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It’s the Technology, Stupid

Michael O’Hara is CEO Consensus Advisors

A goal of The Big Story is to relate a major news event from the prior week to the retailing and consumer products universe. For the past two years, the gravity of the global financial crisis has presented countless opportunities to explore the impact of macroeconomic trauma on the businesses with whom we work and upon which we focus. For example, last Thursday, the court overseeing the Lehman Bros. bankruptcy released the 2,200 page report of the court appointed examiner detailing the causes of the giant investment bank’s collapse. Frankly, this subject is getting boring.

While we have obsessed on the drama of the financial crisis, another force has been cutting a swath through the retailing and consumer products landscape: paradigm altering technology. Last week’s technology news focused on the introduction of 3-D television, with the epicenter of the story being at Best Buy’s Union Square store in New York City, where Panasonic’s HD 3D1 home entertainment system was unveiled to the public. This event was one in a long line of recent communication and entertainment breakthroughs that has included the iPod, iPhone and iPad, satellite radio, flat screen and high-definition televisions, the Kindle, video on-demand, Skype, social networking, private sale retailing, affordable global positioning satellite systems and wireless everything (including wireless power through products like PowerMat). These innovations and extensions have impacted both what is selling at retail and how things are sold in revolutionary ways.

And while the receding tide of economic turmoil lowers all boats, the technology tsunami of recent years has been more discriminate: it has made great winners of some and big losers of others.

For example, Amazon’s net sales in 1996 were only $15.7 million. By 1998, its sales had grown to nearly $610.0 million. For the year ended December 31, 2009, Amazon’s sales were in excess of $24.5 billion. Their success mirrors the growth of the Internet and, in particular, the expansion of broadband. During this same time, while Borders Group’s superstore sales have increased meaningfully, their average sales per superstore have dropped from $6.24 million in 1997 to $5.1 million per store last year. Borders still offers an excellent experience to the customer, but there is no doubt that it is swimming against a strong current that threatens its viability. (We think their strategy needs to further emphasize the benefits of the in-store experience, such as showing independent films and documentaries and expanding their coffee and food offerings.)

Apple’s iTunes Music Store opened on April 28, 2003. For the year ended September 26, 2009, Apple reported that sales for the iTunes division exceeded $4.0 billion. In contrast, consider the fortunes of Trans World Entertainment. The owner of F.Y.E. and Coconuts music and video stores had sales of $1.33 billion for the year ended January 31, 2004, or roughly $1.5 million per store. Five years later, TWE’s sales dropped to $814.0 million, and sales per store dropped to $1.2 million. TWE surely did not anticipate the success of iTunes when it invested in its store real estate.

Video rental stores, perhaps more than other retailers, have been forced to fight the war on many new fronts. Coinstar Inc., for example, now operates more than 22,400 Redbox and DVDXpress self-service DVD rental kiosks at grocery stores, mass retailers, drug stores, restaurants and convenience stores. Sales doubled from $388.5 million in 2008 to $773.5 million in 2009. Cable company on-demand has also exploded in the latter half of this decade. Comcast, for example, reports that it has had over 11.0 billion views for its on-demand video services since it launched the feature six years ago. That number, 11.0 billion, is approximately the same number as the videos watched on YouTube in April 2009. Add to this NetFlix, the mail-order DVD service, which tripled the size of its business from $506.2 million in sales in 2004 to $1.7 billion in 2009. Last year, NetFlix expanded its business innovatively by offering product free to subscribers online and through certain gaming systems, reducing its reliance on the postal system and speeding its delivery times. Against these new forces, video rental stalwart Blockbuster’s sales dropped from $6.1 billion in 2004 to $4.1 billion in 2009, giving up nearly one-third of its business in five years.

There seem to be two common threads to these stories. Industry leaders in these sectors were focused on execution at the expense of strategy, and they ceded technological advantage to newcomers who they could have bested if they were properly attentive. Additionally, investment in physical stores can one one-hand build the brand in the consumer’s mind, but also add expense that e-commerce companies don’t have. Even a marginal free-riding Internet-based business can take enough sales from a brick-and-mortar store to make it unprofitable. Value-added e-commerce competitors such as Amazon, Apple and NetFlix can make this investment in real estate suffocating. For many retailers in 2009, technology was the big story, not the economy. In 2010, CEOs and boards focused on cutting inventories and costs would be wise to keep one eye on developing technologies in their markets.