Adapt or Die

“Tina Turner doesn’t need another hero, but Bonnie Tyler is holding out for one. Tina, give one of your surplus heroes to Bonnie. Job done.”

– @limberstar (Dean w) Tweet from 26/04/18

Schumpeter’s thesis on creative destruction is playing out in real time in the retail sector at present, but with more emphasis on the latter than the former. This trend appears to be accelerating as more and more firms are being “Amazoned”, leading to a major change in the way consumers buy “stuff”. UK retail sales in January rose just 0.1%, with food sales down 0.9% year-on-year, after an equally poor December, as record debt, declining real terms income gains, the prospect of higher interest rates and the poor weather seemed to drive customers online. In the last month alone, Carpetright (which has had two profit warnings in the last year) has announced it was seeking an exit from, or a sharp reduction in, its existing store leases via a Company Voluntary Arrangement (CVA), following New Look’s similar decision, which will inevitably involve large numbers of store closures. Moss Bros and B&Q have warned on profits, whilst Mothercare is still trying to raise the extra funding needed to stay afloat. Debenhams have announced store closures in the past month, (along with Marks and Spencer) and House of Fraser have this week decided to follow suit. Sales (and bonuses) at John Lewis and Ocado have also fallen sharply in recent months (though that may well be weather-related to an extent). It isn’t confined to the UK either, as Subway has announced the largest number of store closures in its history, Sears looks like it is heading towards bankruptcy and Toys R US is in the process of being liquidated. Petsmart bonds (issued as a consequence of its recent Private Equity buy-out) are now in free fall, as the market fears it too is heading for the bankruptcy courts. It appears that commercial rental prices are down sharply in Manhattan, partly as a result of the steep drop in retail sales. It isn’t ALL doom and gloom, however- Amazon has just announced a price rise for Amazon Prime subscriptions (by 20%), in what is, in the current environment, either a shrewd ploy or peak hubris.

Back in the UK, the seemingly relentless closure of bank branches seems to be on-going; pretty soon, the High Streets of the UK will be empty.

There appears to be a structural shift in consumer preferences- the use of food delivery services, more travel and technology has siphoned cash from the big superstores and high street retailers, leaving the potential for the large out-of-town superstores to become redundant. But we all know this is happening (and thus so does the market). So the question is really about what comes next.

Last weekend, out of the blue, Sainsburys and Asda announced plans for a merger. Precise terms have not been agreed (and it would have to clear the usual regulatory hurdles), but it underscores the deep-seated problems facing the High Street [1]. Predictably, the stock market rejoiced, with Sainsbury’s shares up nearly 20%, though they have fallen a little since then.

The above chart shows the extent of the market’s response to the threat. Substantial underperformance has occurred in the retail space (and the banks), which preceded Brexit, Trump, North Korea, Syria and all manner of other explanations for recent travails. Ironically, one of the best performers has been “Equity Investment Instruments”(which is the fancy name for Fund Managers), who might actually be next in line for the chop…

The idea that “that is it” for retail is rather fanciful, but that does not mean it won’t have to change; much of the spare “capacity” (in the form of stores, shopping centres retail parks etc). will have to go. It may be that retail management lacks the will (or the sense of urgency) to deal with it. But if they don’t do it, the market will do it for them. On the other hand, the idea that Amazon will be the only winner out is also dubious; at one point in the 1980s, everyone was worrying that the Japanese were coming to take over America (as this article reminisces over), but this never happened. In the UK, it was widely expected (in 2013) that Tesco would continue to dominate the supermarket business, but the rise of Aldi, Lidl, etc. and an accounting scandal at the firm have put that idea to rest. Similarly, everyone now believes that Amazon will end up selling everything to everyone. But recently, they shelved (i.e. walked away from) plans to sell Pharmaceuticals and there are signs that politics is now an issue. Donald Trump has publicly attacked Amazon for failing to pay its share of taxes and costing retail jobs across America; a few anti-Trump articles at the Bezos-owned Washington Post has ratcheted up the tension between them, too. Sometimes, it is politics that intercedes to prevent economic success from being realised.

But even if Amazon can survive 4 years of Donald Trump, there is no certainty that there isn’t an even bigger meteorite waiting in the wings- complexity (or more precisely the inability of firms to cope with it).

Freidrich Hayek, in his book “The Use of Knowledge in Society” explained that the efficient use of resources was limited, especially in large organisations by the lack of knowledge by those at the top. Rather, this knowledge is widely dispersed throughout society (or by extension, the company itself). As a firm (or state apparatus) gets bigger, (and thus more bureaucratic in structure), that information is diffused ever more widely, with the result that managers do not have enough information to allocate productive capacity efficiently. (I remember from working at Amazon that decision-making authority was concentrated in very few hands and they were never near the “coalface”). Socialism failed because it could not or would not respond to pricing signals etc. leading to both shortages AND overproduction in the old USSR. Jeff Bezos may well be the exception that proves this rule, [2], but how he is alone privy to the wants, desires, and preferences of millions of consumers on a permanent basis? The big advantage of decentralisation of decision-making authority is that it allows a quick response to change, (which is more or less permanent), most vividly seen via the price mechanism. But as this data shows, profit margins don’t appear to feature in the firm’s thinking; net margins are still half what they were in December 2005, at 3.2%

So if prices are not a strong enough input into decision making, and revenues are all that matter, the oods increase on a stumble of some sort, even if consumers don’t change their minds once again on the benefits of using Amazon (and their ilk). There is no certainty that what has worked will do so in the future.

And this is why we diversify…

[1] This merger is by no means a done deal. Data out this week suggests there is large “overlap” between the two firms’ client bases; together they will account for over 31% of the grocery market, above Tesco’s share of c.28%. But this means that two firms will control nearly 60% of the market. Even ignoring the potential job losses, will the Competition Authorities allow that sort of dominance? The two companies have promised that no stores will close as a result of the merger, but we have heard that before (many times, in fact). If they don’t close stores what would be the point of the merger anyway?

[2] Bezos is THE face of Amazon – if there are any other major players in the company, they keep a low profile. It seems unlikely that any will wish to endanger their careers by questioning his judgment. Is this “group-think” part of the underlying issue at Tesla at present?