Why downsizing is not the solution to the online cannibalisation conundrum

Two recent reports, one from consultants Oliver Wyman in the US and another from investment analysts at Goldman Sachs in the UK, have suggested that the growth of online food shopping should lead to the closure of 20-30% of existing stores. They argue such a reduction in food retail capacity would allow the fittest to thrive and set the stage for an eventual profit recovery. I think this reasoning significantly underestimates how tough the transition to a smaller store estate will be and how long it will take. The “last man standing wins” theory, which used to apply when Wal-Mart came into new markets with its Supercenters in the 1980s and 1990s, is unlikely to work so cleanly for the online channel shift, for three reasons.

1) It assumes retailers as a group will act rationally to close the necessary amount of space, instead of holding on for as long as they can in the hope the other guy will bow out first. After all, if 10-20% of your customers have moved online, closing a store still means you will be giving up the other 80-90% to the competition! Food retailers hate giving up market share and will go to considerably uneconomic lengths to try to win it, as shown by the space race in the UK over the last decade, which is now moving online - despite this channel being even less profitable than stores.

2) The stores that suffer the most from the online shift may be some of the most profitable – i.e., those serving higher income customer segments. Another reason to hold off closing them.

3) Closing outlets that are marginally profitable or even loss-making has a negative impact on a company's profits due to deleverage of central costs such as logistics, marketing and admin. New income streams from alternative use of property that is owned could help offset this, but would require a major easing of existing re-zoning laws to be meaningful. 

The standard strategy for dealing with tougher competition - squeeze out more cost savings to reinvest in price, quality and "service" - is not going to be nearly sufficient to solve this dilemma. So, while a reduction in overall food retail space (especially the larger out-of-town stores) is no doubt desirable and indeed inevitable as weaker operators fail, the transition could be much more drawn-out and messy than most seem to expect, unless the bosses of the major players are willing to try to reinvent the model instead of continuing to tinker with it.