Big box retailers have recently been feeling the heat over earlier store expansion efforts. Hardware store Lowe’s (LOW) and electronics retailer Best Buy (BBY) have been singled out as examples of an ill-advised push to open new stores far away from major metropolises. The pair basically followed the trend of families moving further away from city centers or into newly developing communities. That trend, of course, hit a wall recently as the recession took its toll on the economy.
The problem that these two companies are facing boils down to weak sales at some of their stores. The metric that provides the best clue of how well a company is doing on this front is same store sales. It is a regularly reported figure that details the sales at stores that have been open for more than one year. Essentially, it strips out the sales additions from new locations that aren’t mature enough to give a proper indication of performance. There are times, however, when looking even deeper makes sense, such as on a regional level, but most companies don’t provide such detail.
A host of other big box retailers, like Dow-30 component Home Depot (HD – Free Home Depot Stock Report) and now-defunct Circuit City, also faced or are continuing to face the same problems to varying degrees. There are also other factors leading to poor performance, such as the growth of Internet retailing. Clearly some companies deal better with adversity than others. However, it is important to keep in mind that expansion is an issue for all consumer-focused retail operations.
Over expansion has historically been the bane of the fast-food industry. While many companies grow to survive, all, at some point, appear to test the boundaries of their concept. Krispy Kreme (KKD) and now privately held Boston Market were two notable flameouts that faced near-death experiences because of aggressive expansion. However, Duane Reade, which is now owned by Walgreen (WAG), is an example outside of the food industry. Even companies that everyone seems to love can have problems with expansion, including coffee purveyor Starbucks (SBUX). Niche clothing retailers also frequently join in on the act, as well.
The problem is that in order for a retail focused entity to grow, it must do one of two things: Increase profits derived from existing stores or open new stores. Increasing revenues at existing stores can come from raising prices or increasing sales volume (same store sales growth) or cutting costs, which can have longer term negative impacts if the cuts turn customers off. Opening new stores, meanwhile, is often a lengthy process that includes finding a location, outfitting the location (either building it from the ground up or renovating an existing space), staffing up, and attempting to draw customers to the newly opened establishment. There are a lot of moving parts and any number of mistakes can happen along the way to a new retail store or restaurant successfully opening its doors.
However, new store openings are an important aspect of growth and many companies keep investors updated on the number of stores they believe a concept can support. For example, when Darden Restaurants (DRI) reported that it was purchasing Yard House, a privately held restaurant concept, it made explicit mention of the fact that management believed that The United States could support 150 to 200 restaurants; it has just 39 locations at the time it agreed to purchase the company. Being able to take a profitable business from 39 restaurants to 200 could provide years of business growth and highlights why it is such an important issue.
The problem is that expansion can overshadow same store sales. Indeed, aggressive expansion can lead to impressive top-line numbers as new outlets start to contribute to revenues, even if the performance of existing stores is middling or worse. This is why investors need to keep track of both the top line and the performance of existing stores.
Another item to consider is saturation, or how many stores can exist in a certain area. In Manhattan, it isn’t uncommon to see four Starbucks coffee shops in close proximity to each other (sometimes there will be two on the same block). However, that wouldn’t be plausible in a rural setting. In fact, a single location in one area may be enough to satisfy the demand of several small towns. Indeed, as you open more stores in close proximity to each other, the new locations usually siphon off customers from existing outlets.
There is no right or wrong answer when it comes to expansion efforts. There are some obvious issues to monitor, but sometimes only time can tell what is working and what isn’t. Right now, Lowe’s and Best Buy are suffering because of expansion plans that didn’t work out as expected. They aren’t the first companies to do so and they won’t be the last. In fact, expansion issues are far more common than most people believe. As an investor, it is important to keep an eye on the top line and same store sales to monitor a consumer-oriented retailer’s success.
At the time of this article’s writing, the author had a position in Darden Restaurants.