Forbes, the National Retail Federation, and a bunch of other retail-focused publications that essentially lay out their predictions for major retail trends that will take center stage in 2018. Fools, there were three in particular that Dan and I wanted to cover during the episode. First up, I'm dubbing this one "the ongoing evolution of consumer convenience", which is our fancy way of describing the omnichannel. Dan, what form is omnichannel going to take exactly this year?
Kline: It's more than omnichannel. Omnichannel is the idea that a customer of a store could shop at home, can shop online, can combine the two, you can be in the aisle of a Best Buy (NYSE: BBY) and order a TV that gets delivered. Customer convenience is going to move beyond that. It's going to be everything from kiosk-based ordering in stores to predictive ordering to, maybe Best Buy will have a masseuse that gives you a massage while you're picking out TVs. And I'm kidding a little bit, but I think some of those things, when you look at a high-end clothing store, they might shine your shoes while you're trying on suits. It's really moving to the model that, as a customer, I don't have to leave my house. I've been shopping via Instacart, and in two Instacart deliveries, I can have groceries, I can have beer and wine, I can have whatever I want sent to my house.
So to get me to go to Whole Foods and walk out rather than do it through Instacart, they'd better have an improved, ready to eat lunch display, or have a better coffee bar, or be a place I can get a haircut, or whatever else it is. It's all going to be about consumer convenience. It's not just delivery. It's not just curbside pick up. It's really anything you can imagine that's going to take friction away.
Shen: So some of that stuff is obviously more experimental. But the key players here in terms of how a lot of companies are leveraging omnichannel, you think about the traditional initiatives like buy online pick up in store. You mentioned curbside pick up. That stuff still has a lot of momentum going behind it. I have some quotes and figures here from several companies that mention how initiatives like buy online, pick up in store or mobile ordering have helped to accelerate their direct-to-consumer business or online sales growth.
The first one is, how many times have we talked on the show about how buy online, pick up in store not only gives customers the option of getting their purchase how they want, but also, they end up in the store and they make another purchase and it adds to the ticket size? So from Lowe's, the home improvement retailer, in their latest quarterly earnings call, they say that flexible fulfillment, which also includes buy online, deliver from store -- that drove online comparable sales growth for them 33% during the period. Here's a direct quote from chief operating officer Rick Damron. He said, "From an execution standpoint, 60% of our dot com sales are currently pick up in store, with 40% of those customers buying incremental product when they arrive to pick up their item. Another 10% to 15% is delivered from store, with the remaining 25% to 30% being parcel."
Another example from Tractor Supply Company, which Motley Fool analyst Simon Erickson pitched to Industry Focus listeners back in October, 75% of the company's online orders were picked up in store during the third quarter. Greg Sandfort, the company's CEO, spoke at a retail conference in September, and his relevant quote from that presentation, he said, "Customers buy product online and designate to pick it up at the store. Now, what's also unique about that is, they add around another 15% to that ticket when they come to the store. So it's not just, they're buying what they found online. But when they get into the store to make the pick up, they find other things to purchase."
Kline: And there's a challenge there for retailers. I shop on Amazon (NASDAQ: AMZN) a lot, and I think it's fair to say that Amazon has a shop in store feeling. When you check out, it shows you related items, it might dangle something in front of you that you purchased previously that you might need.
Shen: Yeah, an accessory or something, sure.
Kline: Yeah. And most retailers -- in fact, any retailer, I would say, at least any major one -- is behind Amazon in its ability. Wal-Mart (NYSE: WMT) does some of it, Target (NYSE: TGT) does some of it, but it's not as well honed. So yes, when I walk into a Home Depot (NYSE: HD) to pick up my order, there's every possibility I'm going to buy a Milky Way on the way out or a bottle of water or a magazine. I'm probably not going to get tempted into buying a lighting fixture. It's going to be more of an incidental purchase. But that's absolutely something that could be delivered online. When you look at some of this convenience, something like an Instacart or other delivery services, it's not crazy to think that if you order $1,000 worth of stuff from Home Depot and they're going to deliver it to you, maybe that will come with, "Would you also like a pizza?" There's just so many ways you can spin this. We don't know what's going to work. I think it's fair to say somebody like Wal-Mart that's doing kiosks where you can pick up in store, which, in theory, you're doing all your check out, so you may not get back in line to buy something else, that may work, it may not work. Curbside pick up works in some markets, it doesn't in others. We're in a great period of experimentation, as well.
Shen: It's funny that you mention the Milky Way, for example. To me, this is the new age, e-commerce version of putting candy bars and magazines and small-tickets items in the checkout line at the supermarkets and convenience stores to encourage incremental spending. And it's a very effective way to boost sales with what amount to very highly qualified in-store customers, because they already made a purchase with you, they like what you have to offer. So when they show up to pick up their order or whatever it is, you really have a chance, this is someone who you can really push that additional item or accessory to, and it's working for a lot of companies.
Kline: The challenge is doing it in a way that's not annoying. If you're at McDonald's and they say, would you like fries with that? That's fine. But if they say, would you like a shake? Would you like an apple pie? Would you like a Grimace mask? It gets to the point where at some point, it's annoying. So stores have to find a way to be subtle about this. And really, "Hey, I see you're buying a lighting fixture. Light bulbs might make sense. Do you need some light polish?" Or whatever logical things. And you want that to be a subtle, low-key sale. Nobody has to sell me the Milky Way. I see the Milky Way. I feel like I've accomplished something with my day because I went to Home Depot, a store I'm totally not qualified to be shopping in, and the reward could very well be a Milky Way or a Red Bull or whatever it is I buy on the way out of the store. And the same thing would be true from an impulse magazine purchase at Target on the way out. But it's a very subtle sale. They're not pushing it at me. And both digitally and in stores, retailers are going to have to find the balance of making that happen. "I see you're buying drywall, would you like a drywall cart?" That makes sense. "I see you're buying drywall, would you like to buy a desk?" That doesn't.
Shen: The second part of this trend I want to get your thoughts on has to do with fulfillment, or essentially, delivery expectations for customers. Basically, today, we see that a lot of people are happy to only go as far as their front door to pick up their orders. You mentioned Instacart, for example --
Kline: [laughs] Me.
Shen: Amazon set a standard where two-day service for Prime members, that became the industry benchmark for some time. The company has also been expanding its one-day, same-day, and even one-hour delivery network to Prime members. You have Wal-Mart and Target, they both recently acquired logistics start-ups in the past several months to improve their same-day fulfillment capabilities. Do you think same-day delivery or two-hour delivery is going to be the expectation for consumers going forward? Personally, I hesitate these days to place an order if I think the delivery is going to take too long.
Kline: Here's the thing. I don't think it's going to be the expectation for hard goods. If I'm buying a new Kindle from Amazon, I can probably wait two days for it. If I'm ordering a sweater, I probably don't need it in two hours. So there are some areas. We're heading away for Christmas, and I needed to buy a charging cable for my son, and it was cheaper to spend $3.99 extra on Amazon to have then one-day deliver it than it was to get in my car, drive to Best Buy. So the mix of cost and convenience made that extra fee worth it. So you're going to see consumers demanding the ability to pay for added convenience in some of those areas.
But when you look at groceries, I generally don't want to shop for groceries two days in advance. If you're talking about something like Instacart, part of my Instacart order is, what am I going to cook for dinner tonight? And because I'm generally ordering from Whole Foods, it's also, what do they have prepared at Whole Foods that I would like to eat for lunch today? So my Instacart $35 order -- because I'm a premium member, so I get free delivery if I spend $35 -- already includes maybe $12 in sushi and $8 to $15 in whatever meat or fish I'm going to cook that night, plus whatever accessories. So I'm already at the order threshold, so it really becomes, I could place two or three Instacart orders a week and not really be spending more money. The challenge for all of these players is going to be making it so -- sending me small things, a bunch of them, with high-margin delivery, makes sense. Sending me certain things in same-day or two-hour delivery that are harder to deliver, take more room in the car, that's not going to make sense. It's really finding the right mix for all of these chains.
Shen: Yeah, and I think it's the optionality behind that overall. Let's move on to our second prediction. I'm summing this one up as "showrooming goes full circle". If you think back to 10 years ago, if you were following retail stocks at the time then you probably remember that a lot of big box stores like Best Buy, and also department stores, complained about showrooming. That was when customers would go to their local brick-and-mortar store, they'd test out the products they were interested in, and then they would go online and buy it at the cheapest price. So the traditional retailers fought this by reducing their own prices to be more competitive. They also did things like price matching.
But we're looking at 2018 now, and the showroom idea has really come full circle, because companies that have a physical footprint are happy to showcase their products in stores, let customers try things out, but then, when they go online to buy, hopefully they're buying it from that store's online portal. There have been lots of examples of retailers changing the look and feel of their physical stores, shifting the focus from having enough inventory to showcase their products in the best possible light. How have you seen, Dan, some of these efforts manifest themselves?
Kline: It's been a mixed bag. A lot of retailers, we talked a little bit about J.C. Penney. JCPenney talks about omnichannel, and the idea that I could go into a store and try on a shirt, figure out it's not the right size and I can seamlessly order the correct size from their website. The problem is, execution on this requires customer service, and that's an area where, as much as I like J.C. Penney, sometimes they're lacking. There's no employee in the store to easily facilitate this order, and their website is not super mobile-friendly. So there are problems with it.
But if you look at what Nordstrom is doing with a stand-alone showroom store, you want it to be almost like a high-end car buying experience. You go in and say, "I'm looking for slides. I'm going to the beach and I need a pair of flip flops, or slides," or whatever you want to call them, "to wear." And they can show you some examples, and either virtually, or some real inventory, you can try them on, and then you can get whatever it is you're buying, hopefully it's more than that, it's also a bathing suit, it's also a floppy hat, a towel, whatever the package is. You've seen it all in a showroom, and then exactly what you want gets sent to your house. You don't have to carry it with you, you don't have to worry about it, but you know what you got. It's a very high-end experience that has to be customer service driven.
Shen: The examples that I found that really jumped out to me, the first one, this is not a public company, it's Warby Parker, which I think is pretty recognizable. We did an interview with one of the founders last year. They sell glasses. It launched as an online start-up, but they opened up their first retail location a few years later in 2013. They now have 65 locations in the U.S. and Canada to showcase their products. You walk in, you try on as many different frames as you like, and that's part of the appeal for them. A similar example is Bonobos. They also started online only first. They started opening small locations in 2012, where customers could go in and try it suits or shirts. I visited a location for Bonobos in D.C. not too long ago and once you know the size, the fit, and the color that you want, it's all showcased and available for you to try on in the store, you place your purchase, but then the order actually gets delivered to your home. You're not walking home with anything in a bag.
Kline: I think this model is the future. You talked about two things. I wear glasses, as everyone can see, and fit is exact. The old Warby Parker -- they send you three different tester pairs, I forget the exact number, but they send you some test pairs and you try them on. That's an unwieldy model, because I don't like mailing things back. It's a pain, I have to figure out how to do it, there's just no way to make that easy. But if I can walk into a store, and they have generic gray glasses in all the different sizes and all the different styles, and I can pick out and find ones that are comfortable and then get a deal on my prescription -- because glasses, I go to a LensCrafter for my glasses and it's $500 to $600 with reasonable frames. So if I've already tried them on -- and the same is true of a suit. You and I both know that you might be a certain pants size at one store and a certain pants size at another store, there's no consistency to it. So if I can walk into a Bonobos, try on everything, and then feel comfortable that what I'm going to order is going to fit me, I will do that time and time again. You've noticed, I wear the same two shirts. I have 30 of each of them because I don't want to have to think about this or stress about it. I would absolutely go try on things once to be able to then order stuff for the next year.
Shen: The last examples that I'll give here, coming from more of the traditional space, think about the sports apparel leaders. You have Nike, Under Armour, Adidas, they are also in a similar boat in that they have opened flagship locations. These are huge stores. They span several floors. They have custom shoe workshops, there's half basketball court, tracks that attract customers and get them to interact with the brands. Now, in terms of how well the throughput and the sales at these locations, it depends on the store. But ultimately, this is the way for them to interact with those consumers, build up a little bit of that brand loyalty, showcase their products and how cool their products are, and then go from there.
Kline: The mega destination model is as much about branding as it is about the actual throughput of sales in that store. In Orlando, which is about two and a half hours from here, there's two different Nike warehouses, a clearance center and a factory store. I have no idea what the difference is. But they're both palaces to Nike, with all sorts of stuff. That's a model, you can't have a thousand of those. What you could have is stores like that that are kind of a destination for sneakerheads, and then you could have your store within a store with the mixed virtual reality ability to look at a sneaker and see if it's in your size and order it and try on a test pair that may not be the exact color scheme you want. So it's going to be blending all of these different things, because I don't think we're at the point -- and we might get there within a few years -- where consumers are comfortable with any of the purely digital ways of buying things that require fit. I might buy a winter coat or a sweatshirt or something where I absolutely know the size range is going to be pretty forgiving online without looking at it. But if I'm going to buy sneakers, I wear a 10 in Nike, a 10.5 in New Balance, and a 9.5 in other things. So if I can walk into a store and get some of that, I don't need to leave with sneakers. And it just keeps coming back to, maybe someday there's going to be a little laser scanner that can get everything perfect that can send you sneakers that are exactly fit for you, but we're not there yet.
Shen: Overall takeaway for this one, whether these companies are leveraging new technology or it's just a shift in how these management teams look at their physical store presence, I think the companies are managing to turn what was once seen as a huge weakness in terms of their physical store presence, big weakness in their cost structure, they're turning it into a better way to connect with the customers and build that brand loyalty, and also offer them some expertise or one-on-one customer service that I think helps stand out from the online channel.
Wrapping up here, we have a few minutes to cover this third trend. This one is closely related to everything else we've talked about so far, and that's the idea that brick-and-mortar retail comes in all shapes and sizes. This one I'm separating from the examples we already discussed in terms of the retail showcases, because the end goal is a little bit more of a sustainable means of geographic expansion. If you're a company with, for example, over 90% penetration in the U.S., you have massive stores in every major metropolitan area, your next goal might be to go small and try to establish a presence in more dense urban markets where your big box store is not feasible. How is this playing out in terms of companies playing with different formats for their stores?
Kline: It's kind of a holy grail, and it hasn't always worked. Wal-Mart tried this a couple of years ago with Wal-Mart Express. And the idea was, if there's a Wal-Mart every five miles, the Express stores would fill in the middle, so you wouldn't go to CVS or the local grocery store. And it wasn't a big enough game, and they closed them. They sold a lot of them off to Dollar General. But Target is now using, call it a micro-store even though it's a 20,000 to 25,000 square foot store. They're opening locations in cities, in places that identify with the Target brand but weren't going to be able to or be that willing to get in a car to drive out to a full-size Target. And they're tailoring the merchandise for people who live there.
So if you live in Manhattan, you're probably not buying 64 rolls of toilet paper at a time. You don't have any place to put them. So in terms of inventory, that store is probably stocking four-packs and six-packs and single rolls of paper towels, and smaller amounts of trash bags. And these stores are being organized so grab-and-go items, or the things people are most likely to need quickly, are at the front. So maybe in New York, umbrellas would be included in that mix or something else you might just quickly want to get -- get in, get out. These smaller store models are going to work, but you see, a lot of people are testing them. Whole Foods, which is now owned by Amazon, had its Whole Foods 365, which was a smaller, lower-frills store meant to go in a more dense, urban environment. And some of them have worked, some of them haven't.
Amazon is using small, call them bookstores, but really, they're Amazon experience stores. Yes, you may buy a book, but you're just as likely to play with a device or get exposed to the new Echo, and it's not so much about retail sales. I will say, the one advantage all these chains have right now is, even the successful malls have vacancies. So there's a lot of ability for an Amazon, a Wal-Mart, a Target, whoever it is, to go into a mall company or a retail development and say, "I want that space, but I want a short-term lease. I'm not going to commit to 20 years, because this is an experiment and I don't know if it's going to work."
Shen: Yeah. If we can jump back to the Target example, in the latest earnings call, COO John Mulligan actually talked about how adaptable they need to be when they're designing these new locations. He says, "We're also investing to reach guests in new neighborhoods and elevate the experience in all of our stores. To reach new, densely populated neighborhoods, we've completely changed our approach to choosing the location for our small-format stores. In the past, we had a relatively rigid prototype for store size and layout, and our real estate team focused on finding sites that would accommodate that prototype. Today, when we find space available in an attractive neighborhood, we custom design a store that can fit the available space. These stores generate high sales productivity and higher than average gross margin rates, driving strong returns on investment. And for the smaller group of these stores that have now been operating for more than a year, we continue to see very healthy growth in both traffic and comparable sales." Another example I have here, a huge underdog, Sears -- they're hoping for a miracle. The company is testing new locations focused solely on two of their stronger departments, mattresses and appliances. They've been opening these in the past six months and hoping this will maybe help right the ship for them, but they're pretty far down the road already.
Last couple of minutes here, to recap, our picks for 2018 trends -- the consumer convenience and how omnichannel is growing in scale, the brick-and-mortar retailers showcasing their products, and also how their store formats are taking new forms. Looking at this list, including a lot of the other trends that have been discussed elsewhere -- for example, likely to be more M&A activity, more acquisitions and deals between online and traditional retailers in 2018. We saw a lot of that activity last year. What I see connecting everything that you mentioned earlier as well is experimentation.
Kline: Yeah. We don't know, and I think that's the important thing. I don't think there's anyone who believes we're going to move to a storeless society, where at least in the next 20 years, we won't grocery shop out, we won't buy clothes out, there won't be malls. I don't think that's what's happening. I think we're seeing a retail contraction, where some chains had too many locations, some had too big. But I do think there's still a place for physical stores. And that might be varied concepts, like Best Buy has revived itself largely through store within a store. You walk into a Best Buy and there's more than just Best Buy -- you can get your cable, you can see an Apple store. You're going to see a lot more of that. And it's not all going to work. And it's not all going to work in every market. I live in a downtown walking market where some of your retail choices are limited. So if a Target came in, it would probably do very well, even though there's a Target a few miles away. That might not be true where the Fool office is, where there's a Whole Foods and other things you can walk to all within that area. So you're going to see a lot of experimentation, a lot of different ideas, and some stores that open and go away pretty quickly.
Shen: Alright. Thanks a lot, Dan, for hopping on today. Happy new year!
Kline: Happy new year to you!
Shen: Thanks, Fools, for tuning in. People on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against any stocks mentioned, so don't buy or sell anything based solely on what you hear during the program. Fool on!
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Daniel B. Kline owns shares of Apple. Vincent Shen has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon, Apple, Netflix, Nike, Shopify, Under Armour (A Shares), Under Armour (C Shares), and Walt Disney. The Motley Fool has the following options: long January 2020 $150 calls on Apple, short January 2020 $155 calls on Apple, short May 2018 $175 calls on Home Depot, and long January 2020 $110 calls on Home Depot. The Motley Fool recommends CVS Health and Home Depot. The Motley Fool has a disclosure policy.