Wednesday, June 11, 2008

Shrinking Retail Floorplans

Gap announced this week that it plans to reduce the size of many of its stores, and suspend the opening of new U.S. locations. In particular, many of its 12,000 square foot stores will shrink to somewhere between 6,000 and 10,000 square feet. Now, Gap has struggled mightily this decade; thus, it's not surprising that they are undergoing such changes. However, one could argue that we could be seeing the start of a trend in retail.

Over the past two decades, retail formats have gotten larger and larger, with superstores cropping up everywhere. It's not just the mass merchandisers such as Target and Wal-Mart, but a whole array of other specialty retailers as well. These giant stores perhaps made sense in an era of $25 oil, but executives will have to rethink the notion of optimal store size given oil prices in excess of $130 per barrel.

Heating costs represent a largely fixed cost. As they rise, the breakeven point for a retail store suddenly rises as well; in short, you need far more revenues to cover your fixed costs today. Given near term pressures on sales, companies need to rethink their cost structure. Reducing variable costs such as labor may be one option, but retailers do not want to cut too deep in that area, for fear of harming customer service. They may find that shrinking the size of the store helps bring down the breakeven sales figure, while also helping to improve inventory turns. Slower moving items can simply be sold on-line today, something that wasn't possible two decades ago. Overall, retailers may lose some revenue from shrinking their floorplans, but they could more than make up for it in higher asset efficiency (more sales per square foot, greater inventory turns, etc.).