Last quarter we discussed the challenges facing grocery stores as demographics shift and consumer preferences undergo rapid and dramatic changes. Grocery stores are not the only “brick-and-mortar” retailers coping with these challenges, which, of course, also include the competitive rise of online and mobile commerce. Retailers from across the spectrum – from mall-based apparel chains to standalone auto parts suppliers – have been compelled to alter their strategies. Those that haven’t now find themselves relegated to history, as several thousand stores have been shuttered in the past year, and many more are planned. Entire chains, including the Limited, Wet Seal, and Colorado’s own Sports Authority, have filed for bankruptcy.

It’s worthwhile to highlight what has driven retail to this point. First, the effects of online and mobile commerce – convenience, price transparency, quick (and often free) shipping – have rendered much of our physical retail space obsolete. As a result, the United States in particular is “overstored.” While estimates vary, the United States has anywhere from four-to-six times the amount of retail space per capita than most other developed nations. Second, there is a timing mismatch between retail trends, which can develop seemingly overnight, and commercial real estate development cycles, which by necessity can be years-long. The investment in physical retail assets during the 1990s and early 2000s did not anticipate the changes in consumer preferences that have developed more recently. Lastly, we have seen in recent years a trend toward consumers, and especially Millennial consumers, spending more of their discretionary income on experiences rather than physical goods.

In the face of all these pressures, just how are retailers handling the new landscape? Short of closing underperforming stores (which is occurring apace), forward-thinking retailers have adopted a number of strategies. First, they have begun using their stores as an integral part of their companies’ broader distribution networks – namely as warehouses in support of their e-commerce operations. Many companies offer customers the ability to buy merchandise online and then pick it up in a nearby store, with the physical store also accepting online returns. This partly addresses the issue of convenience, but it also helps boost in-store foot traffic. In a similar fashion, many retailers have invested in their logistics systems to allow for shipping from a local store rather than from a centralized (and distant) distribution center. For stores with large regional or national footprints, this arrangement may permit for same-day or two-day shipping, removing a key competitive advantage from the behemoth that is Amazon.com.

Second, it’s often said that “retail is in the details,” suggesting that the concepts which make shopping an enjoyable experience should thrive. Of course, those stores also need compelling merchandise at the right price point. Retailers are experimenting with merchandise that is either exclusive to their stores or to their e-commerce platforms, effectively precluding competition on specific items. Some are able to balance their inventory of traffic-driving necessities with larger-ticket discretionary items, enticing the customer who comes in intending to spend $20 to walk out with $200 in merchandise. Retailers are also developing “stores within the store,” wherein vendors pay to establish these areas and often staff them with their own (non-store) employees. Best Buy found success with this model, bringing in major suppliers like Samsung and Microsoft to carve out their own presence within the larger Best Buy sales floor.

For our part, we believe there is a place for retail holdings in our clients’ portfolios. But here, in particular, it’s wise to be selective, as all retailers are not created nor managed equally. Amazon.com has eviscerated certain segments (like bookstores), but there are concepts, like Home Depot or Costco, where Amazon has had only limited competitive effect. Home Depot benefits from the immediacy of a customer’s maintenance needs and its ability to carry items which cannot be easily shipped, like seasonal plants or lumber. Meanwhile, Costco plays to its customers’ enjoyment of a “treasure hunt” shopping experience, wherein new products are constantly rotated through its stores to entice return visits. Costco’s membership format also sets it apart from other retailers in that most of its profitability derives from its membership fees, allowing it to give up some profit on the merchandise in order to keep prices low – and thus customers happy.

Home Depot and Costco have also made significant strides in their own e-commerce offerings, bolstering what retailers refer to as their “omnichannel” efforts. These retailers have adopted a more balanced approach between selling through a physical store and also through their own online or mobile platforms. Williams-Sonoma is one retailer which certainly “gets” omnichannel; with its legacy in catalogue sales, it has been one step ahead in the shift toward e-commerce. Williams-Sonoma now generates more of its total sales from online and mobile transactions than from in-store purchases.

Of course, our selectivity in retailers also contemplates the valuations that are attached to the companies’ stocks. While retailers like Kohl’s or Target have certainly faced challenges in the evolving retail landscape, we feel the market has unnecessarily priced those stocks for a future which is far more dire than what is likely to unfold. As long as the management teams of these and other retailers acknowledge what needs to be done (and then execute on those strategies), we believe the share prices will ultimately revert to a level which is much more reflective of the companies’ true operating fundamentals.

*It was Joni Mitchell, in her 1970 song Big Yellow Taxi, who sang, “They paved paradise and put up a parking lot.”